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Billions of Defense Contract Dollars May Go Unaudited

Potentially billions of taxpayer dollars may be going out the door to defense contractors without the normal scrutiny Defense Department auditors usually give to this spending. And it might be too late for the government to get our money back even when some of those contract dollars are examined and overcharges are found.

High-level Defense Contract Audit Agency (DCAA) and Defense Contract Management Agency (DCMA) personnel met in May of this year to discuss audits of contractor billing that are nearing the six-year statute of limitations on when the U.S. government can readily recoup overpayments, according to DoD email correspondence provided to the Project On Government Oversight. When contractors overbill the government and the statute of limitations is exceeded, the government is limited in its ability to recover taxpayer funds.

The end result is many contract dollars, possibly running into the billions, may go without audits. These audits by the DCAA check to see whether the costs contractors are billing to the government “are permissible under government regulations,” according to a December report by the Government Accountability Office (GAO).

One DCAA insider told POGO that “eliminating billions of dollars from DCAA audits would hurt the taxpayers” and would benefit contractors.

Two lawyers who routinely represent government contractors agreed with the DCAA insider’s point in an article in November 2011. “[F]rom a contractor’s perspective, one bright side to the current state of audit and contract administration gridlock is that it may provide contractors opportunities to clear out the growing backlog of audit issues and preclude otherwise meritorious Government claims,” stated Robin Schulze and Karen L. Manos in an article in Government Contract Costs, Pricing & Accounting Report.

These developments should be no surprise to observers of the DCAA.

For a few years now, insiders and experts have been concerned that the incurred cost audit backlog might get so big and so overwhelming and take so long to deal with that contractors will pressure DoD to close out these contracts without auditing them (the contractors are waiting to get paid). The Commission on Wartime Contracting projected that the backlog will reach $1 trillion by 2016 (and was $558 billion as of 2011) because DCAA takes much longer to do audits now. This is due to what some call an excessive focus on compliance with Generally Accepted Government Auditing Standards (GAGAS). Richard C. Loeb, a University of Baltimore adjunct professor of government contract law, asserted that this was the case in an article in the May 2012 Government Contract Costs, Pricing & Accounting Report. “Spending valuable taxpayer dollars documenting audit results far in excess of GAGAS requirements should be unacceptable to everyone,” he wrote.

DCAA’s focus on GAGAS came after two GAO reports found fault with numerous DCAA audits for not being in compliance with those standards. DCAA had cut corners after a boom in post-9/11 defense contracting came without a corresponding increase in its staffing. But some say it is overcompensating after being slammed by Congress after its failings were exposed by GAO. So, despite some subsequent increases in its staffing levels in recent years, it is falling farther behind—hence the growing backlog.

Last year, Loeb wrote of the project backlog:

This means that $1 trillion in contractor costs are not being audited by DCAA. Without a significant course correction in the manner that DCAA conducts its audits, which seems unlikely given the 400-percent decrease in audits performed by DCAA since 2008, one does not have to be a statistician to conclude that DCAA will not reduce the backlog in any meaningful manner. It is very likely that for many of the contracts, the statute of limitations for recouping overpayments will run out before DCAA gets around to completing the audits, resulting in a significant loss of savings to the taxpayer.

The December GAO report found that DCAA has been implementing an initiative to tackle this backlog that mostly involves triage—trying to focus on higher-dollar contracts and those determined to be of “high risk”:

DCAA raised the dollar threshold that triggers an automatic audit on a contractor’s incurred cost proposal from $15 million to $250 million, revised the criteria used to determine a proposal’s risk level, and significantly reduced the number of low risk audits that will be randomly sampled. This initiative appears promising, and DCAA plans to track certain characteristics, such as the number of risk determinations made and audits completed. But DCAA has not fully developed the measures by which it will assess whether the initiative reduces the backlog in a manner that protects the taxpayers’ interests. Specifically, DCAA does not have a plan for how it will determine whether key features of the initiative, such as the revised risk criteria and the revised sampling percentages, should be adjusted in the future. By 2016, DCAA estimates it will reduce the backlog and reach a steady state of audits, which it defines as two fiscal years of proposals awaiting review.

Unfortunately, “DCAA’s ability to achieve this goal will depend on a number of factors, including the number of proposals determined to be high risk, which as of September 2012 was about two-and-a-half times more than anticipated,” according to the report.

GAO recommended “that DCAA develop a plan to assess its incurred cost audit initiative; that DCMA improve data on over-age contracts; and that the military departments develop contract closeout data and establish performance measures.”

In a guest post for the Public Contracting Institute, Capitol Edge Consulting was critical of GAO’s recommendations, and theorized why there may be far more high-risk proposals than DCAA earlier thought:

First, there just may have been 2 ½ times more high risk proposals than anticipated and DCAA guessed wrong. However, the likely reason can be found in the “Prior Work” section of the GAO report, where GAO mentions its 2009 report wherein it severely criticized DCAA for the lack of sufficient testing to support audit reports and opinions. That report and other factors resulted in several significant departures from DCAA, including its Director. DCAA reacted to that experience by migrating to the other extreme with their current approach to audits (specifically Incurred Cost Proposal audits) which is to minimize materiality considerations to practically zero. The Risk Assessment process intended to establish the scope of substantive testing during the audit, now frequently consumes more time and resources than the entire audit may have taken in the past. This hypersensitivity to risk assessment and substantive testing likely contributed to the discovery of 2 ½ times more high-risk proposals than expected and has complicated the effort to eliminate backlog.

POGO is concerned that DCAA and DCMA—responsible for administering DoD contracts—will simply move the goal posts even more to change the definition of “high risk” to further reduce their workload. Contractors, of course, would be thrilled with this development since it means less of the bills they’re charging to the government will be reviewed closely.

We are not alone in thinking this might happen. Capitol Edge Consulting further wrote:

We predict the DoD will ultimately significantly reduce requirements to be met to close out (overage) contracts. We further anticipate that DoD will pressure DCAA to raise the threshold for requiring an audit of an Incurred Cost Proposal. This prediction is not unreasonable. The GAO report mentions that the Government has found itself in this position before, in 2000, when there were over 350,000 overage contracts in the MOCAS [Mechanization of Contract Administration Services] system. In that instance, the Deputy Under Secretary of Defense at the time directed military departments and the Defense Contract Management Command to “…develop comprehensive plans to close out all completed contracts….” Essentially wipe the board clean. Problem solved.

Instead of allowing billions of dollars to flow out the door unchecked or conducting an audit only when a contract crosses a monetary threshold, DCAA needs to better manage its workload in accordance with risk—lowering the monetary threshold and focusing on auditing contractors with over-billing histories or inadequate business systems. The government should improve the quantity and quality of its audits and better protect taxpayers by auditing those that need it most. It should also redefine GAGAS compliance in a way that DCAA can act in a timely manner appropriate to the actual risk at hand for contract audits.