Chapter 7
Conquering Compliance
In This Chapter
▶ Understanding the need for compliance policies
▶ Reintroducing FAR and introducing CAS
▶ Submitting a disclosure statement
▶ Creating solid timekeeping policies
▶ Making sure compensation and benefits are allowable
▶ Understanding contract procurement policies
▶ Getting to know your government audit agencies
▶ Steering clear of noncompliance penalties
Get used to it. No matter what industry you’re in, compli- ance of some type is required. If you’re a government contractor, compliance should always be top of mind for you and your entire organization because the federal government is allowed to come in and audit your organization at any time. Even if you aren’t a government contractor, you may still be exposed to accounting regulations, both in the U.S. and abroad. This chapter explains why complying with regulations isn’t really all that bad.
Understanding Compliance
Sure, rules and regulations can be a hassle. Who really looks forward to April 15? But it’s best not to gripe; better to embrace compliance by developing and following sound compliance policies, for several key reasons.
Compliance policies show your corporate commitment to following the federal government’s rules. They demonstrate consistency in how you and your staff behave. They also lower your risk of exposure. And solid policies that your orga- nization really follows reduce noncompliance in your govern- ment procurement program, and isn’t that the whole point?
To be fully compliant, you need to create policies on time- keeping, travel, delegation of authority, accounting, estimating, billing, and labor. You should even have a “policy on policy.” No kidding. It’s an outline of what a policy should look like.
Introducing FAR and CAS
If you do work for the federal government, two sets of fed- eral government rules apply specifically to government con- tractors: FAR and CAS. FAR is short for Federal Acquisition Regulation, which is essentially the bible of government procurement. It’s the primary set of rules agencies use when purchasing goods and services. The guide to FAR can be found at most public libraries, federal agency resource centers, and online.
CAS stands for Cost Accounting Standards. Established in 1968, CAS was created to drive consistency within and between contractors’ cost accounting practices. There are three major areas these standards cover (look it up for yourself in 48 CFR
9903.302-1, if you want):
✓ Measurement of cost: This involves the methods and techniques used in defining the components of cost, determining the basis of cost measurement, and establishing criteria for the use of alternative cost- measurement techniques. Here are some examples of cost measurement:
• The use of historical cost, market value, or present value
• The use of standard or actual cost
• The designation of items of cost that must be included or excluded from tangible assets or pension cost
✓ Assignment of cost to the cost accounting period: This has to do with determining the amount of cost that will be assigned to individual cost accounting periods.
Examples are the requirements for use of accrual-basis or cash-basis accounting.
✓ Allocation of cost to the cost objectives: This refers to the method of determining direct and indirect allocation of cost. Here are some examples of allocation issues:
• The accumulation of costs
• The determination of whether to charge costs as direct or indirect
• The determination of the composition of cost pools and their allocation bases
The federal government’s auditors and the Defense Contract
Audit Agency use FAR and CAS as their rule books. The latter group, known as the DCAA, is responsible for auditing Department of Defense contracts, but it also provides audit- ing assistance to other agencies. Audits assure the govern- ment that your organization is following the rules. For more information on Earned Value Management System audits by the DCAA, please reference EVM For Dummies, Deltek Special Edition.
Want to know what they’re looking for when they audit? It’s all spelled out in FAR. Check out the following list for common items and where to find the details:
✓ Allowable costs: FAR 31.201-2
✓ Unallowable costs: FAR 31.201-6, CAS 405
✓ Direct costs: FAR 313.202
✓ Indirect costs: FAR 31.203
✓ Cost pools, pooling of indirect costs: FAR Part 31
Filing Your Disclosure Statements
A disclosure statement describes a contractor’s accounting practices and procedures. Fully CAS-covered contractors usu- ally must complete a disclosure statement prior to landing a CAS-covered contract of $50 million or more. Also, corporate offices or other intermediate home offices that allocate costs to one or more disclosing segments must complete Part VIII of the disclosure statement. File it with your contract audi- tor and your government administrative contracting officer (ACO). The ACO administers day-to-day activities after you’re awarded a contract.
Once a disclosure is submitted, the ACO will ask auditors to make sure that the disclosure actually discloses everything it’s supposed to under the CAS Board’s rules, regulations, and standards. Simply put, the process is intended to collect a full description of a government contractor’s accounting system, uncover any deficiencies, and give contractors such as you
a chance to address those deficiencies, clarify wording, or expand upon a description or accounting practice.
There are eight sections to a CAS disclosure statement:
✓ General information
✓ Direct costs
✓ Direct versus indirect costs
✓ Indirect costs
✓ Depreciation and use allowances
✓ Other costs and credits
✓ Deferred compensation and insurance
✓ Home office expenses
Watching the Clock Carefully Every government contractor must track labor every day because auditors want to be sure the government is paying for its project and nothing else. You can keep track manually or electronically, but if you’re doing it manually, do it in blue or black ink (that’s what the government wants). Track by project number or a contract name/number, and be sure that both employees and their supervisors sign off. If there’s an error, draw a line through it and initial the change.
Want to help prevent audit headaches? Fully integrate your accounting system with your timekeeping system.
If you have an electronic timekeeping system, there are numerous considerations to keep in mind:
✓ Employees should be able to enter their own time into the system, and supervisors should use the same system to review and approve staff time.
✓ Payroll and timekeeping need to be segregated.
✓ Procedures must be evident and clear-cut.
✓ Controls must be verified, and any violations must be documented and remedied.
✓ Policies and procedures must be periodically reviewed with employees and managers.
✓ The system should allow direct entry of charging infor- mation, such as the project or contract number.
✓ Time should be entered on a daily basis.
Enter all hours, whether they’re paid or not. Every employee needs to know that accurate and up-to-date time entry is a critical part of her job and that entering the wrong hours or improperly preparing timekeeping reports will be penalized. The government may do a floor-check audit at any time — that’s when auditors ensure that employees are spending their time where their timesheets say they’re supposed to be.
So be proactive and perform your own floor-check audits from time to time. Record them and make them available to audi- tors to show that you’re serious about following the rules and regulations. Better for you to uncover any issues, rather than your DCAA auditor!
The employees themselves should enter the time; supervisors may only complete an employee timesheet if the employee is absent for an extended period of time.
Examining Pay
When dealing with employee compensation, some costs are allowable and others aren’t. Allowable cost for salaries include:
✓ Compensation reported on W-2 forms
✓ Payments in accordance with a written plan, offer letter, or employee contract
✓ All reasonable remuneration paid or proffered for services rendered
✓ Commitments made before services rendered
Auditors tend to pay special attention to executive compensa- tion (don’t we all?). For executive compensation to be con- sidered allowable, it must be reasonable compared to other firms and it must be related to services performed, rather than distribution of profits. That “golden parachute” for the top brass? It’s only allowable if it’s not above normal sever- ance pay limits.
A lot of people benefit from variable compensation — you probably call it a bonus. This is considered allowable as long as a written plan is in effect before services are rendered, the plan is followed consistently, and it’s incentive-based, not based on profits. As for consultant pay for contract work, that’s fine, but not if the consultant was previously classified as an employee.
Looking at Procurement and Subcontracts
What if you need to acquire property or equipment in the course of doing government work? There are a number of principles to keep in mind.
First of all, the government maintains any lease-or-buy author- ity. If these kinds of purchases are made with government money, the title resides with the government, not your orga- nization. And lease or rental costs are allowable as long as they’re reasonable, but interest costs aren’t.
In other cases, you’ll be working with government-furnished property or equipment. Take good care of that property because you’re responsible for any loss or damage to the equipment. You’re also responsible for tracking the equip- ment and conforming to FAR Part 45 requirements.
When dealing with subcontractors, many rules exist — you’ll find them listed in FAR 19.502-2, if you’re looking for a good read tonight. You’ll need ACO approval when the subcontract is for cost reimbursement, time and material (T&M) or labor hours, and the cost is greater than $25,000 including the fee. You’ll also need approval if the subcontract is fixed price and the cost is greater than $25,000 or 5 percent of the total esti- mated cost of the prime contract. And for most subcontracts greater than $100,000, approval is also a must.
Getting to Know Your Auditor
The DCAA is just one of the potential auditors you might face. You could hear from an inspector general (or IG), whose job is examining the actions of a government agency as a gen- eral auditor. The IG ensures that the agency is operating in compliance with generally established government policies, audits the effectiveness of security procedures, and is on the lookout for misconduct, waste, fraud, theft, or certain types of criminal activity. There also are audit agencies within the U.S. Department of Urban Housing and Development (HUD), the U.S. Environmental Protection Agency (EPA), and the National Aeronautics and Space Administration (NASA).
But no matter which agency is conducting the audit, there are key topics of interest. The auditor is ensuring that all transac- tions (including those involving your firm) are proper and legal. The auditor wants to be sure transactions are recorded accu- rately and that everyone is complying with established policies.
Want to be as audit-safe as possible? Make sure that everyone in your organization has a role and employees are responsible for timesheet accuracy and consistently following established policies. And management must ensure that policies are con- sistently applied and that auditors get the help they need.
When the auditors arrive, demonstrate a spirit of cooperation and show that you have a genuine desire to assist in the audit process. If possible, assign an audit liaison to be the primary face of your organization with the audit staff.
Following the Rules
Civil and criminal penalties await your organization if you’re found to be out of compliance. Civil penalties are determined per violation per invoice. The government can recoup $5,500 to $11,000, and the contractor may pay the government up to three times the damage. Ouch!
If that’s not bad enough, criminal penalties are much more serious. We’re talking up to five years’ imprisonment for who- ever signed the Certificate of Cost and Pricing data.
It’s probably a no-brainer but still worth mentioning that you run the risk of having your payments suspended or the con- tract terminated if you’re found to be out of compliance. The latter can happen if termination is deemed to be in the best interests of the public (that’s called convenience), or if your company is found to be in default on the contract, meaning you’ve failed to deliver.
Then there’s debarment, which essentially means you’re banned from the government contracting world. Debarment can either be statutory (for willful violations of certain stat- utes) or administrative (for violations of criteria provided in agency regulations).
It is a best practice to use accounting systems that help keep you compliant by ensuring you have accurate data, process flows, and canned reports that help you respond to audits quickly and effectively.
A rundown of audit types
✓ Incurred cost: A review of accounting practices and sys- tems, ensuring that costs charged are allowable, allocable, and reasonable.
✓ Pre-award audit: A review of pro- cedures for generating a price.
✓ Defective pricing: Ensures that cost and pricing data are cur- rent, accurate, and complete.
✓ Forward pricing plan audit: A check of contract pricing rates to determine a fair and reason- able basis for negotiating a cost proposal.
✓ Compensation and benefits: An audit of the contractor’s com- pensation system and related internal controls.
✓ Contract purchase systems review (CPSR): A review to understand the contractor’s purchasing system and related internal controls.
✓ Labor charging/floor checks: A check for mischarges, fraud, and cost shifting, and a general check for accounting policy compliance.