DCAA attacking compensation rates. DCAA is using their own generalized survey and mis-labeling personnel into wrong categories. In addition their survey does not take into account technical expertise or clearances very well. Contractors should do their homework find a survey that fits their business and employee skill sets and bench mark their compensation. These surveys can be used to offset any DCAA attacks on compensation.

I am often asked about compensation in a private small business environment. Often DCAA raises this issue in its audit reports questioning the costs as unreasonable or unallowable. It is a focus area for DCAA for sure. The FAR itself also focuses on it suggesting it requires special treatment. It is a crucial item requiring special attention.

The allowability of compensation is governed by FAR 31.205-6. To be allowable the cost must be reasonable. It must be for services provided. It cannot be for services provided in a prior year. Labor costs paid in the current year for a prior year are unallowable. The burden of proof for reasonableness is on the contractor not the government. That is DCAA can question the cost without substantiating their position. It is the responsibility of the contractor to demonstrate that the cost is reasonable.

Reasonableness is defined as what a prudent business person would do. In other words what is reasonable in light of industry established practices. The government usually assesses reasonableness of compensation by using salary surveys. DCAA uses a selected survey and varies from agency to agency. Often the government will judge the reasonableness of compensation without any survey at all. It will make a subjective determination from their own personal vantage point. The burden is on the contractor to demonstrate reasonableness.

Another important point for privately or closely held contractors is that owner compensation cannot exceed the amount that is deductible as compensation under the Internal Revenue Code. Any excess would be unallowable.

Bonuses

An even more common DCAA questioned cost is bonuses or incentive compensation. Practically every privately owned closely held contractor maintains some form of a bonus program. These programs are usually informal and subjective. In this form, the cost is unallowable. For this reason it is a hunting ground for DCAA auditors, a gold mine for DCAA to cherry pick questioned costs.

Bonuses and incentive programs are allowable costs if certain criteria are met. These include:

1. The bonuses must be based on a written agreement, plan or policy implying an agreement.
2. The criteria should avoid subjective evaluations. The more objective the evaluation criteria the better.
3. The basis for the award is supported. This means the criteria for award must be supported and documented.

Recommendations:

1. Maintain support for owner and executive compensation. This can be industry statistical comparisons, salary surveys, etc. The challenge is to secure relevant data that resembles the personnel in question. Often these surveys are to general. Remember burden of proof for reasonableness is the responsibility of the contractor. DCAA may question the costs without this support. DCAA very well may question the cost any way if it exceeds what they consider reasonable. In any event you will have a basis to refute whatever the DCAA position is.

2. Develop agreements, plans or policies to address bonuses. This must be written. It is best to base the bonus compensation on objective criteria versus a subjective year end evaluation. Profit distribution concepts should be avoided as DCAA may conclude the bonus is a profit distribution. Profit distributions are unallowable.Please contact me if you have questions about the FAR position on compensation of bonuses.

DCAA is seeking provisional indirect cost rate proposals for 2013. Some offices have set a due date of mid January 2013. Getting provisional indirect rate agreements in place as soon as possible for 2013 is important. In many cases DCAA will not approve billings under cost reimbursable contracts without it. Provisisional indirect cost rate agreements establish the billing rates throughout the year subject to change as may be required. I normally include the following in provisional indirect rate proposals.
1. Provide 2013 budgetary data showing the proposed pool and base by cost element for each indirect rate. I normally provide a narrative explaining any significant variances from prior years and any accounting or organizational changes impacting the rates.
2. Final 2012 actual indirect cost rates showing pools and bases by cost element.
3. Financial statements if available, unaudited statements are ok.

4. A break down of sales estimated for 2013 and a comparison to 2012.
5. DCAA often prefers executive compensation, aged accounts payable and government sales data supplemental schedules as well. I normally provide this data if requested.

If you have cost reimbursable contracts I suggest you pursue this proactively to avoid any delays in government payments for 2013.

In regards to accounting systems for government contractors please note the following. Deltek GCS or Essentials is no. 1 in my opinion, provided the contractor can afford it and can handle the back office support required. At a minimum an experienced Controller is required. JAMIS is a close second. Both are excellent integrated solutions for government contractors.

A very viable alternative for small business is Procas. I tested it and like it for small business with some accounting resources. Procas is a very good intermediate step for those that cannot afford Deltek. It offers remote capabilities that are lacking in most Quick Books options. It also offers integration that is lacking in Quickbooks . Procas offers the ability to meet government contract accounting system requirements.

For very small business, Quick Books Premier or Enterprise is a common approach. To be compliant, at a minimum, a compliant timekeeping system or approach is needed on the front end. Compliant timekeeping systems include GHG, Spring Ahead, EFAACT, Replicon, Unanet, etc. QuickBooks is a decent accounting system processor. To be compliant and to pass DCAA accounting system audits, an application will need to be added on the back end. Preferable applications include ICAT, Govcon, EFAACT and GovCalc. Manual options for DCAA cost reporting are a last resort and time intensive. I don’t recommend this option as DCAA acceptance is not guaranteed. This acceptance varies from auditor to auditor.

I have reviewed or used all the systems mentioned.

No matter what system is used, adequate policies and procedures is a must. Second, employees must be properly trained on government accounting requirements to succeed. It goes without saying, that success requires proper system set up, policies and procedures and training.

If you have questions about accounting system selection for government contractors please contact me.

To emphasize the importance of documenting costs incurred please consider the following.

I was retained by a new client to help them resolve a nasty DCAA audit report of a small business. The report questioned $200,000 in costs mainly due to a lack of cost support such as receipts, invoices, consulting agreements and mileage logs. The company relied mainly on credit card statements. This simply will not answer the mail. Additionally DCAA is attempting to apply Level 1 Unallowable cost penalties equal to the $200,000. So as you might imagine this is a huge issue for the small business. I expect I will be able to at least cut that number in half and hopefully negotiate something reasonable with the ACO.

This is a classic example why it is so important to maintain adequate records and fully document the costs incurred as well as business purpose. Credit card statements simply will not fly in an audit. Must have receipts, must document consultants and legal charges with agreements and require your consultants to detail the charges on their invoices. If you are involved with automobile expense must document the business usage with mileage logs or similar documentation. Need written plans or policies for any bonuses, etc.

Yes this is very bureaucratic and an nuisance to everyone involved, but better to be safe today than sorry later.

I have noticed that DCAA is placing more emphasis on budgeting and forecasting in its audits of contractor accounting systems. This is not a direct requirement of accounting systems but is at least implied in a number of contract clauses related to pricing and invoicing and limitations of funds and similar clauses. To get DCAA buy-in need to adequately cover the budgeting, forecasting and cost reporting processes. Particular attention should be placed on monitoring actual indirect cost rates each month, comparing to provisional and updating budgets/forecasts on a timely basis. I have noticed an increased interest by DCAA on forecasting of costs on a given project. This is all driven by cost reimbursable projects. Suggest processes and policies be updated accordingly.

As I have mentioned on my website, Deltek is the leader in government contract accounting systems. However, for the most part Deltek has not been very attainable for most small businesses. As a result most small businesses have been limited to Quick Books. As I mention on this website, Quick Books can be made DCAA and FAR compliant. This involves some add-ons and other work arounds. I do this rather often for small business clients. Deltek apparently has now developed an alternative that may be reachable by some small businesses. I feel the need to let the small business community know about this capability. It is called Deltek Essentials. I have not experienced this new Deltek product so I cannot comment on how well it will work for small business. The price tag is greater than any Quick Books solution; however, it is within reach of some small businesses. My first reaction to Essentials is whether the typical small business would have the adequate resources to run it and manage it. Or is this a tail wagging the dog thing. That would be my number one question. There is no doubt it will exceed the FAR and DCAA accounting system requirements as the Deltek technology has always been a leader. Deltek has always been an excellent technology for government contract accounting systems; actually it is no. 1 in the industry. JAMIS is right there as well. It has a lot of advantages over Quick Books. Assuming government contract accounting expertise is not required to run and manage it, and additional accounting resources are not required either, then I believe it will be a good solution for small businesses. This new Deltek product is certainly worth investigating. If I get the chance to see Essentials in action I will certainly comment on its viability for small business. At this point, it sounds like an alternative worth investigating.

I hear DCAA is going to re-focus on marketing costs for allowability. I understand they are going to start increasing its scrutiny on reviewing sales and marketing expense reports for allowability. This should make one emphasize the segregation of promotional marketing from Bid and Proposal efforts and direct selling efforts. The latter two are allowable in most cases. Contractors should review its expense reporting practices to make certain unallowable costs are properly segregated.

The whole idea under a cost reimbursable contract is to submit an Incurred Cost Submission at year end and firm up the billings to actual rates. However, DCAA has fallen far behind on its audits to finalize rates at year end. In some cases as much as three years. This situation is not addressed in the Allowable Cost and Payment clause. This is unfortunate for contractors. Unfortunately situation places contractors in a delay position on collecting any amounts due as a result of final indirect cost rates. It results in an under-recovery and the inability to collect until DCAA gets around to auditing the Incurred Cost Submission. Some suggestions to minimize this situation include:

1. Get submissions into DCAA as soon as you possibly can to get the ball rolling.
2. Go on offense pressure both DCAA and the Contracting Officer to make the audit a priority.
3. Get provisional rate proposals and agreements in place as soon as possible.
4. Remain conservative on forecasting the provisional rates knowing it may take years for DCAA to finalize the final rate. Do not understate these rates. Understating these rates is in essence an interest free loan that you are offering the government. This loan may take years to unravel.

To get caught up, I hear DCAA is hiring special audit travel teams to come in and get caught up in areas where DCAA is unreasonably behind. I have found this situation to be favorable to contractors. Get your submissions in so your rates can be audited and settled.

Most important is get the Incurred Cost Submissions into DCAA. Failing to do so puts the obligation on you. This further delays finalizing these rates and unltimately getting what your entitled to for indirect costs. Remember, you can only recover costs for indirect rates if there is funding available. The sooner you get the rates submitted, the more likely you can make certain there is adequate funding. If you have a funding issue, solicit additional funds sooner versus later. It is difficult to secure these funds late in a fiscal year or late in the contract’s period of performance.

DCAA by its Memorandum dated October 18, 2010 increased the threshold for conducting audits on price proposals to $10 Million for fixed price proposals and $100 Million for cost type proposals. The only exception is under exceptional circumstances outlined in the contracting officer audit request letter.

I agree with this development as it reduces potential audits on small insignificant proposals. This may prove beneficial to small businesses. However, small businesses must still develop its proposals in a manner that is compliant with cost or pricing data requirements. The upside is there should be less audit activity on smaller proposals resulting a more streamlined approach to contract negotiations.