New to Cost Reimbursement Contracts? Meet Your New Friends Breakout Session #: G07 Brent Calhoon Partner Baker Tilly Shingai Mavengere Director, Government Accounting UnitedHealthcare Military & Veterans Date: Wednesday, July 27 Time: 9:45am-11:00am
INTRODUCTIONS Brent Calhoon Brent joined Baker Tilly s Government Contract Advisory practice in 2009. He has more than 20 years of experience providing consulting, accounting, auditing, and investigative services to government contractors in connection with complex cost accounting, contract pricing, and regulatory compliance matters. He advises contractors on business processes and functions critical to managing compliance and financial risks unique to government contractors. Shingai Mavengere Shingai Mavengere is the Director of Government Accounting for UnitedHealthcare Military and Veterans. His portfolio includes a wide range of matters such as analyzing compliance with Government procurement regulations, including the Federal Acquisition Regulation (FAR), Cost Accounting Standards (CAS), agency supplements to the FAR and other federal government procurement regulations and guidance. Shingai also is responsible for financial reporting, cost accounting and other regulatory compliance. 2
Contents Introductions Overview: Government Contract Risk Factors Contract Value / Volume vs. Risk Continuum Key Compliance Requirements and Oversight Risks Organizational and Operational Considerations The Watchdogs 3
Understanding your contract risk profile Although many factors can influence the nature and extent of government contract oversight, five have the greatest impact. They are interdependent on each other, and therefore must be considered individually and in the aggregate. Contractor Size Commerciality Contract Type Contract Size Competition/Negotiation Successful contractors use these factors as a tool to understand, anticipate, manage, and mitigate government contract compliance risk. 4
Risk Factor #1: Contractor Size Contract requirements and exemptions vary for smaller and larger firms, as well as whether a firm is a prime contractor or a subcontractor. Small businesses (meeting the Small business Administration s size standards) are exempt from some of the Government s most onerous regulations. As contractors grow, they can expect more regulatory burdens and more direct government oversight 5
Risk Factor #2: Product/Service Commerciality Commercial item means any item that is customarily used by the general public or by non-governmental entities for purposes other than governmental purposes and o o Has been sold, leased, or licensed to the general public; or Has been offered for sale, lease or license to the general public Modifications are acceptable if they are customarily available in the commercial market or do not significantly alter the function, essential physical characteristics, or purpose of an item, component, or process Services are commercial items if based on established market prices for specific tasks performed or outcomes to be achieved and under standard commercial terms and conditions 6
Risk Factor #2: Product/Service Commerciality (cont d) The government s rules require it to acquire commercial products and services at reasonable prices established in the commercial marketplace, making a contractor s production costs irrelevant. Accordingly, commercial item contracts are exempt from many onerous regulations and generally insulated from many (but not all) government audit and oversight activities. Contractors selling commercial and non-commercial items on a single contract must persuasively demonstrate commercial pricing to rebuff the Government s ever-present desire to audit production costs (and deny reasonable/necessary commercial margins). 7
Risk Factor #3: Contract Type Contract type is the nucleus of government contract risk. It is the instrument by which performance and cost risks are allocated between the parties. Contractors willing to accept greater performance and cost risk are rewarded with less burdensome requirements. As the government accepts greater performance and cost risk, contractors must accept heavier regulatory compliance and oversight burdens. Contractors new to cost reimbursable contracts must enter with eyes wide open and with considerable organizational preparedness for the oversight that will ultimately follow. 8
Risk Factor #3: Contract Type (cont d) Contract Type Continuum Firm-Fixed Time & Materials/ Cost Price Labor Hour Reimbursable Labor price per unit is fixed and labor cost risk shifted to Performance risks are Performance risks are Contractor; Government allocated to Contractor allocated to Government retains risk for volume and incidental "materials" Cost Contractor High Low Risk Government Low High Technical Contractor High Low Risk Government Low High Compliance Contractor Low High Risk Oversight Government Low High Risk 9
Risk Factor #4: Contract Size Contracts below the simplified acquisition threshold ($150,000) generally carry the fewest compliance requirements. Additional regulatory burdens accumulate as contract value grows beyond $750,000. Generally, a large volume of low dollar contracts will attract less direct government oversight than a small volume of large dollar contracts. 10
Risk Factor #5: Competition & Negotiation The competitive spectrum ranges from sealed bidding to solesource negotiation. Combined with the four factors above, competitively awarded fixed price contracts for commercial items offered by small businesses below $150,000 carry the least compliance and oversight risk. The opposite carries the most risk. In the absence of commercial market information and competitive forces, the government deploys its arsenal of regulations to prescribe nearly every contractor business activity. 11
Cost-Type Contract Profile Cost reimbursable, CAS-covered contracts carry the most challenging compliance requirements o o o These contracts allocate all cost and performance risk to the Government In return for accepting this risk on behalf the contractor, the Government allocates a wide variety of compliance requirements to the contractor. This is because the Government does not trust commercial companies to perform these contracts efficiently or effectively without specific contractual requirements for nearly every accounting and business process Unlike the commercial market, the Government has significant audit rights and a robust oversight and enforcement regime To be successful, Management teams must have a general appreciation of the requirements and what it takes to comply Failing to invest in compliance creates significant risks today that will go unquantified until many years later 12
Contract Value/Volume vs. Risk Continuum Active Government Oversight & False Claims Act Allegations Cost Accounting Standards (CAS) CAS Administration Contractor Business System Clause Cost Accounting (FAR Part 31) Timekeeping and Labor Accounting Annual Cost Reporting Business System Criteria 13
KEY COMPLIANCE REQUIREMENTS AND OVERSIGHT RISKS 14
Key Compliance requirements and Oversight Risks Cost Accounting (FAR Part 31 Cost Principles) Cost Allowability o Specific types of cost that the Government will or won t reimburse o Complex rules on pricing of inter-organizational transfers o Compliance requires awareness, discipline, and consistency throughout organization o Noncompliance may carry penalties and interest o Also governed by applicable agency FAR supplements and unique contract terms Cost Allocability o Requires logical and equitable methods o Must consistently charge costs direct vs. indirect 15
Key Compliance requirements and Oversight Risks (cont d) Timekeeping and Labor Accounting Labor is generally the single largest cost charged to contracts Increased management oversight is necessary to drive employee timekeeping discipline Inconsistent labor charging across customers and contract types (including frequent uncorrected mistakes) can become basis for false claim allegation Unrecorded uncompensated overtime increases risk of inequitable labor cost allocations and accounting system significant deficiency Labor accounting impacts the integrity of both the accounting and cost estimating systems 16
Key Compliance Requirements and Oversight Risks (cont d) Annual Cost Reporting (FAR 52.216-7, Allowable Cost and Payment Clause) Provisional/Forward Pricing Indirect Cost Rate Proposals o Used for interim billing/pricing of indirect costs when actual o o costs not yet known Subject to true-up after each cost accounting period (usually fiscal year end) for cost type contracts Established by Contracting Officer or Auditor after evaluation of indirect rate proposal Final Indirect Cost Rate Proposal (a.k.a. Incurred Cost Proposal) o o o Establishes final indirect cost rates; submission due no later than six months after year end Considered a claim and must exclude unallowable costs Subject to stringent adequacy review and audit 17
Key Compliance Requirements and Oversight Risks (cont d) Business System Criteria (DoD Contracts Only, but DOE rules coming soon) Accounting 18 criteria (internal control requirements) covering indirect and other direct costs; compensation; billing; labor accounting; and general information technology Cost Estimating 17 criteria covering budgeting, planning, cost estimating methods & techniques, bases of estimates, disclosure of factual information (i.e., cost or pricing data), etc. Purchasing 24 criteria covering nearly every aspect of purchasing, subcontracting, and intercompany work orders Government Property, Earned Value Management System (EVMS), and Material Management Accounting System (MMAS) are less common among service contractors 18
Key Compliance Requirements and Oversight Risks (cont d) Cost Accounting Standards (48 CFR 9904) Specific requirements for measuring, assigning, and allocating costs to contracts Modified Coverage Four standards apply (401, 402, 405, 406) and a CASB Disclosure Statement may be required. o Applies when a negotiated contract initial award value exceeds $7.5 million and does not meet the requirements for full CAS coverage Full Coverage All 19 standards apply and a CASB Disclosure Statement is required. Full coverage applies when: o Single contract award $50 million; or o Multiple CAS-covered contract awards in prior fiscal year $50 million in aggregate Standards generally require: o Cost accounting consistency o Cost allocations using proscribed principles o Prescribed rules to accounting for specific cost types CAS Administration (much more complex than complying with 19 standards) o CAS applicability (when it applies, and to what extent) o Disclosure Statements (must be current, accurate, and complete) o Notifying, Measuring, and Negotiating Cost Accounting Practice Changes o Resolving CAS non-compliances o Subcontractor CAS administration 19
Key Compliance Requirements and Oversight Risks (cont d) DFARS Contractor Business System Clause (DFARS 252.242-7005) Applies to CAS-covered DoD contracts when any of the individual system criteria apply (See Business System Criteria Section) Significant deficiencies with any system criteria will lead to system disapproval and billing withholds of 5% to 10% System disapprovals create a significant competitive disadvantage 20
Key Compliance Requirements and Oversight Risks (cont d) Active Government Oversight Defense Contract Audit Agency (or other auditors) pre/post contract award audits; incurred cost audits; billing audits, business system audits; labor audits/floor checks; Disclosure Statement audits; CAS compliance audits; etc. Defense Contract Management Agency (or other admin agencies) active contract administration, three business systems (purchasing, property, & EVMS) Inspectors General/Department of Justice (False Claims) Your own employees (lucrative whistleblower rewards) Government watchdog groups (i.e., POGO) and the mainstream media Congress increasingly politicizing the government procurement process 21
Key Compliance Requirements and Oversight Risks (cont d) False Claims Act (FCA) Establishes civil and criminal remedies for the Government if a contractor knowingly presents or causes to be presented, a false or fraudulent claim for payment or approval Allegations can arise from many directions: employees, government employees (including auditors and contracting officers), subcontractors, higher tier contractors, or private citizens Mandatory Disclosure Rule contractors are required to timely disclose to the Government credible evidence of criminal wrongdoing contractors must have robust procedures to discover disclosable events Up to treble damages, plus civil penalties of $5,500 to $11,000 per false claim May cause significant reputational damage including suspension/debarment 22
KEY ORGANIZATIONAL AND OPERATIONAL CONSIDERATIONS 23
Organizational and Operational Considerations To effectively and profitability conduct business in an environment flush with additional requirements and oversight risks, organizational and operational considerations in the following areas must be taken into account: o o o Home Office Support Functions Government business unit / operations Compliance requirements previously described will directly or indirectly affect (or be affected by) each consideration listed in this section 24
Organizational and Operational Considerations (cont d) HOME OFFICE Business strategy Financial reporting Corporate compliance/ethics Executive Management SOX compliance Financial performance metrics, measurement, management Organizational structure legal, management, accounting Conflict identification and mitigation Customer satisfaction Public and government relations Employee compensation and benefits Delegation of authority and responsibility Risk management Business development and investment planning Business development resource alignment and oversight Employee performance and development expectations 25
Organizational and Operational Considerations (cont d) Information systems and data capture Data quality (accuracy, timeliness, consistency, completeness) Routine/non-routine activities Administrative or clerical activities vs. analytical activities requiring professional judgment SUPPORT FUNCTIONS Policies, processes, and procedures (internal controls) IN THE AREAS OF: Accounting Travel IT Support & Security Pricing/Estimating Legal Training Employee Timekeeping Procurement Contracts Benefits admin, employee relations, recruiting Contract compliance, audit support 26
Organizational and Operational Considerations (cont d) GOVERNMENT BUSINESS UNIT/ OPERATIONS Tactical strategy and policy execution Markets, customers, and contracts (type and size) Opportunity evaluation Bid and proposal preparation Project and program management Resource optimization and resource management Government compliance awareness and discipline Inter-organizational Support Business partner due diligence and relationship management (such JV partners, teaming partners, and subcontractors) Employee performance management Technical disciplines and expertise Customer relationship management Risk (legal, compliance, performance) identification, communication, mitigation Budgeting and financial management Government property management 27
Government Contract Compliance Framework 28
Questions, Comments, Banter? Brent Calhoon, Partner Baker Tilly Government Contractor Advisory Services Shingai Mavengere, Director UnitedHealthcare Military & Veterans Government Accounting 29