Applicability: This FAR clause is incorporated in cost reimbursement contracts and Time-and-Materials (T&M) contracts for other than commercial items. For T&M contracts, the clause only applies to the part of the contract that reimburses materials on the basis of actual cost. The clause also includes four alternate versions, whose inclusion was discussed in Part 1 of this two-part series.
Key Requirements: The clause addresses two key areas, (1) interim reimbursement of costs, and (2) determination of final indirect rates. Part 1 of the two part series addressed the interim reimbursement of costs. This Part 2 of our series addresses the determination of final indirect rates.
In regards to the determination of final indirect rates, the clause requires the contractor to submit an adequate final indirect cost proposal to the Cognizant Federal agency official (CFAO) and auditor within six months after the end of the contractor’s fiscal year. Reasonable extensions, for exceptional circumstances only, may be requested in writing by the Contractor and granted in writing by the CFAO. The appropriate Government representative and the Contractor shall establish the final indirect cost rates as promptly as practical after receipt of the Contractor’s proposal. In addition, the clause requires that the contractor support its proposal with adequate supporting data. A detailed description of what constitutes adequate supporting data is listed in the clause, and must be included unless otherwise specified by the CFAO. This listing is extremely detailed, and as a result, is not repeated in this column.
Compliance Verification: Where the contractor has at least one DoD cost type and/or T&M contract that incurred costs during the fiscal year, compliance verification will usually be performed by the Defense Contract Audit Agency (DCAA). When the contractor had no such DoD contracts, civilian agencies have a number of compliance verification options available. These agencies may request DCAA to perform the review, do their own internal review, or contract out the services to an outside firm.
It is important to note that over the past ten years, there has been a significant change in the DCAA approach in reviewing incurred costs. In past years, DCAA would perform reviews of all contractors. Some of those reviews were extensive, while others would take only a few days, based on the risk factors (including, but not limited to, dollar value). However, for each of those reviews, DCAA was issuing an Attestation report, which represents a statement that a full audit was performed. As a result, the GAO issued a report critical of DCAA, noting that the incurred cost reviews in many cases did not meet the auditing standards to which the report was attesting. The GAO stated that it was not requiring/recommending that DCAA to do a full audit of all incurred costs; however, a full audit must be done when the report states that such an audit was done. DCAA had a couple of options in responding to this report. First, DCAA could have adjusted the report language for the reviews, no longer calling them audits. Alternatively, DCAA could decide to do full-blown audits for all incurred cost submissions, regardless of the dollar amount or other risk factors involved. DCAA chose the latter option. As a result, the short reviews of the smaller contractors are no longer performed.
The consequences of this decision is that DCAA is now significantly behind on its incurred cost workload. Many companies have incurred cost submissions that are 5-10 years old with no DCAA audit. DCAA has recently responded to this dilemma with a new policy, whereby the agency is taking an IRS sampling approach to incurred cost audits for smaller companies. As a result, many companies will simply have their proposed rates accepted for a particular fiscal year, with a possible cursory desk review conducted.
Remedies: The CFAO is responsible for negotiating/determining final indirect cost rates. For smaller contractors, DCAA issues reports with audit-determined rates. However, those smaller contractors also have a CFAO, and if they do not agree with the audit-determined rates, the issue is raised to the CFAO for negotiation/determination. Where the CFAO and the contractor are unable to agree on the final rates, the CFAO makes a unilateral determination of the final indirect rates. If the final rates result in the contractor owing monies as a result of interim reimbursements exceeding the amount computed using the CFAO determined rates, those monies are generally required to be returned to the Government. The contractor has the right to appeal the CFAO’s determination thru the contract disputes process. In addition, if the contractor is delinquent in submitting the incurred cost submission (e.g., does not submit within the six month period), DCAA and/or the CFAO may issue reports/determinations regarding the adequacy of the contractor’s business systems, particularly the accounting and estimating systems. To mitigate the possibility of a report stating a system is inadequate, contractors should maintain close communication with their CFAO, justify any requested extensions, and document any such extensions that are granted by the CFAO.
Background: The purpose of the clause is to provide a process for determining final indirect cost rates. It includes a specific timeframe for contractors to submit their incurred cost submissions, a detailed listing of what constitutes an adequate submission, and a requirement for the CFAO to “promptly” establish final indirect cost rates. The concept is logical, but the effectiveness of the actual implementation has varied over the years. In addition, recent changes to the FAR have also impacted the efficiency of the process.
Other Key Information: The current clause was significantly changed by a June 30, 2011 final rule, which added a myriad of items that must be included in a final indirect cost submission. This, coupled with the fact that DCAA had already fallen significantly behind in performing the required audits, has resulted in a broken process. In the 1980’s, the Government was in a similar position, where contractor submissions were 5-10 years old without DCAA audit. The Government response was to hire more DCAA auditors. By the mid-1990’s, DCAA was current on almost all incurred cost audits. In fact, at one point in time, DCAA had instituted a program entitled “Concurrent auditing”, whereby costs were being audited in the same year they were being incurred. This was the pinnacle of efficiency, at least from a timing standpoint, for the incurred cost audit process. Having current incurred cost reviews also facilitated the determination of forward pricing rates, since the most recent years had audited rates to use as reference points.
Unfortunately, it has been downhill (at least from a currency perspective) ever since the GAO report on DCAA was issued. DCAA’s decision to perform only full attestation audits for all incurred costs, coupled with adding to the FAR a listing of items that were formally in an internal DCAA guide to contractors, has resulted in an inefficient process that continues to fall further and further behind. As previously noted, this listing of what constitutes an adequate final indirect cost proposal is very extensive, and has resulted in contractors having significant difficulty in submitting “adequate” incurred cost submissions. On a positive side, the FAR does leave the determination of what constitutes an “adequate” submission to the CFAO, leaving the contractor an avenue to pursue should the auditor take an unreasonable position (in the contractor’s opinion) regarding the FAR requirements.
In the long run, it is hopeful that the DCAA risked-based approach will provide more currency to the process; however, this approach is also coupled with the risk of a potential scandal, since many smaller contractors will have little or no oversight of their incurred costs audits for certain fiscal years. Should such a scandal occur, we may see another sea-change, as watchdog organizations will request some form of review of each contractor submission, thereby returning us to some form of the DCAA approach of the 1980-1990’s.
In addition to the above problems, the current clause also has a significant terminology problem in its use of the terms “Contracting Officer” and “CFAO”. Under FAR 42.7, the CFAO is responsible for determining the final indirect cost rates. But the current version of the clause sometimes refers to the Contracting Officer (e.g., the contractor shall submit its proposal to the Contracting Officer). Since a Contracting Officer can be a Procuring Contracting Officer, an Administrative Contracting Officer, or a CFAO, this can cause potential confusion, particularly among smaller contractors. Hopefully this problem will be corrected by the FAR Council. However, in the interim, to assure proposals are submitted to the proper Government personnel, contractors should assume that the clause is referring to the CFAO when it uses the term “Contracting Officer”.
FAR 52.216-7 requires that every GC with flexibly priced contracts generally prepare and submit their incurred cost proposal no later than six months following the end of their fiscal year.
If my indirect rates are capped for the duration of the contract period would I still need to submit a Incurred Cost Report?