Deferred Compensation

I am often asked about deferring compensation especially in start up situations. This cost can be allowable if it meets all the requirements of FAR 31.205-6 (k) which incorporates CAS 415, Deferred Compensation. Keep in mind under cost reimbursable contracts and in situations where the Progress Payments clause is invoked billable direct costs must be paid in the normal course of business, usually within a business cycle. For deferred compensation to be allowable the FAR and CAS criteria must be met. There are special rules for unique circumstances and what if scenarios. If your company uses deferred compensation suggest the program be reviewed in light of these requirements. Also recommend that the awards be reduced to a written agreement.

A brief description of the main requirements is provided below. It is not meant to be a complete discussion on the subject but to list the main requirements. Please contact me for details if needed.

1) There is a requirement to make the future payment(s) which the contractor cannot unilaterally avoid.

(2) The deferred compensation award is to be satisfied by a future payment of money, other assets, or shares of stock of the contractor.

(3) The amount of the future payment can be measured with reasonable accuracy.

(4) The recipient of the award is known.

(5) If the terms of the award require that certain events must occur before an employee is entitled to receive the benefits, there is a reasonable probability that such events will occur.

(6) For stock options, there must be a reasonable probability that the options ultimately will be exercised.

FAR 52.203-13, Implements Significant Compliance Requirements

New rule affecting a contractors compliance and internal control systems is codified by FAR 52.203-13. Actually the clause has been around for a while. It was established in 2008. The rule has been heavily debated with back and forth but is now implemented. In addition DCAA has started an initiative to audit against it. The new rule is applicable to contracts exceeding $5 Million and 120 days of contract performance. Certain parts of the rule apply to small business. The rule requires:

1. Contractors maintain written standards of conduct, be diligent in the prevention and detection of criminal conduct and maintain a culture of ethical conduct/compliance. It also requires contractors to disclose in writing to the Office of the Inspector General incidents where there is credible evidence that a violation has occured of criminal law or the civil False Claims Act.

2. Contractors must implement an ongoing employee awareness program regarding standards of conduct and reporting incidents, an internal controls system that is designed to detect incidents of noncompliance and corrective measures are implemented and carried out. The rule goes on to describe minimum requirements including periodic audits, testing and monitoring. This item only applies to large businesses, small businesses are exempt from the internal control system requirement.

This is an alert and is intended to notify contractors of the new rule and is a summary. It is not an analysis of the new rule as it is a substantial rule with detailed requirements. I encourage contractors to get a copy of FAR 52.203-13 and review the clause in its entirety.

This new rule imposes substantial compliance responsibility upon large and small businesses. Small businesses are only subject to the standards of conduct policies, training and the reporting provisions of this new rule. I encourage all contractors to review its compliance policies, procedures and monitoring in light of this rule. I encourage contractors to enhance its policies, procedures and internal control programs to comply with this complex but important rule. In regards to the reporting to the Office of Inspector General I strongly encourage contractors to seek legal counsel regarding its rights in light of disclosure. Contractors should engage qualified professionals and possibly legal counsel as needed.

Government Makes Changes to Allowable Air Fare Costs

The Government revised the Air Fare allowable cost rules (FAR 31.205-46) by further limiting allowable costs to the lowest air fare available to the contractor. DCAA chimed in and issued revised audit guidance by its MRD dated March 22, 2010. In this guidance DCAA is instructing its auditors to make assessments of contractor policies and procedures to secure the lowest air far available. It even goes as far as requiring its auditors to investigate the use of nonrefundable air fares or lower fares that have been negotiated by the contractor with airlines, travel agents, credit card companies, etc. Auditors will be making assessments of contractor policies relative overall travel management and advance planning to get the lowest possible air fares. It will also be investigating whether utilizing nonrefundable air fares will benefit the government net of cancellation fees.

I guess the government made a straight forward regulation more complicated. The added costs of administration may very well erode any real savings the government thinks it may recieve. DCAA is complicating this further with the added evaluation of non refundable airfares. In any event contractors should evaluate their policies and procedures relative to travel management and be aware that DCAA may be questioning normal coach air fare costs if there are possible lower cost air fares available to the contractor. Nonrefundable airfares will now be considered if the contractor’s history of cancellation fees does not outweigh any savings from non refundable air fares.

This regulation like most is aimed at the larger Defense contractors. In most cases these regulatory changes trickle down to small contractors. Small contractors are not immune to this new rule nor the DCAA audit guidance.

Reminder: Incurred Cost Submissions Due For Certain Contractors

Contractors that execute cost reimbursable contracts or other contracts that invoke the Allowable Cost and Payment Clause (FAR 52-216-7) are required to submit its Incurred Cost Proposal submission within six months after the the completion of the accounting year. This proposal establishes final direct cost and indirect rates for the fiscal year. For calendar year contractors the due date is June 30. The proposal submission must be considered adequate for audit. Use of the DCAA Incurred Cost Electronically(ICE) Model is the expected format. This model is a very substantial submission.

As a reminder the June 30 date for calendar year contractors is soon approaching. If you have questions about this submission or its requirements please contact me.

April 26, 2010

Over a year ago DCAA made an abrupt change in how it handles audits by considering even minor deviations from compliance requirements a major deficiency. As a result, it has been recommending a host of negative actions including rejecting the adequacy of accounting systems for government contracting. Initially this was aimed at large DoD businesses. However it is also being applied to small businesses. I personally have witnessed these actions across the country at many small business locations. However, the DCAA application of this radical change in audit guidance has been very inconsistent. It varies by location and even by auditor. I have successfully turned many of these scenarios around for the contractor and to facilitate the award of contracts. But this required lots of work. I have also seen situations where the government procurement personnel have avoided DCAA essentially circumvented this guidance to get past the DCAA audit report, amazing.

The bottom-line is this, if you get one of these auditors that is following this guidance then the smallest deviations in accounting policy or practices, once considered to be immaterial, now render your systems to be inadequate. For a small business this may very well prevent you from securing contracts or a host of other negative consequences. Suggest systems, practices and policies/procedures be closely reviewed and corrective actions be taken immediately.

DCAA Provided Guidance on Indirect Cost Limit For Research Projects

This is an information post. DCAA on December 10, 2009 provided direction and audit guidance to its auditors to determine compliance with the 2009 Appropriations Act. This Act limits indirect costs on DoD research grants and other contract vehicles. The limit is 35% of total costs. DCAA has instructed its auditors to verify compliance with this requirement and to audit the contractor’s internal controls regarding this compliance requirement.

Contractors should keep this in mind understand its indirect costs invoicing will be to limited to this cap and make adjustments in its billing procedures to not exceed this limitation. Should you have questions on this or been requested by DCAA to demonstrate your system meets this requirement please contact me.

DCAA Targets Compensation Again

Recently I received information confirming that DCAA is applying a full court press on a number of subjects. One is compensation. For small and medium sized businesses this means owner and partner compensation. The DCAA will be looking closer at these costs to make sure they meet the requirements of FAR 31.205-6. The costs to participate and run the business are generally allowable if considered reasonable by the government. The DCAA is using various compensation surveys to validate reasonableness. Government perceptions that a cost is actually a distribution of profits is not allowable. Also bonuses if reasonable are allowable. However, these bonuses must be documented in policy or a plan implying an agreement or actual agreement with the employee or member or partner. Discretionary plans versus performance based plans will not fly. Obviously this all gets a bit complicated for partnerships and LLC’s. My suggestion is (1) document compensation with plans, policies and agreements; (2) bounce your compensation off of at least three compensation surveys that are relevant, unbiased and reputable so you are prepared for DCAA and make adjustments as needed; (3) avoid discretionary compensation practices and (4) develop a strategy for owner and partner compensation.

DCAA Revises Guidance

Recently the DCAA has revised its guidance to its auditors significantly. One such change is how they assess accounting systems. Now auditors are supposedly limited to a pass/fail evaluation. In the past auditors had the flexibility to `consider materiality, and contractor actions in making an assessment. This guidance was presumed to be focused on the major contractors, but I had suspicions that it would flow down to small contractors. Recently I have witnessed that this change in guidance is now impacting small and medium sized businesses as auditors appear inflexible in their evaluations. I have successfully raised the issue up the chain of command and have negotiated with contracting officers in some cases.

Bottom line is this, auditors will be more indifferent to materiality and contractors will need to enhance their systems to minimize the effect these changes will have. This will include internal controls and documented procedures.

Allowable Rental Costs

Recently, DCAA was taking exception to rental costs of a small business contractor, claiming the cost was a related party transaction as an owner was the lessor or leasing the facility to the contractor. Truth was the lessor was a minority (less than 50% owner). DCAA claimed that since the owner of the building was also an owner of the the company it qualified as a related party transaction and that the FAR limited allowable costs to ownership costs, depreciation, insurance, taxes and insurance. This was a large disallowance to the contractor.

Well, the truth is, that is not what the FAR says. The FAR (FAR 31-205-36) states allowable costs are limited to ownership costs provided the there is “common control” between the contractor owner and the building owner. The DCAA’s own audit guidance states the same concept. Well there was not any common ownership. the primary or majority owner of the contractor did not have any ownership in the building and the owner of the building was a minority (less than 50% ownership) in the contractor. So in this case the allowable costs were not limited to ownership costs. The full value of rental costs, provided they were reasonable, was allowable.

We prevailed on the issue and the contract in question was re-negotiated to the contractor’s satisfaction.

This situation is common in small businesses. I advise against it for this very reason, DCAA questioning costs without getting all the facts and not applying the regulations or their own audit guidance properly. Best not to open the door to the possibility of questioned costs. But if you are in this situation, just keep in mind the limitation on allowable costs (the ownership cost rule) only applies where there is common control between organizations.