Current Issues in Government Contract Accounting

Current Issues in Government Contract Accounting Jim Thomas, Partner David Eastwood, Senior Manager PricewaterhouseCoopers LLP Tysons Corner, VA Agenda Page 1 Revenue Recognition Update 1 2 Current Environment 19 3 Recent Regulatory Changes and Proposed Rules 21 4 Cost Accounting Standards 41 5 Recent Legal Cases 44

Section 1 Revenue Recognition Update 1 Section 1 Revenue Recognition Update Revenue Recognition background Part of US GAAP and IFRS convergence effort Single comprehensive revenue recognition model that improves consistency and comparability Applies to all entities and industries Core principle Recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. See s Dataline 2011-35, including the Aerospace & Defense Industry Supplement, and Dataline 2012-07 2

Section 1 Revenue Recognition Update Revenue recognition project timeline 2002 2008 2010 2011 2012 2015? Deliberations began Discussion paper issued First exposure draft issued First comment period Redeliberations November 14, 2011 2 nd exposure draft March 13, 2012 2 nd comment period ended April / May roundtables / outreach July to December Redeliberations First half of 2013 Final standard expected Effective date no earlier than January 1, 2015 3 Section 1 Revenue Recognition Update Revenue recognition scope Applies to all contracts with customers Contracts that are scoped out: - Financial instruments - Insurance contracts - Lease contracts - Guarantees (excluding warranties) - Certain nonmonetary exchanges Contracts with elements in multiple standards - Apply other guidance first if it has separation and measurement guidance - Otherwise, apply the principles of the new standard 4

Section 1 Revenue Recognition Update Revenue recognition proposed model Step 1: Identify the contract with the customer Step 2: Identify the separate performance obligations in the contract Step 3: Determine the transaction price Step 4: Allocate the transaction price to separate performance obligations Step 5: Recognize revenue when (or as) a performance obligation is satisfied 5 Section 1 Revenue Recognition Update Revenue recognition July 2012 redeliberations Tentative decisions were reached regarding: - Identifying separate performance obligations - Performance obligations satisfied over time - Onerous performance obligations These tentative decisions are included, as applicable, in the charts that follow 6

Section 1 Revenue Recognition Update Revenue recognition proposed model including July 2012 tentative decisions Step 1 Identify the contract with the customer Generally expected to be consistent with existing practice Contract creates enforceable rights and obligations; may be written, verbal or implied by customary business practice Combine contracts when they are entered into at or near the same time, and: - Negotiated as a package - Payment of one depends on the other - Goods/services are a single performance obligation Contract modifications - Separate contract if adds distinct goods or services and price reflects standalone selling price - Otherwise combined impact treated prospectively or cumulative catch-up depending on whether additional goods or services are distinct The above reflects decisions made by the boards to date, but the decisions are tentative and subject to change until a final standard is issued 7 Section 1 Revenue Recognition Update Revenue recognition proposed model including July 2012 tentative decisions Step 2 Identify the separate performance obligations in the contract Performance obligations are promises in a contract to transfer goods or services to the customer Distinct replaces standalone value for multiple element arrangements Separate performance obligation if the good/service is: - Capable of being distinct: Customer can benefit from the good or service either on its own or together with other readily available resources - Distinct based on the substance of the contract: Good/service is not highly dependent on or interrelated with other goods/services in the contract Indicators rather than criteria provided to assess performance obligations based on contract s substance The above reflects decisions made by the boards to date, but the decisions are tentative and subject to change until a final standard is issued 8

Section 1 Revenue Recognition Update Revenue recognition proposed model including July 2012 tentative decisions Step 3 Determine the transaction price Transaction price includes contingent consideration - Probability-weighted amount, or - Most likely outcome amount Consider - Variable consideration - Time value of money - Noncash consideration - Consideration payable to the customer Collectibility no longer a hurdle for recognition - Allowance presented in line adjacent to revenue - Subsequent changes also recorded on this line - Presentation will impact gross margin Apply time value of money when a significant financing component exists The above reflects decisions made by the boards to date, but the decisions are tentative and subject to change until a final standard is issued 9 Section 1 Revenue Recognition Update Revenue recognition proposed model including July 2012 tentative decisions Step 4 Allocate transaction price to separate performance obligations Transaction price allocated to separate performance obligations based on relative standalone selling price Price when sold separately or Estimate if no actual standalone sales Residual approach permitted in limited situations If standalone selling price is highly variable or uncertain Discounts and variable amounts can be allocated to specific performance obligations, if certain criteria are met The above reflects decisions made by the boards to date, but the decisions are tentative and subject to change until a final standard is issued 10

Section 1 Revenue Recognition Update Revenue recognition proposed model including July 2012 tentative decisions Step 5 Recognize revenue when (or as) a performance obligation is satisfied New model is based on control Recognize revenue over time if any of the following criteria are met: - Customer receives and consumes benefits of an entity s performance as the entity performs, or - Entity s performance creates/enhances an asset the customer controls as the asset is created/enhanced, or - Entity s performance does not create an asset with alternative use, the customer does not control the asset, the entity has a right to payment for the performance completed to date and the entity expects to fulfill the contract Indicators for when control transfers at a point in time The above reflects decisions made by the boards to date, but the decisions are tentative and subject to change until a final standard is issued 11 Section 1 Revenue Recognition Update Revenue recognition proposed model including July 2012 tentative decisions Step 5 Recognize revenue when (or as) a performance obligation is satisfied (continued) Introduction of reasonably assured constraint for recognition of variable amounts Circumstances when not reasonably assured : No experience with similar contracts Have experience but the experience is not predictive Exception for sales based royalty arrangements for intellectual property licenses Not reasonably assured until subsequent sales occur The above reflects decisions made by the boards to date, but the decisions are tentative and subject to change until a final standard is issued 12

Section 1 Revenue Recognition Update Revenue recognition proposed model including July 2012 tentative decisions Other Onerous losses assessment removed based on tentative July 2012 board decision - Follow existing guidance Rights of return similar to current guidance Warranties - Not sold separately - cost accrual - Sold separately or provides a service - separate performance obligation Licenses recognition based on transfer of control Capitalize certain costs to obtain and costs to fulfill Disclosure much more extensive, interim and annual Transition full retrospective The above reflects decisions made by the boards to date, but the decisions are tentative and subject to change until a final standard is issued 13 Section 1 Revenue Recognition Update Revenue recognition moving forward Future redeliberations to include: - Reasonably assured constraint on recognition of variable consideration - Collectibility - Time value of money - Contract combination and modification - Disclosures - Transition The boards plan to complete all major redeliberations by the end of 2012 Final standard expected during the first half of 2013 Effective date no earlier than January 1, 2015 14

Section 1 Revenue Recognition Update Revenue recognition Selected areas of interest for the Aerospace & Defense sector Should goods or services under a contract be bundled or accounted for separately? Many in A&D believe that the production of each individual unit under a contract is not distinct because the production process is highly interrelated and the items are highly customized to meet the customer s specifications The revised guidance allows for judgment and the indicators will help management make an assessment that reflects the terms and intent of the parties to the contract - Companies will need to weigh all of the indicators to determine whether units should be accounted for as one performance obligation or multiple separate ones. - Documentation of the considerations and assessment will be important 15 Section 1 Revenue Recognition Update Revenue recognition Selected areas of interest for the Aerospace & Defense sector How will a company determine when revenue is reasonably assured under the constraint? If the amount of consideration is variable, the amount of revenue allocated to performance obligations is limited to the reasonably assured amount - Look to predictive experience and outcome for similar contracts Is a qualitative assessment Not a quantitative probability threshold Not a collectibility assessment All forms of variable consideration are viewed through this lens 16

Section 1 Revenue Recognition Update Revenue recognition Selected areas of interest for the Aerospace & Defense sector How to recognize costs incurred when units are used as an output measure of progress? Recognition of costs as incurred when using cost an input measure is clear in the exposure draft Exposure draft requires costs to fulfill a contract to be capitalized if they relate to satisfying future performance obligations and are recoverable Many respondents raised the question of when costs should be recognized when an output measure such as units is used Exposure draft can be read to require costs of satisfying a performance obligation to be expensed as incurred Some believe the exposure draft is not clear and costs should be capitalized to result in a smooth margin similar to today 17 Section 1 Revenue Recognition Update 2nd exposure draft comment letter trends see Dataline 2012-04 Comment letters were due March 13th FASB/IASB outreach continuing roundtables April/May Aerospace & Defense comment letter topics of focus were: - Performance obligations satisfied over time - Presentation of the effects of credit risk - Onerous test - Disclosures - Time value of money - Transition - Identification of separate performance obligations - Contract costs Redeliberations began July 2012 18

Section 2 Current Environment 19 Section 2 Current Environment Emerging Issues and Trends Increased focus on contractor role in cyber security Commission on wartime contracting final report reform needed due to ineffective acquisition procedures and contractor compliance issues Greater use of fixed price incentive contracts Access to records and internal audit activities Restructuring issues Program disruptions and terminations Increased pressure on the procurement community to demonstrate regulatory enforcement and cost savings 20

Section 3 Recent Regulatory Changes and Proposed Rules 21 Section 3 Recent Regulatory Changes and Proposed Rules Multiple Award Contracts Final rule effective April 2, 2012 Revises competition requirements in FAR 16.505(b) applicable to multipleaward task- and delivery-order contracts, other than FSS contracts Requires agencies to provide fair notice of intent to make a purchase to all contract holders and allow all contract holders an opportunity to submit offers for consideration Applies to all orders exceeding the simplified acquisition threshold 22

Section 3 Recent Regulatory Changes and Proposed Rules Final DFARS Rule Addresses Competition and Price Reasonableness if Only One Bid Received Highlights of the final rule: Final rule effective June 29, 2012 implements policy at DFARS 215.371 to take the required actions to promote competition and ensure that the price is fair and reasonable if only one offer is received and exceptions do not apply If the solicitation allowed fewer than 30 days for receipt of proposals, the contracting officer shall consult with the requiring activity to determine if requirements should be revised to promote more competition and resolicit for a period of at least 30 days If there was a reasonable expectation that two or more offers competing independently would submit offers, adequate price competition is not established unless determined by an official one level above the contracting officer 34 Section 3 Recent Regulatory Changes and Proposed Rules Final DFARS Rule Addresses Competition and Price Reasonableness if Only One Bid Received Highlights of the final rule (cont.): If solicitation allowed at least 30 days for receipt of proposals, the contracting officer shall: - Determine through cost or price analysis that the offered price is fair and reasonable and that adequate price competition existed with the approval of the determination at one level above the contracting officer, or - Obtain cost or pricing data necessary to determine a fair and reasonable price and comply with the requirements for certified cost or pricing data. Implication is that certified cost or pricing data may be unexpectedly required subsequent to proposal submission 35

Section 3 Recent Regulatory Changes and Proposed Rules Independent Research & Development 2012 National Defense Authorization Act allows the government the right to use technical data if the data relates to an item or process developed with a majority of federal funds Limitations on allowability of IR&D/B&P costs for defense contractors under DFARS 231.205-18 is effective January 30, 2012 Applies to major contractors (any contractor whose covered segments allocated a total of more than $11 million in IR&D/B&P costs to covered contracts during the preceding fiscal year) IR&D projects must be reported to the Defense Technical Information Center http://www.dtic.mil/ird/dticdb/index.html Records must be updated at least annually and when the project is completed Copies of records must be made available to the Cognizant ACO and DCAA 23 Section 3 Recent Regulatory Changes and Proposed Rules Final DFARS Business Systems Rule Highlights of the final rule: Effective February 24, 2012 If defined business system(s) contains a significant deficiency a percentage of payment can be withheld on interim payments (5% for a single system, up to 10% for multiple systems) Significant deficiency defined as: A short coming in the system that materially affects the ability of DoD to rely upon information produced by the system that is needed for management purposes DFARS clause (252.242-7005) self-deletes if inapplicable Periodic monitoring accounting system requirement clarified to specify management reviews or internal audits No clarification on materiality Clarifies that subcontract costs are subject to a withhold Potential issue here as withholds are not passed down to subcontractors 24

Section 3 Recent Regulatory Changes and Proposed Rules Final DFARS Business Systems Rule Determination to withhold payments: Contractor must respond in writing within 30 days to an initial determination that there are one or more significant deficiencies in one or more of the contractors business systems The initial determination by the Government will describe the deficiency in sufficient detail to allow the Contractor to understand the deficiency. Contracting Officer (CO) will evaluate the contractors response and notify the contractor in writing of whether there are significant deficiencies CO issues final determination that will include notice to withhold payments if it is determined there is a significant deficiency System(s) at issue will become disapproved Unilateral contract modification not required to withhold payment 25 Section 3 Recent Regulatory Changes and Proposed Rules Final DFARS Business Systems Rule Determination to withhold payments: After a written final determination - the CO shall: Identify one or more covered contracts containing the clause at DFARS 252.242-7005 from which payment will be withheld - The total percentage of payments withheld shall not exceed: -Five percent for one or more significant deficiencies in any single contractor business system and ten percent for multiple contractor business systems -If a contract has existing withholds - above limits cannot be exceeded CO has sole discretion to identify the covered contracts from which to withhold payment CO not required to withhold payment from every contract containing the Contractor Business Systems clause Current stated policy - contracts over $50 million 26

Section 3 Recent Regulatory Changes and Proposed Rules Final DFARS Business Systems Rule Determination to withhold payments: If the contactor submits an acceptable corrective action plan (CAP) within 45 days of receipt of the CO s intent to withhold payments CO will reduce withholding to two percent CO must consult with auditor or functional specialist throughout process Contracting Officer may not be Administrative Contracting Officer Could be Procurement Contracting Officer FAR 42.302 Payment withholding is not subject to the interest penalty provisions of the Prompt Payment Act and Withholding is not a penalty, but a good faith estimate sufficient to mitigate the Governments risk Enabling legislation (NDAA act section 893 (c)(1)) requires appropriate officials of the Department of Defense will be available to work with the contractor to develop a corrective action plan defining specific actions to be taken to address the significant deficiencies identified in the system and a schedule for the implementation of such action Final rule does not speak specifically to this requirement 27 Section 3 Recent Regulatory Changes and Proposed Rules Final DFARS Business Systems Rule Determination to withhold payments: CO to monitor CAP progress (in consultation with auditor or functional specialist) - If contractor does not adhere to corrective action plan - withholding will be increased to original withhold amount - Requires that no significant deficiencies remain before a system is approved When contractor notifies CO that the deficiencies have been corrected - CO shall - - Request verification from auditor or functional specialist - Make determination of correction - Discontinue withholding - release prior payment withholds and approve system Within 90 days of contractor notification to CO of correction - CO will - - Determine if contractor has corrected all significant deficiencies - Determine if there is a reasonable expectation that corrective action has been taken - Determine if contractor has not corrected significant deficiencies If CO does not make a determination - withholding must be reduced by 50 percent - If CO fails to act withholding at this level could continue indefinitely Possible remedy initiate dispute under Contracts Dispute Act and/or FAR 33.204 ADR process 28

Section 3 Recent Regulatory Changes and Proposed Rules Final DFARS Business Systems Rule Key Issues Cash flow - In general and timely release of funds DCAA interpretation of significant deficiency Statutory definition of significant deficiency : A short coming in the system that materially affects the ability of DoD to rely upon information produced Generally Accepted Government Auditing Standards (GAGAS) definition Significant deficiency is a deficiency or combination of deficiencies that adversely affects the entity s ability to authorize, record, process, or report data reliably Strong potential for interpretation type issues - Materially affects - Not defined 29 Section 3 Recent Regulatory Changes and Proposed Rules Final DFARS Business Systems Rule Key Issues continued Various implications of non-approved systems For example, accounting system - - FAR 16.301-3(a) (3) A cost-reimbursement contract may be used only when The contractor's accounting system is adequate for determining costs applicable to the contract Government is targeting contractors with known system deficiencies that have not been resolved Contractors need to be alert to: Segments with open audit issues, especially audit issues reported after May 18, 2011 Materiality of cited deficiencies Systems approved more than three years ago Systems that have not been internally evaluated Major organizational, process, or technology changes 30

Section 3 Recent Regulatory Changes and Proposed Rules Final DFARS Business Systems Rule Next actions for contractors As the burden of demonstrating compliance with business system requirements falls on the contractor, managing business systems compliance in the current environment is priority As a result of the rule, contractors should: - Educate staff on new rules, implications and system requirements - Evaluate current guidance issued by DCMA and DCAA - Conduct a comprehensive analysis of current business systems status - Define documentation standards for business systems compliance - Develop methodologies for assessing materiality of deficiencies - Maintain a business system compliance monitoring process 31 Section 3 Recent Regulatory Changes and Proposed Rules Final DFARS Business Systems Rule DCAA Business Systems Audit Guidance On April 24, 2012, DCAA issued guidance on its new approach and policy for auditing contractor business systems and specific guidance on auditing accounting systems Although focused on accounting system audits, the approach and policy described are expected to apply to all 6 DFARS business systems Significant points included: - Contractor system demonstrations and walk-throughs of various processes to ensure compliance are an essential audit program element for understanding the relevant internal controls - Separate audits of the Labor Accounting System and Indirect and Other Direct Cost Systems will no longer be performed as relevant procedures have been incorporated into the Accounting System audit procedures 32

Section 3 Recent Regulatory Changes and Proposed Rules Final DFARS Business Systems Rule DCAA Business Systems Audit Guidance (cont.) Significant points included (cont.): - The new audit approach opines on the contractor s compliance with the DFARS criteria rather than the internal controls or the adequacy of the contractor s business system - A material non-compliance with any one of the stated DFARS system criteria indicates a significant deficiency/material weakness exists and the contractor has not complied in all material respects with the DFARS criteria - DCAA reports on contractor business systems will no longer recommend that the contracting officer disapprove portions of the system or pursue suspension of a percentage of payments or reimbursement of costs; the DFARS contract clause provides specific procedures for the contracting officer s disapproval of the system and withholding of payments 33 Section 3 Recent Regulatory Changes and Proposed Rules Labor Relations (December 2, 2011) As required by Executive Order 13494, Economy in Government Contracting, costs of any activities undertaken to persuade employees, of any entity, to exercise or not to exercise, or concerning the manner of exercising, the right to organize and bargain collectively through representatives of the employees' own choosing are unallowable. Examples of unallowable costs include, but are not limited to, the costs of: (1) preparing and distributing materials; (2) hiring or consulting legal counsel or consultants; (3) meetings (including paying the salaries of the attendees at meetings held for this purpose); and (4) planning or conducting activities by managers, supervisors, or union representatives during work hours. 36

Section 3 Recent Regulatory Changes and Proposed Rules Limitations of Amounts Available for Contract Services Class Deviation 2012-O0012 (July 31, 2012) Implements Deputy Secretary of Defense memorandum Guidance for Limitation on Aggregate Annual Amount Available for Contracted Services dated June 3, 2012 and section 808 of the National Defense Authorization Act for Fiscal Year (FY) 2012 Negotiation objectives for labor & overhead rates shall not exceed the rates paid to the contractor for the same or similar services in FY 2010 if the contract services have an estimated value in excess of $10 million in FY 2012 or 2013 unless approval of negotiation objectives has already been granted Prenegotiation objectives apply unless the rates are otherwise established by law Where applicable 2010 labor and overhead rates cannot reasonably be compared to the proposed labor rates, the contracting officer must develop estimated labor and overhead negotiation objectives, not to exceed rates paid to the contractor for the same or similar contract services in FY 2010 Approval of Secretary of the Military Department or Head of the DoD component required when annual cost for continuing services exceeds the amount paid for the same or similar contract services in FY2010 including amounts paid to different contractors 37 Section 3 Recent Regulatory Changes and Proposed Rules Proposed Rule- Security Protocols for Information Systems Proposed FAR Rule 52.204-XX would aid in protecting non-public government data on contractor information systems Requires the contractor to provide protective measures to information provided by or generated for the Government (other than public information) that will be resident on or transiting through contractor information systems Protective measures include updated virus protection, security software patches, etc. Security measures in the proposed rule should not be a great burden for most contractors. However, contractors may need to provide updated, comprehensive training to employees to demonstrate compliance 38

Section 3 Recent Regulatory Changes and Proposed Rules Proposed Rule- DFARS Proposal Adequacy Checklist December 2, 2011 When a solicitation requires certified cost or pricing data, contractors will be responsible for answering 47 questions including: Status of CAS issues or estimating deficiencies Reorganizations, contingencies, pre-contract costs Detailed support for estimates Truth in Negotiations Act (TINA) exemptions Source justification and price analysis of subcontractor proposals Details on inter-organizational transfers 39 Section 3 Recent Regulatory Changes and Proposed Rules DCAA Access to Internal Audit Reports August 14, 2012 memorandum requires the DCAA Contract Audit Coordinator (CAC) & Field Audit Offices at major contractor locations to establish a process and central point of contact (POC) to obtain access to internal audit records. Duties of the POC: Obtain semi-annual listing of all internal audit reports including description of impact to government contracts Provide listing to CAC or FAO audit teams DCAA may also request working papers supporting the audit reports For non-major contractors, DCAA may request internal audit reports when warranted Resistance to requests will be handled in accordance with guidelines set at DCAM 1-504 (if access is denied, costs may be questioned) 40

Section 4 Cost Accounting Standards Incurred Cost Proposals Changes to the ICE Model (June 2012) ICE Version 2.0.1c (June 2012) Includes Computational or Functional Changes Renamed Schedule Q (1 4) TO Supplement A (1 4) to reflect FAR 52.216-7 change. Renamed Schedule S to Supplement O to reflect FAR 52.216-7 change. Changed format and renamed Schedule T to Supplement B to reflect FAR 52.216-7 change. Modified Schedule J to require reporting of all subcontracts awarded under flexibly priced prime contracts by contract type. Modified Schedule K to compute the Material Overhead if a Material Overhead rate is included in the submittal. Removed Schedule P - Computation of Allowable IR&D/B&P Costs (no longer required). Removed Schedule R Reconciliation of Claim to Corporate Tax Return (no longer required). 43 Section 4 Cost Accounting Standards 41

Section 4 Cost Accounting Standards CAS Pension Harmonization Final Rule: Effective for contracts awarded on or after February 27, 2012 Generally, for large contractors, applicable on the first date of a contractor s cost accounting period starting after June 30, 2012 Pension costs are determined using the greater of the Pension Protection Act costs or the CAS pension costs Changes CAS 412 and 413 to: Include the recognition of a minimum actuarial liability and minimum normal cost which are measured on a basis consistent with the liability measurement used to determine the PPA minimum required contribution Establishes a five year transition period beginning with the first day of the contractor s cost accounting period starting after June 30, 2012 Year 1 = 0%; Year 2 = 25%; Year 3 = 50%; Year 4 = 75%; Year 5 = 100% Reduces the amortization period for gains and losses from 15 years to 10 years. 42 Section 5 Recent Legal Cases 44

Section 5 Recent Legal Cases False Claims Related to Allegations of False Estimates & Fraudulent Underbidding U.S. ex rel. Hooper v. Lockheed Martin Corp., No. 11-55278, (9th Cir. Aug. 2, 2012) In summary judgment, the 9 th Circuit held that a contractor s cost proposal for cost reimbursement contracts can be considered a false claim under the False Claims Act (FCA) if the proposal is developed using false estimates or fraudulent underbidding Subject contract was awarded to Lockheed in 1995 by the U.S. Air Force for hardware and software support. Lockheed bid $432.7M; the Air Force eventually paid over $900M Lockheed argued that estimates of cost could not be grounds for false claims because they are "a type of opinion or prediction In a 1999 case, the 4 th Circuit court held that an opinion or estimate carries with it an implied assertion, not only that the speaker knows no facts which would preclude such an opinion, but that he does, know facts which justify it US Dept. of Justice filed an amicus brief arguing that false estimates and fraudulent underbidding could create liability under the FCA 45 Section 5 Recent Legal Cases CAS 403 Cases CACI International Inc., ASBCA, No. 57559, April 25, 2012 Board denies government's motion to dismiss appeal challenging finding of noncompliance with CAS 403. CACI's contracts contain FAR 52.230-2(b)6, which explicitly provides that the failure to agree on whether a contractor has complied with an applicable CAS rule is a dispute that can be appealed under the Contract Disputes Act. General Dynamics Land Systems, Inc. ASBCA No. 57293, Sept. 21, 2011 Denied motion for partial summary judgment opposing the government's claim for refund of residual home office expenses. It was unclear what "inventories" were for CAS 403 purposes. From an accounting perspective, it was not known if unbilled receivables and inventories could be treated one way for CAS 403 purposes and another way for financial statement purposes. 46

Section 5 Recent Legal Cases Executive Compensation (J.F. Taylor, Inc., ASBCA No. 56105, January 18, 2012) ASBCA found DCAA s analysis and the underlying data to be fatally flawed. JFT successfully challenged the results of DCAA compensation audit/reviews (ECRs) and the government's disallowance of over $800,000 in executive compensation. JFT argued lack of a valid statistical method by the DCAA in its use of compensation survey data to determine compensation reasonableness : The government made no effort to respond to the statistical arguments made by the contractor, thus leaving un-rebutted the contractor's evidence that DCAA's methodology was fatally flawed statistically and therefore unreasonable. The judgment of the government's expert witness was "questionable," while the contractor's expert performed reasonable computations to overcome the flaws in the government's methodology 47 Section 5 Recent Legal Cases Executive Compensation (Metron, Inc., ASBCA Nos. 56624, 56751, 56752, June 4, 2012) The ASBCA found Metron successfully proved the reasonableness of its challenged executive compensation costs based on a single survey of high technology companies. A DCAA audit found Metron s executive compensation costs to be unreasonable after comparing the costs with several additional compensation surveys and disagreeing with Metron s classification of senior engineers as executives. The ASBCA found Metron s executive compensation was reasonable based on various factors: Metron s and the individual executives financial and nonfinancial performance; Expert witness testimony on executive compensation; Metron s use of the Radford Executive Survey data in setting compensation best reflected Metron s market for labor and business; The other surveys cited by DCAA were not sufficiently comprehensive, reliable, or relevant to Metron s business; 48

Section 5 Recent Legal Cases Executive Compensation (Metron, Inc., ASBCA Nos. 56624, 56751, 56752, June 4, 2012) The disputed senior engineers had business development responsibilities and were appropriately matched with comparable executive positions from the Radford Survey; and DCAA s analysis was flawed and unconvincing. 49