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Doing business with the government is completely unlike a normal business relationship between companies conducting a typical commercial business transaction. Government procurement regulations control practically every aspect of the business relationship including (a) source selection; (b) how the procurement is priced; (c) how much profit can be included in the price; (d) cost accounting requirements; (e) costs that are chargeable and not chargeable to the contract; (f) audit requirements; (g) how employees must be recruited, hired, and paid; (h) subcontracting and purchasing; (i) inspection and acceptance of the contract deliverables; and (j) payment. Government procurement regulations also include a rather complex set of cost accounting standards (CAS) that govern the way costs are allocated to contracts and include burdensome regulations that must be followed before any significant changes can be made to the established cost accounting practices.

The government employs thousands of DCAA auditors scattered around the world to enforce the accounting and business system requirements in the procurement regulations. The regulations require contractors to grant auditors broad access to any and all information within the contractor’s organization that has or could have any bearing on contract costs. The mission of DCAA is to provide advisory audit reports to government contracting officers to assist it as it administers contracts on behalf of the government.

Within DoD, DCAA is officially independent from the contracting officers in order to minimize or eliminate any possibility that a procurement office would dictate audit findings to the DCAA audit office with access to the

contractor’s accounting records. However in a practical sense, the amount of real independence changes from time to time commensurate with the degree of DCAA’s responsiveness or non-responsiveness to the needs of the procurement offices in awarding and administering contracts. Although DoD has not seen fit to formally put DCAA under the organizational control of procurement offices, it has effectively done the same thing recently by severely limiting DCAA’s roles and responsibilities in the procurement process. This diminishment of DCAA’s role was a self-inflicted wound that was the result of counterproductive policies put in place within DCAA in the wake of critical GAO reports issued in 2008 and 2009. These DCAA policies greatly reduced the timeliness and usefulness of audit reports to contracting officers and inevitably led to the diminishment of DCAA’s role in the procurement process. Please refer to the section titled “Recent Developments at DCAA” in this survey report for additional information.

Relationships with the government auditor and contracting officer

Companies surveyed provided information on the quality of their business relationships with the government auditor and primary contracting officer from two perspectives. First, we inquired whether or not government positions that are adverse to the company’s business interests were well substantiated with appropriate regulatory citations. Second, we asked whether the auditors and contracting officer were open-minded and receptive to contractor rebuttals to government positions.

It is evident from the responses that the government’s manner in conducting business with contractors is deficient. Regarding auditor positions, only 57% of respondents find DCAA’s positions to be supported with appropriate regulatory citations (Figure 31) and only 67% report that DCAA is receptive to contractor rebuttals to the DCAA positions (Figure 32). The ratings for contracting officers are even worse than those given to DCAA. Only 51% of surveyed companies report that contracting officer positions are substantiated with appropriate regulatory references (Figure 33) and only 55% believe that contracting officers are receptive to rebuttal information provided by contractors (Figure 34).

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Fig 31: DCAA audit opinions Substantiated with appropriate regulatory references 57% Arbitrary and not

appropriately referenced 43%

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Fig 32: DCAA receptivity to contractor rebuttals Open-minded and receptive 67%

Inflexible and rarely receptive 33%

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Fig 33: Contracting officer positions Substantiated with appropriate regulatory references 51% Arbitrary and not

appropriately referenced 49%

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Fig 34: Contracting officer receptivity to contractor rebuttals

Open-minded and receptive 55% Inflexible and rarely receptive 45%

36 Grant Thornton's 2015 Government Contractor Survey

Government efficiency in resolving contract issues

We have observed an increasing trend in recent years which is even more disturbing than the lack of a regulatory basis for issues and a lack of receptivity to contractor rebuttals. Specifically, it has become common for contracting officers in some agencies to simply ignore an issue altogether and take no action to resolve matters that have been set forth in audit reports. This is particularly harmful to contractors when the issue involves a contractor’s entitlement to payment as a result of a routine billing, a contract change, or a termination for convenience. We have observed situations where contracting officers simply ignored the matter entirely for months and years, and in some cases, refused to pay even those amounts where DCAA and the contractor concur. It appears that some contractors may tolerate this situation in an attempt to mitigate further difficulties. We asked surveyed companies to assess the government’s efficiency in resolving contract issues. The results are shown in Figure 35, along with results from the prior four surveys, presented for comparison. Only 45% of respondents believe that the government resolves issues efficiently. Of the 55% that believe the government is inefficient, 38% put the primary blame on the auditor while 17% find that the contracting officer is primarily responsible for failing to efficiently resolve contract issues. 2015 survey 2013 survey 2012 survey Issues resolved efficiently Auditor delays Contracting officer delays 45% 18% 22% 26% 35% 50% 95%

Fig 35. Government efficiency in resolving issues 38% 56% 28% 56% 45% 50% 95% 17% 26% 50% 18% 20% 2011 survey 2010 survey

Most frequent cost issues

Surveyed companies were asked to identify which costs were most frequently challenged by DCAA during incurred cost audits. The results are shown in Figure 36 along with the results from the previous five surveys which are presented for comparative purposes.

The most frequently challenged cost is executive compensation, continuing the trend from the prior five surveys. This audit issue is most common in small to medium sized companies where the executive compensation for the highest paid executives is below the statutory ceiling in the procurement regulations. We frequently assist clients in rebutting DCAA challenges to executive compensation. It has been our long-held belief articulated in many recent annual surveys that DCAA’s standard analytical techniques for executive compensation are fundamentally flawed. There have been recent decisions by the Armed Services Board of Contract Appeals (ASBCA) which drew the same conclusion. Executive compensation is covered in more detail in a later section of this survey report.

DCAA also tends to challenge consultant and legal expenses from the perspective of the adequacy of the supporting documentation. We have noted situations where DCAA has challenged these expenses if a consultant agreement didn’t exist or was out of date or if the description in the consultant’s invoice of the work performed was not as specific as DCAA desired it to be. We have had considerable success assisting clients faced with this challenge by providing other evidentiary matter supporting the expense and by strongly rebutting DCAA’s all or nothing approach to costs when incomplete documentation is the only issue. In December 2013, DCAA issued guidance to field offices which distinguished consultants from purchased labor and instructed auditors not to apply the same documentation requirements to purchased labor that apply to consultants. That guidance memorandum has been removed from DCAA’s website.

Labor charging issues are also mentioned by some surveyed companies as an area of DCAA focus. In some cases, these issues arise when DCAA questions labor costs because the costs were incurred in an unallowable activity (e.g., lobbying, mergers and acquisitions, entertainment). We believe that DCAA’s approach to this issue is inconsistent with the plain language in the procurement regulations. Those regulations are explicitly clear

Executive compensation Consultants Incentive compensation Labor charges Indirect cost allocations 21% 23% 29% 27% 23% 18%

Fig 36. Most frequent cost issues

50% 95% 11% 7% 7% 9% 14% 15% 50% 95% 21% 17% 11% 15% 14% 6% 2015 survey 2013 survey 2012 survey 2011 survey 2010 survey 2009 survey 50% 95% 10% 11% 12% 14% 14% 16% 50% 95% 10% 12% 10% 8% 12% 13% 50% 95% 3% 9% 8% 14% 6% 5% 50% 95% 8% 5% 7% 2% 5% 6% Legal Employee morale

38 Grant Thornton's 2015 Government Contractor Survey

Costs questioned as a percentage of revenue

We asked surveyed companies to provide the amount of DCAA questioned costs as a percentage of revenue. The results are shown in Figure 37. The amount of costs questioned is very minor with the vast majority of respondents reporting costs questioned of less than 1% of revenue. It should also be noted that even this paltry amount is overstated since many of the recommended disallowances may not be sufficiently valid to be sustained during negotiations between the contractor and the contracting officer. Partially as a result of its past tendency to focus audit resources on immaterial matters, DCAA has been very far behind in conducting incurred cost audits which has delayed the close-out of contracts and which has taken audit resources away from more significant potential issues which could be affecting current contract activity. DCAA has been criticized for its failure to complete incurred cost audits in a timely manner and is now using aggressive risk assessment techniques to eliminate audit backlog without conducting any significant audit testing. that a cost associated with an unallowable activity should only

be disallowed if the cost would not have been incurred but for the unallowable activity. That is rarely the case with salaries and wages.

Most frequent CAS issues

We asked surveyed companies whether they were subject to full CAS coverage, modified coverage, or exempt from CAS. Twenty-four percent of companies reported they are subject to full CAS and have filed disclosure statements describing their cost accounting practices.

Companies subject to full CAS coverage identified the CAS standards where DCAA had raised compliance issues and the results are shown in Table 7 along with the results from the five prior surveys. It appears that the number of companies facing CAS issues is very minor and shrinking compared to prior years. It’s not clear how much of this decline is the result of fewer DCAA audits and how much is the result of a higher degree of compliance by contractors.

We have encountered situations where DCAA has raised CAS compliance issues several years after the fact while performing incurred cost audits. Assuming the finding has merit, a cost impact process will follow in which the cost impact of the issue on each CAS-covered contract will be computed and potentially refunded to the government. We have found that many contractors in this situation compute the impact on all CAS-covered contracts including those that are only technically subject to modified CAS. This becomes problematic where the compliance issue is for standards other than CAS 401, 402, 405 and 406. The CAS certification in government solicitations allows for modified coverage (e.g., CAS 401, 402, 405 and 406) in situations where the contractor did not receive a contract subject to full coverage in the period immediately preceding the period in which the proposal was submitted. We have observed that companies with a disclosure statement routinely certify the proposed contract is subject to full CAS even when they have not received a contract subject to full CAS in the immediately preceding period. This approach may create additional and unnecessary financial exposure in the event that CAS compliance issues arise in the future which require cost impact submissions.

>5% 5% 4% 3% 2% 1% <1

Fig 37: Costs questioned as a percentage of revenue <1 of revenue 72% 1% of revenue 13% 2% of revenue 7% 3% of revenue 1% 4% of revenue 1% 5% of revenue 1% >5% of revenue 5%

Satisfaction with the resolution of contract issues

We asked companies to provide their level of satisfaction with the resolution of audit issues. The response is shown in Figure 38 along with the results from the prior five surveys. Thirty- six percent of surveyed companies are very satisfied with the resolution of audit issues and another 53% are somewhat satisfied. The level of satisfaction with the resolution of contract issues has improved significantly when compared with earlier surveys. This is likely the result of DCAA writing off a large part of its audit backlog with minimal review based on new risk assessments specifically designed to eliminate backlog.

2015 survey 2013 survey 2012 survey Very satisfied Somewhat satisfied Not satisfied 36% 18% 16% 33% 49% 35% 50% 95%

Fig 38. Company satisfaction with resolution of issues 53% 61% 60% 42% 36% 52% 50% 95% 11% 21% 24% 25% 15% 13% 2011 survey 2010 survey 2009 survey

Table 7: Most frequent CAS issues

CAS issue type Frequency cited2015 Survey Frequency cited2013 Survey Frequency cited2012 Survey Frequency cited2011 Survey Frequency cited2010 Survey Frequency cited2009 Survey

CAS 401 consistency 0% 2% 16% 10% 16% 8%

CAS 403 home office 1% 3% 4% 7% 13% 7%

40 Grant Thornton's 2015 Government Contractor Survey 40 Grant Thornton's 2015 Government Contractor Survey