Contractor Business Systems Series: Part 7 – Material Management and Accounting System

HOST: BRENDAN HALLORAN: Welcome to Cherry Bekaert's GovCon podcast, where we discuss current government contracting trends, compliance matters, and best practices to guide federal contractors forward. I'm Brendan Halloran, a senior manager with Cherry Bekaert, and with me today are John Bula, a manager, and Chris Morris, a senior associate in Cherry Bekaert's Government Contractor Advisory Services Group.

HOST: BRENDAN HALLORAN: As part of our continuing series on contractor business systems, today we will be talking about Material Management and Accounting (MMAS) systems. Thanks for joining me today, John and Chris.

JOHN BULA: Good to be here, Brendan.

CHRIS MORRIS: Thank you. Good afternoon.

HOST: BRENDAN HALLORAN: First, we'll get into details around what a Material Management and Accounting system is, the requirements, and the criteria. We've covered business systems that more commonly apply, such as accounting, estimating, and purchasing. One nuance with MMAS is that it's primarily applicable in manufacturing or production environments where materials are utilized.

HOST: BRENDAN HALLORAN: Many contractors who are services-focused may not have MMAS applicable to them, but as we discuss today, there is a lot of interplay between systems and functional areas to make MMAS work. Material requirements and standards are part of Cost Accounting Standards, and MMAS takes it further into operational aspects of how a company runs.

HOST: BRENDAN HALLORAN: John, can you talk a little bit about when MMAS will be a requirement or something an organization needs to consider?

JOHN BULA: Material Management and Accounting System is a system for planning, controlling, and accounting for the acquisition, use, issuance, and disposition of material. As Brendan mentioned, it's primarily geared toward manufacturing and production organizations.

JOHN BULA: When we say MMAS, we mean the compliance areas, the elements, the criteria, and what constitutes an acceptable system. An acceptable MMAS reasonably forecasts material requirements, ensures the cost of purchased material is charged or allocated to a contract based on time-phased requirements, and retains consistent, equitable costing of material.

JOHN BULA: Contractors should have adequate policies, procedures, and operating instructions that describe their MMAS. We'll go through high-level and common elements of MMAS today.

JOHN BULA: An obligation for contractors is to maintain an adequate and acceptable system for cost-reimbursement or fixed-price progress payment contracts exceeding the Simplified Acquisition Threshold. This does not pertain to small businesses, educational institutions, or nonprofits.

JOHN BULA: A contractor must have $40 million in sales in the preceding fiscal year, or the government risk assessment must establish an MMAS review as needed. So either the $40 million threshold applies, or a significant risk prompts a government audit. Exemptions exist for small businesses, educational institutions, and nonprofits.

JOHN BULA: MMAS elements may include a system description within policies, procedures, and operating instructions, and these must comply with the FAR and DFARS. Compliance criteria include ensuring costs of purchased material charged or allocated to a contract are based on valid, time-phased requirements.

JOHN BULA: Certain performance objectives are expected. For example, bill of materials (BOM) accuracy should be approximately 98 percent, and master production schedule (MPS) accuracy should be approximately 95 percent. These goals help ensure requirements are valid and time-phased.

JOHN BULA: From a systems standpoint, there should be a mechanism to identify within the ERP system good reports and data to resolve system control weaknesses. Above all, there must be a good audit trail that maintains records necessary to evaluate system logic and verify through transaction testing that the system operates as required.

JOHN BULA: Operational areas include fiscal inventories, transfers, cost of material transactions, inventory allocations, and commingled inventories. Contractors should establish and maintain adequate inventory levels and record inventory accurately, targeting the inventory accuracy objectives mentioned earlier.

JOHN BULA: Inventory quantities should be reconciled to fiscal inventory counts by part number on a periodic basis. Transfers should have detailed descriptions that result in system-generated transfers of parts.

JOHN BULA: For material costing transactions, contractors should use a consistent, equitable logic for costing. Inventory allocations and reallocations and credits should be processed during the routine billing cycle. Inventories must be retained for contract requirements and allocated to those contracts.

JOHN BULA: For commingled inventories, controls should ensure that physically commingled inventories that include material for which costs are allocated to cost-reimbursement, fixed-price, and commercial contracts do not compromise MMAS compliance criteria.

HOST: BRENDAN HALLORAN: Thanks, John. That's a great overview of key areas and requirements. One key aspect of MMAS is the contracting officer assessment, typically done in conjunction with the auditor, to conduct a risk assessment as to whether a review is warranted or required.

HOST: BRENDAN HALLORAN: Large contractors may have multiple sites, but production or manufacturing activity may be concentrated at certain sites, so the government often focuses audits where material is present as part of contract work. Chris, can you describe what an MMAS review or audit looks like if a company is selected after a risk assessment?

CHRIS MORRIS: Once a decision is made to perform an MMAS audit, DCAA's goals include obtaining an understanding of the contractor's compliance with DFARS criteria and determining if the contractor is compliant with MMAS criteria listed in DFARS.

CHRIS MORRIS: DCAA will perform testing across the DFARS criteria, with the extent of testing based on the risk of each criterion. The audit team will determine whether to use statistical or judgmental sample selections to test DFARS compliance.

CHRIS MORRIS: The audit report will identify any significant deficiencies or less severe deficiencies in compliance with the DFARS criteria. Prior to testing, DCAA will conduct initial planning, notify points of contact within the contractor organization, and seek an understanding of inventory locations and production facilities.

CHRIS MORRIS: DCAA will schedule kickoff meetings, identify significant processes, and assess risk. They will review permanent files for prior MMAS audit results, recommendations, or corrective action plans. For larger companies, DCAA may perform a walkthrough with affected areas such as finance, contracts, engineering, and program management to understand what crosses over to MMAS.

CHRIS MORRIS: From the walkthrough, DCAA develops a risk assessment to guide which attributes to test and how extensively to test them. The risk assessment is based on prior audit experience, relevant aspects found during the walkthrough, other identified risk factors, and the audit team's understanding of relevant internal controls related to MMAS.

CHRIS MORRIS: Based on that risk-based evaluation and testing approach, DCAA tests defined criteria requirements. Key criteria include BOM and MPS accuracy, inventory accuracy, valid time-phased requirements, material costing, and periodic internal reviews. Loan paybacks are included under material costing criteria.

CHRIS MORRIS: Contractors should prepare by establishing an internal review process and preestablished points of contact for DCAA. Historical testing data should be tracked internally for BOM accuracy, inventory accuracy, and cycle counts. DCAA will look for logs showing periodic monitoring.

CHRIS MORRIS: Training records for internal stakeholders who touch MMAS and any external stakeholder training should be maintained. Reports submitted to management showing metrics on a trending basis are also helpful. These are examples of what DCAA will look for during an MMAS audit.

HOST: BRENDAN HALLORAN: Thanks, Chris. That's a great overview of the process and key areas. We're seeing increased activity in business system audits, and MMAS audit programs are being performed or initiated for clients who may not have seen such intensive reviews in years. Being ready is important.

HOST: BRENDAN HALLORAN: There are also immediate benefits to having approved business systems. MMAS touches many functions and facilitates operational efficiencies. Cost Accounting Standards apply to the treatment of material and direct costs, so there's crossover in ensuring compliance.

HOST: BRENDAN HALLORAN: Practical benefits include accurate material requirements, better definition of warehouse space, and improved production planning. John, what are some typical issues contractors encounter during internal monitoring or government reviews?

JOHN BULA: Common issues include inaccurate bills of materials from engineering, engineering requisition issues, purchase order revisions and inaccuracies, and shipping and receiving errors that cause inaccurate inventory levels.

JOHN BULA: Inaccurate material inventory counts and reconciliation issues are frequent. Constant inventory adjustments throughout the fiscal year and ERP data integrity problems affecting reporting are also common pitfalls.

HOST: BRENDAN HALLORAN: Those are great points. Many of those issues are common across business systems, but MMAS has unique areas to cover. We could talk for hours about MMAS and how companies should develop and implement systems that touch many functional areas.

HOST: BRENDAN HALLORAN: We at least scratched the surface today. If anyone has specific MMAS questions or needs, please reach out to Chris, John, or myself. Thanks for joining us, and please join us again for our next podcast.