What Exactly is an Acceptable Accounting System? Presented by CohnReznick s Government Contracting Industry Practice Kristen Soles, Partner and Kiran Pinto, Senior Manager
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AGENDA Review DFARS Business System Rule What Agency is Responsible for Audits Criteria for an acceptable accounting system Material Weakness and Significant Deficiency definitions 2
DFARS BUSINESS SYSTEMS RULE The Business Systems Rule was established in response to the National Defense Authorization Act (NDAA), section 893, which set forth statutory requirements for the improvement of contractor business systems The goal was to ensure timely and reliable information for the management of DoD programs Published 18 May 2011 and effective that day To be incorporated into the Defense FAR Supplement (the DFARS) at 252.242-7005 3
DFARS BUSINESS SYSTEMS RULE DFARS 252.242-7005 Contractor Business System Clause Establishes a mechanism that allows the contracting officer to withhold a percentage of payments when the contractor s business system contains significant deficiencies The clause is only included in contracts and solicitations that are subject to the Cost Accounting Standards (CAS) and contain one or more of the business systems clauses 4
BUSINESS SYSTEMS & CLAUSES DFARS 252.215-7002 Estimating DFARS 252.234-7002 EVMS DFARS 252.242-7004 MMAS DFARS 252.242-7006 Accounting System DFARS 252.244-7001 Purchasing DFARS 252.245-7003 Property Management 5
WHO IS RESPONSIBLE? 6
THE NEW ACCOUNTING SYSTEM AUDIT 7
DCAA.MIL 8
BUSINESS SYSTEMS RULE Defines accounting systems as: The contractor s system or systems for accounting methods, procedures, and controls established to gather, record, classify, analyze, summarize, interpret, and present accurate and timely financial data for reporting in compliance with applicable laws, regulations, and management decisions, and may include subsystems for specific areas such as indirect and other direct costs, compensation, billing, labor, and general information technology. 9
DOES THIS AFFECT YOU? Does the DFARS Business Systems clause affect you if you are not CAScovered? 10
THE REAL DANGER How FAR does the Business Systems Rule Reach (get it?) 16.104(h) Adequacy of the contractor s accounting system Before awarding other than a firm fixed price contract, the CO shall ensure that the contractor s accounting system will permit timely development of all necessary cost data 11
DCAA RESPONSE Activity Code 11070 Accounting System Audit Work program Revised April 2012 to incorporate testing of the 18 criteria defined in DFARS 252.242-7006 This program can be used at Major and non-major contractors and Contractors that do not have DoD contracts And who are not contractually required to comply with the DFARS criteria Nevertheless, the DFARS criteria are standards used in determining the acceptability of any Government contractor s system for the accumulation and billing of cost under Government contracts. 12
OTHER REVISIONS Activity Code 11010 Billing Audit Work program, Revised June 2012 to incorporate testing of the 18 criteria defined in DFARS 252.242-7006. Activity Code 17741 Post Award Accounting System Audit and Non major Contractors, Revised June 2012. Activity Code 17740 Pre-Award Survey of Prospective Contractor Accounting System, Revised August 2012. 13
PRE-AWARD SURVEY OF PROSPECTIVE ACCOUNTING SYSTEM Common misconception: I passed my Pre-award Survey (SF1408); therefore, I have an adequate accounting system. A pre-award audit involves the evaluation of the design effectiveness, not the operating effectiveness of the accounting system. It involves NO detailed testing of transactions or re-performance of controls and, therefore, CANNOT be relied upon to determine adequacy. There is no opinion issued. It is also only applicable to the prospective contract award and that award only; it cannot be applied to other contracts. 14
CHANGE IN FORMAT OF AUDIT Entrance Conference and System Demonstrations List of requested items Contractor presents an overview of the Accounting system Processes (policies and procedures) Within 2 weeks of entrance conference, the contractor must present detailed demonstrations of key processes these presentations must detail how each of the 18 criteria are being complied with Audit Fieldwork Draft audit report Exit conference Incorporate the contractors reaction and auditor response Finalize the report 15
Accounting System Criteria
IS YOUR SYSTEM ADEQUATE? Don t think that just because your system has been operational for X number of years that it is adequate It s a whole new ball game You should use the 18 system criteria as a checklist to review your system and policies and procedures You should be confident it is compliant before the auditor shows up 17
POLICIES AND PROCEDURES You should have written policies and procedures for each one of the 18 system criteria This will be the first thing that DCAA requests Document(s) do not have to be long; they just need to describe, in adequate detail, how your system operates and who does what Refer to the ICQ form for additional policies you should have in place 18
POLICIES AND PROCEDURES Make sure your policy documents are up to date A revision date of five years ago isn t exactly current Policies should agree to what is actually happening and agree to your FS Distribute them and train your employees Good business sense 19
THE 18 CRITERIA A sound internal control environment, accounting framework, and organizational structure: Policies & Procedures/Code of Ethics/Tone at the Top/Organizational Structure and Assignment of Authority/Governance Proper segregation of direct costs from indirect cost; Chart of accounts Direct cost can t be charge indirect and vice versa Approval by a knowledgeable person 20
THE 18 CRITERIA Identification and accumulation of direct costs by contract: Project-based system Job cost ledger ability to accumulate by contract A logical and consistent method for the accumulation and allocation of indirect costs to intermediate and final cost objectives. Indirect rate structure should provide for a fair and equitable allocation of cost. Reasonable cost/benefit relationship is established Written description of pools and bases 21
THE 18 CRITERIA Accumulation of costs under general ledger control: Frequency of subsidiary ledger posting to GL AR, AP, Labor Reconciliation of subsidiary ledgers and cost objectives to general ledger: AP, AR, Project Ledger, Rates How often? Monthly, quarterly? How are variances corrected? Monitored? 22
THE 18 CRITERIA Approval and documentation of adjusting entries: Segregation of duties - Entry, approval, posting Supporting documentation on entry Management review or internal audits of the system to ensure compliance with the Contractor s established policies, procedures, and accounting practices: Polices and procedures for monitoring Who will monitor? Audit committee, Senior management How will you document this review? 23
THE 18 CRITERIA A timekeeping system that identifies employee s labor by intermediate or final cost objectives: Paper or automated system Employee recording hours worked and to what cost objective Frequency of time entry, self-certification, supervisory approval A labor distribution system that charges direct and indirect labor to the appropriate cost objectives: Labor is posted to the general ledger (account / project on TS) Reconciliation exists between labor and payroll 24
THE 18 CRITERIA Interim (at least monthly) determination of costs charged to a contract through routine posting of books of account: Closing the books on a monthly basis Project reporting on a monthly basis, billings, financial reporting Exclusion from costs charged to Government contracts of amounts which are not allowable in terms of FAR part 31 and other contract provisions. Separately identified in the chart of accounts Ongoing training for employees on unallowable cost, most importantly A/P folks Burden of proof is on the contractor adequate backup documentation 25
THE 18 CRITERIA Identification of costs by contract line item and by units if required by the contract: Understanding of contract reporting Can the system expand to the level of detail required? Proper set up of project for billing and reporting Segregation of preproduction costs from production costs: Unique project/accounts for segregation Process for communicating actual vs. estimated costs to the pricing group for use in follow on pricing or re-pricing 26
THE 18 CRITERIA Cost accounting information as required for: Limitation of Cost (52.232-20), Limitation of Funds (52.232-22) and Allowable Cost and Payments (52.216-7), You must be able to calculate rates /provide cost incurred/billed information to be in compliance with these clauses Who monitors? Process for communication between contracts and accounting Readily recalculate indirect rates from books of account Calculation of indirect rates based on cost incurred Monitor and review of actual against provisional 27
THE 18 CRITERIA Billings that can be reconciled to the cost accounts for both current and cumulative amounts claimed and comply with contract terms: Invoices should tie to/reconcile to project cost reports If special contract terms, your system should accommodate this Adequate, reliable data for use in pricing follow-on acquisitions: If you have complied with 1 16 your data should be accurate and reliable Use as your basis for forecasting/pricing If necessary, incorporate impact on rates for potential win(s) 28
THE 18 CRITERIA Accounting practices in accordance with standards promulgated by the CAS Board and GAAP Policies and procedures CAS Disclosure Statement, if applicable Financial statements CAS 401, 402, 405 and 406 incorporated into FAR CAS 401 -> Consistency in estimating, accumulating, and reporting costs CAS 402 -> Consistency in allocating cost incurred for the same purpose CAS 405 -> Accounting for unallowable cost CAS 406 -> Cost accounting period 29
ACCEPTABLE ACCOUNTING SYSTEM Business System Rule defines an acceptable accounting system as one that complies with: Applicable laws and regulations are complied with; The system and cost data are reliable; Risk of misallocations and mischarges are minimized; and Contract allocations and charges are consistent with billing procedures 30
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NOW WHAT? You have the 18 criteria in place and your system is operational. You are ready for an audit. Turns out DCAA disagrees Can you say Significant Deficiency? Material Weakness? What does that mean? 32
DEFINITIONS The DFARS definition, ignificant Deficiency: Shortcomings in the system that materially affect the ability of officials of the DoD to rely upon information produced by the system that is needed for management purposes. Material Weakness: A deficiency, or combination of deficiencies, in internal control over compliance, such that there is a reasonable possibility that a material noncompliance with a compliance requirement will not be prevented, or detected and corrected on a timely basis. 33
GUIDELINES FOR DETERMINING MATERIALITY The nature and frequency of the noncompliance (extrapolation possible) The nature of the compliance requirements The root cause of the noncompliance Effect of compensating controls Possible future consequences Qualitative considerations (honoring public trust) History of corrections (vouchers, incurred cost submissions, proposal pricing) Noncompliance with FAR 31.2, CAS, FAR part 15 34
IS 17 OUT OF 18 GOOD ENOUGH? THAT S 94%! AN A IN FAIRFAX COUNTY DCAA guidance: A material noncompliance with any one of the 18 criteria indicates a significant deficiency/material weakness exists and the contractor has not complied in all material respects with the DFARS criteria. 35
TIMELINE FOR POTENTIAL WITHHOLD 36
QUESTIONS/COMMENTS 37
RESOURCES Kristen Soles, Partner Kristen.soles@cohnreznick.com (703) 847-4411 Kiran Pinto, Senior Manager Kiran.pinto@cohnreznick.com (703) 847-4444 www.govcon360.com GovCon360 keeps you abreast of the ever-changing regulatory environment that is Government contracting. From reference materials, like searchable pdf copies of the FAR and DCAM, to our past Lunch and Learn seminar slide decks and thought pieces on industry matters, we ve got it covered. Subscribe to our RSS feed to receive short alerts on recent industry changes. It s always been our job to help our clients maintain a competitive advantage by staying ahead of the curve. This website is an extension of the services we ve been providing for over 35 years by putting useful resources and up-to-date information at your fingertips. 38