Do you know what's on the DCAA radar screen? Read more to learn what Christine Williamson, Member Watkins Meegan and Karen Williams, Systems Consultant of WJ Technologies have to say about Dealing with DCAA Audits. Being unprepared for a DCAA audit can hit your back pocket and affect your future in government contracting. For more information contact Christine Williamson at Christine.Williamson@watkinsmeegan.com.

1. Dealing with DCAA Audits - Are you prepared? Christine Williamson – Member, Watkins Meegan LLC Karen Williams – Senior Consultant, W J Technologies LLC May 25, 2010 Proprietary & Confidential

2. Agenda Changes within DCAA over past several years 5 Major Memorandums Audit Initiatives and Trends New Regulations – Travel, Prime Resp., Exec Comp, Pass-thru Costs, & Recapture Payments Specific DCAA Audits Proprietary & Confidential 2

3. DCAA ORG CHART Director Patrick Fitzgerald Deputy Director Frank Summers Executive Officer Joe Garcia General Counsel Defense Legal Service John Farenish Assistant Director, Integrity & Quality Assurance Don McKenzie Assistant Director, Resources Philip Anderson Assistant Director, Policy & Plans Ken Saccoccia Assistant Director, Operations Karen Cash Headquarters Regions Northeastern Region Ron Meldonian William Adie Western Region Chris Andrezze Susan Barajas Central Region Ed Nelson Tim Carr Eastern Region Paul Phillips Gary Spjut Mid-Atlantic Region David Eck Steve Hernandez Field Detachment Tom Peters Terry Schneider

4. DCAA’s NEW mission statement The DCAA, while serving the public interest as its primary customer, shall perform all necessary contract audits for the Department of Defense and provide accounting and financial advisory services regarding contracts and subcontracts to all DoD components responsible for procurement and contract administration. These services shall be provided in connection with negotiation, administration, and settlement of contracts and subcontracts to ensure taxpayer dollars are spent on fair and reasonable contract prices. DCAA shall provide contract audit services to other Federal agencies, as appropriate. Proprietary & Confidential 4

8. GAO Findings on DCAA First in July 2008; Second in September 2009 14 of 14 Audits failed to comply with GAGAS (Govt. Auditing Standards) 33 of 37 Internal Controls audits failed to comply with GAGAS; primarily inadequate substantive testing DCAA Management inexplicably dropped findings Reports were more favorable to contractors (influenced by contractors and contracting agencies) Proprietary & Confidential 8

9. Reaction/Response by DCAA Rescinding previously issued audit reports (for lack of sufficient audit testing) No reliance on outdated audit opinions e.g. internal control audit more than four years old—prior opinions on adequacy will be excluded from the report More aggressive audit strategies (to prove that DCAA is protecting the “Taxpayer”) 5 Major Memorandums all issued within a month of each other Proprietary & Confidential 9

10. DCAA says “It’s a Brave New World” 10

11. MEMORANDUMS ISSUED Three memo’s with sweeping changes issued on same day No more in part opinions, only wholly adequate or inadequate for system reviews Audit reports can not include suggestions for corrective action or improvement in internal controls Inadequate system audits require the auditor to recommend to the ACO that payments on affected contracts are suspended Proprietary & Confidential 11

12. #1 -Creation of Limited Scope Audits Memo 08-PAS-041®– December 19, 2008 – creates new requirement for “limited scope” audits of internal control deficiencies identified during the course of other audits the FAO should… issue a flash report to report the potential deficiencies establish a separate limited scope audit assignment Failure to accomplish a single control objective will render the overall internal control system inadequate [If this occurs the auditor will] recommend that the system and pursue suspension of progress payments or reimbursement of costs i.e. 10% withhold 12

13. #2 - Access to Records Memo 08-PAS-042 ® – December 19, 2008 – imposes new rules and procedures for reporting and resolving “access to records” disputes Memo is specifically about obtaining documentation to support on-going audits limited to “audit of contractor assertions” such as proposals, rate submissions, incurred cost submissions, etc. Memo extends prior guidance with respect to written requests to also cover all requests made “either verbally or in writing” Establishes “specific date, not to exceed one week” as the standard for compliance with requests for records the Agency may request a subpoena to enforce their request in an instance when the seven-day standard was not met the Agency may not negotiate either scope or date with a contractor once a request has been made 13

14. #3 - You Either Pass or Fail Memo 08-PAS-043 ®– December 19, 2008 – imposes new restrictions on audit findings and reports on Internal Control Reviews DCAA will NO LONGER issue reports with “inadequate in part” findings – all findings will be either “adequate” or “not adequate” DCAA will NO LONGER make recommendations for improvement in contractors’ systems When any part of a contractor’s internal control system is found to deficient, the entire system will be deemed inadequate for use When a system in deemed inadequate, the auditor is REQUIRED to recommend to the ACO that the system be disapproved for use and payments be suspended (in whole or in part) 14

15. #4 -Reconcile Public Vouchers Memo 08-PAS-044 ® – December 22, 2008 – requires additional reconciliation to contractors accounting records for all Public Voucher Reviews CAM 6-1008b has been revised to require auditors to reconcile billed costs to the contractor’s accounting records for the interim vouchers selected for review For non-major contractors, auditors may perform this step on the auditor’s next visit to the contractor For Time-and-Materials and Labor-Hour vouchers, auditors should ensure that labor hours and material cost reconcile to the contractor’s accounting records 15

16. #5 - No Review of Findings or Drafts EVM Memo 09-PPD-002® – January 22, 2009 – new procedures prohibiting participation in meetings to review draft findings or draft corrections to contractors system with regards to EVM Auditors should not participate in meetings or conferences with the contractor and DCMA where the purpose of the meeting is to discuss draft findings and draft corrections to the contractor’s EVM system Auditors should not share draft audit results with the EVMS review team Auditors report significant deficiencies/material weaknesses discovered during the audit even when the contractor corrects the deficiencies during the audit 16

17. DCAA Audit Trends Nancy Arasin Wood, Mid-Atlantic Regional Audit Manager – March 2010 GWSCPA Event “Incurred cost audits are not on our radar screen” Forward Pricing Audits Systems Audits Pilot Program for Billing Audits Proprietary & Confidential 17

18. DCAA FY 2009 Audit ResultsBy Audit Area Incurred Cost. Includes audits of historical costs, internal control systems, and final contract closings. Forward Pricing. Includes audits of price proposals, estimating systems, and forward pricing rate agreements. Special Audits. Includes audits of terminations proposals, other claims, progress payments, financial capability, and earned value management systems. Other. Includes Cost Accounting Standards, operations audits, and Truth-in-Negotiations (Defective Pricing Audits).

19. Major vs Non-Major Contractor Any contractor that had $90 million or more in annual auditable costs for the prior fiscal year. 19

20. Commission on Wartime Contracting Congressionally Mandated in 2008; Scope includes Iraq/Afghan contract administration; 8 members Interim Report in June 2009 “At What Cost”? Special Report issued in September 2009 DoD should have one voice to the Contractors Inadequate contractor business systems (internal controls) by contractors caused billions of dollars wasted (DCMA) DCAA needs to expand beyond pass/fail reporting Dysfunctional relationship: DCMA and DCAA Commission will sunset 60 days after final report is issued in 2010 (www.wartimecontracting.com) Proprietary & Confidential 20

21. Defining Internal Control Audits DCAAM 3-300 released 4/2/10 Definitions of Internal Controls are not contained in FAR New Terminology ICAPS = Internal Control Audit Planning Summary ICRS = Internal Control Review System database DCAA audits of internal controls come in two flavors: ICAPS audits broken into 10 systems cyclically applied to “major” contractors Post award accounting & billing system review Proprietary & Confidential 21

22. New - Prime Contractor Administration of Subcontractors Where: DCAA Memo PSP 730.5.1 dated 6/30/09 FAR 15.404-3/DCAM 9-104.2/DFARS 215.404-3/ DCAA expectation that prime contractor will audit subcontractor invoices (emulate DCAA) Prime contractor failure to audit = 100% disallowance & billing system inadequacy Primes are expected to show proof that subcontractors have adequate accounting and billing systems (i.e. DCAA expects primes to audit subcontractors) Proprietary & Confidential 22

23. New - FAR Rule on Travel Costs January 11, 2010, FAR 31.205-46 was amended to remove inconsistency on treatment of allowable airfare Before was either “lowest available to contractor” or “lowest available to public” (lowest standard offered) Cost of airfare is now limited to the “lowest priced airfare available to the Contractor” Implications Additional documentation of similar airfares Contractor negotiated rates with airlines Challenging to monitor due to the variability in airfares Proprietary & Confidential 23

24. New - Payment Recapture Push OMB Recovery Audit Guidance – March 2010, Executive Order to expand payment recapture audits and OMB to develop guidance within 90 days for departments and agencies to carry out the requirements. Uses tools / technology and compensation tied Misspent funds to uncover problems such as duplicate payments, payments for services not rendered, overpayments, etc. Proprietary & Confidential 24

25. New - Excessive Pass Through Costs FAR Clause 52.215-23, Limitations on Pass-Through Costs, requires Contractor to disclose what percentage of a contract’s work will be subcontracted If amount exceeds 70%, Contractor must state the indirect costs and/or fee which will be applied and the value-added by the Contractor to the subcontracted effort Contracting Officer may determine that pass through costs are excessive if Contractor is subcontracting large amount of effort without performing value-added functions Proprietary & Confidential 25

26. New – Executive Comp Cap is set annually Issued 4/23/10 CFY 2010 $693,951 from $684,181 in CFY 2009 FAR 31.205-6 Proprietary & Confidential 26

27. Most Common DCAA Audits Today Specific Audits Pre Award Survey/Accounting System Audit Financial Capability Audit Estimating System Audit Purchasing System Audit Billing System Audit Incurred Cost Audit CAS Audit Proprietary & Confidential 27

28. Specific DCAA Audits What is the purpose? What will the DCAA require? Focus Completion Proprietary & Confidential 28

29. Pre-Award Survey/Acctg System AuditWhat is the Purpose? Obtain an understanding of the accounting system Opine as to whether the design of the contractor’s system is acceptable for the award of a prospective Government contract A financial capability audit may be triggered as a result of the Pre-Award Survey Proprietary & Confidential 29

30. Pre-Award Survey/Acctg System Audit What will DCAA Require? DCAA will request an ICQ (Internal Controls Questionnaire) DCAA will review the accounting system with respect to the following: GAAP compliant Proper segregation of costs-Direct vs. Indirect and Job cost Allocation of indirect costs Accumulation of costs under General Ledger control Timekeeping System / Labor Distribution Proprietary & Confidential 30

31. Pre-Award Survey/Acctg System Audit What will DCAA Require? Interim Determination of Costs/Interim monitoring of rates Exclusion of Unallowable Costs Costs by Contract Line Item Procedures to ensure proper and adequate billings Adequate & Reliable / Is the accounting system in operation Proprietary & Confidential 31

32. Pre-Award Audit Focus Verification that the accounting system and related policies and procedures are in place to demonstrate and ensure compliance with the 15 key items contained in the DCAA Preaward Survey Audit Program Proprietary & Confidential 32

33. Pre-Award Survey/Acctg System Audit Completion DCAA will review the documentation and materials provided and prepare a draft audit report Contractor will respond to the draft DCAA will incorporate the contractor’s comments into the final report An adequate or inadequate opinion will be given by DCAA Proprietary & Confidential 33

34. Financial Capability AuditWhat is the Purpose? To determine if the contractor has adequate financial resources to perform on Government contracts in the near term. Proprietary & Confidential 34

35. Financial Capability AuditWhat will DCAA Require? 3 years financials, YTD FS for last Qtr available, and tax returns Explanation Off-balance sheet arrangements & Related party transactions Cash Flow Forecast Operating Budget Proprietary & Confidential 35

36. Financial Capability Audit Focus DCAA will Review FS Indicators: Profit/Loss Sales Working capital Net Worth Long-term Liabilities Accounts Payable Aging Loan Covenants Proprietary & Confidential 36

37. Financial Capability Audit Focus DCAA will Review Non FS Indicators: Timely Payment of Payroll Taxes Management of Subsidiary using Parents Cash Alert to: Non-Payment of Insurance premiums Borrowing from under-funded pension plans Poorly maintained infrastructure Proprietary & Confidential 37

38. Financial Capability AuditCompletion DCAA will prepare a draft audit report summarizing the results of the risk assessment and any deficiencies found DCAA will conduct an Exit Conference with Contractor and provide Contractor an opportunity to respond to findings DCAA will then draft its Final Report and update the ICRS database Proprietary & Confidential 38

39. Estimating System AuditWhat is the Purpose? Evaluate the adequacy of and the contractor’s compliance with the estimating system internal controls. Assess the adequacy of the contractor's policies and procedures, whether they have been implemented, and if they are working and being monitored effectively. Proprietary & Confidential 39

40. Estimating System AuditWhat will DCAA Require? Contractor’s written estimating system policies and procedures. Organization charts depicting the functional areas responsible for developing and processing estimating system related data. Estimating system flowcharts providing a pictorial overview of all manual and computerized processing steps. Information systems documentation Proprietary & Confidential 40

41. Estimating System Audit Focus DCAA will review the following: Control Environment (ICAPS) Risk Assessment Interview personnel Information and Communications Methods and records established to record, process and summarize contract data Monitoring/Internal Audit System Description and Training Proprietary & Confidential 41

42. Estimating System Audit Focus DCAA will review the following: Cost Estimate Development Summary of Total Cost by Element Cross-referenced to each line item Breakdown of Labor (FAR 15.408, Table 15-2 II.B.) Hours Rates and Costs by Appropriate Category Consolidated Priced Bill of Materials Types, Quantities, Cost FAR 15.408, Table 15-2 II.A. Certification Proprietary & Confidential 42

43. Estimating System AuditCompletion DCAA will prepare a draft audit report considering all five components of internal control: Control Environment Contractor Risk Assessment Information and Communications Monitoring Control Activities that relate to Control Objectives DCAA will conduct an Exit Conference with Contractor and provide Contractor an opportunity to respond to findings DCAA will then draft its Final Report and update the ICRS database Proprietary & Confidential 43

44. Purchasing System AuditWhat is the Purpose? Evaluate the adequacy of and the contractor’s compliance with the purchasing system internal controls. Assess the adequacy of the contractor’s policies and procedures, whether they have been implemented, and if they are working and being monitored effectively. Proprietary & Confidential 44

45. Purchasing System AuditWhat will DCAA Require? Contractor’s written purchasing policies and procedures Organization charts depicting the functional areas responsible for developing and processing purchasing related data. Purchasing charging and distribution system flowcharts providing a pictorial overview of all manual and computerized processing steps. Information systems documentation Proprietary & Confidential 45

46. Purchasing System Audit Focus Contractor Compliance, training, policies and procedures Purchase Orders and Subcontract Clauses Management of Purchasing Selecting Sources Pricing and Negotiation Subcontract award and Negotiation Proprietary & Confidential 46

47. Purchasing System Audit Completion DCAA will prepare a draft audit report to determine if the purchasing system is adequate to reasonably assure proper pricing, administration and settlement of Government contracts considering: Contractor Compliance Training Policies and Procedures Purchase Orders and Subcontract Clauses Management of Purchasing Selecting the Source Pricing and Negotiation Subcontract Award and Administration DCAA will then complete draft final audit and conduct and Exit Conference with Contractor Final Audit report will include Contractor’s response and audit rejoinder if applicable Proprietary & Confidential 47

48. Billing System AuditWhat is the Purpose? Evaluate the adequacy of and the contractor’s compliance with the billing system internal controls. Assess the adequacy of the contractor’s policies and procedures, whether they have been implemented, and if they are working and being monitored effectively. Proprietary & Confidential 48

49. Billing System AuditWhat will DCAA Require? Contractor’s written policies and procedures and billing system manual. Organization charts depicting the functional areas responsible for developing and processing billing related data. Billing system flowcharts providing a pictorial overview of all manual and computerized processing steps. Information systems documentation Proprietary & Confidential 49

50. DCAA Billing System Audit Focus Contractor’s system orientation briefing or a demonstration of the billing system transaction flow including data input, data processing, data output, and related internal controls Changes in the billing system process since the last examination Contractor’s Risk Assessment Process Contractor’s Monitoring Process to ensure that established manual and computerized controls are functioning as intended Contractor’s Billing System Procedures and internal controls that assure timely identification and resolution of contract overpayments. Proprietary & Confidential 50

51. Billing System AuditCompletion DCAA will draft a DCAA will prepare a draft audit report considering all five components of internal control: Control Environment Contractor Risk Assessment Information and Communications Monitoring Control Activities that relate to Control Objectives such as: Management Reviews Policies and Procedures Implementation of Policies and Procedures DCAA will conduct an Exit Conference with Contractor and provide Contractor an opportunity to respond to findings DCAA will then draft its Final Report and ensure the paying office and CO have notifies of any unresolved overpayments, contract administration adjustments, demand letters, and subcontract billings that are over 30 days old and any other improper offsets. Proprietary & Confidential 51

52. Incurred Cost AuditWhat is the Purpose? Establishes final indirect cost rates for a respective Calendar Year Audit determines whether costs charged to auditable Government contracts are allowable, allocable, and reasonable in accordance with the contract and applicable Government acquisition regulations ICS is due 6 months after the close of the fiscal year Proprietary & Confidential 52

53. Incurred Cost AuditWhat will DCAA Require? Incurred Cost Proposal in the following Format: Schedule A - F Rates and Allocation schedules Schedule G - H Reconciliation of Books of Account and Claimed Direct Costs by Project (Schedule H is time-consuming) Schedule I Schedule of Cumulative Direct and Indirect Costs Claimed and Billed Schedule J Subcontract Information Schedule K Summary of Hours and Amounts on T&M/Labor Hour Contracts Schedule L Reconciliation of Total Payroll to Total Labor Distribution Schedule M Listing of Decisions/Agreements/Approvals and Description of Accounting/Organizational Changes Schedule N Certificate of Final Indirect Costs Schedule O Contract Closing Information for Contracts Completed in this Fiscal Year Proprietary & Confidential 53

54. Incurred Cost Audit Focus Perform reconciliation and analysis by major cost element Test the reconciliation of book to billed cost Verify claimed labor cost to the 941’s Sample a set of contracts to test claimed hours, rates and qualifications Select a sample of material transactions for testing Select a sample of subcontract and ODC transactions Proprietary & Confidential 54

55. Incurred Cost Audit Focus Indirect Cost to include Executive Comp and sampling of indirect expenses Review of Unallowable Costs Evaluate the cost allocation basis Review FCCOM, if applicable Proprietary & Confidential 55

56. Incurred Cost AuditCompletion After completing the Audit, DCAA will discuss the results and provide a copy of the draft audit report to the Contractor Contractor is given the opportunity to respond to the draft report and the final audit will contain the Contractor’s comments If Contractor and DCAA cannot agree on Audit results, DCAA will forward audit report to the cognizant CO and issue a DCAA Form 1 to recover any reimbursement of unallowed costs. Contractor may appeal the Form 1 to the CO or file a claim under the contract Disputes Clause Proprietary & Confidential 56

57. CAS AuditWhat is the Purpose? To determine if the contractor's policies, procedures, and practices used to estimate, accumulate, and report costs on Government contracts and subcontracts comply with the requirements of CAS. Two types - Adequacy and Compliance Proprietary & Confidential 57

58. CAS AuditWhat will DCAA Require? Policies and Procedures Explanation of Contractor’s Internal Control Structure related to CAS Any changes since last Audit Contractor’s monitoring process for classifying costs Identified weaknesses that may have been reported and related follow up actions Proprietary & Confidential 58

59. CAS Audit Focus Internal Controls Review the ICQ or the ICAPS Any changes since last audit Adequacy audit Does your Disclosure Statement contain Current Accounting Practices; Accurate Accounting Method and all schedules are Complete and contain sufficient information Compliance audit What are the dates you became CAS covered What Standards apply Are you in Compliance Proprietary & Confidential 59

60. CAS AuditCompletion Initial Audit Summary will be discussed internally and only material non compliances will be reported Immaterial non-compliances are to be reported internally and to the Contractor at earliest possible date If Contractor does not correct immaterial non-compliance, Government may make appropriate contract adjustments DCAA will then complete draft final audit and conduct and Exit Conference with Contractor Final Audit report will include Contractor’s response and audit rejoinder if applicable Proprietary & Confidential 60

61. Conclusion Be prepared for your Audits! Have Policies, Procedures and Controls in Place Make Sure They are Being FOLLOWED! Sign up for WM Eblast L&L This Fall to Update DCAA Proprietary & Confidential 61