Report to Congress Paints Difficult Landscape for DCAA

July 31, 2017

Law360

The Defense Contract Audit Agency’s report to Congress for fiscal year 2016 continued to demonstrate impressive gains by the agency in reducing its audit inventory, yet highlights the equally persistent challenges that the agency will face in 2017 and beyond in order to sustain this momentum.

Pursuant to its March 31, 3017, report, the DCAA examined $287 billion in defense costs, saved $3.6 billion in defense spending, and realized a return to the taxpayer of $5.70 per every dollar spent. According to the report, the DCAA completed more than 4,200 audits, including 2,103 incurred cost audits, 873 forward pricing audits, 981 special audits, and 312 other audits. Significantly, DCAA reduced its incurred cost audit backlog to 17.6 months, which is below the 18 months imposed by Congress under Section 818 of the 2016 National Defense Authorization Act that suspended the DCAA’s civilian audit activities until the agency’s reduced its outstanding incurred cost backlog below the threshold. The report shows that the DCAA realized substantial progress when it focused on its core mission to support U.S. Department of Defense activities in connection with forward pricing rate and incurred cost audits.

Despite these accomplishments, however, the report paints a difficult landscape for DCAA. While the report states that the DCAA has reduced its average backlog for incurred costs audits to 17.6 months, this obviously is just four months under Congress’ 18-month requirement. Maintaining this narrow margin will be difficult with the current pace of incurred cost submissions and forward pricing audits, coupled with the hiring freeze for 2017, and particularly now that the DCAA has resumed its civilian audit activities, which will only increase the agency’s workload. As a result of a static workforce, and increasing burdens, the DCAA will need to adopt a "do more with less" attitude in 2017 and beyond as well as look for new ways to increase efficiency and effectiveness.

First, because the DCAA will need to keep its incurred cost backlog below Congress’ 18-month requirement in order to retain its civilian audit authority, we can expect the DCAA to continue its use of multiyear, risk-based techniques to prioritize close outs of aging and larger incurred cost audits. However, constrained by a static workforce and increasing commitments elsewhere, such as time-sensitive forward pricing rate audits and the DCAA’s best efforts to accommodate scheduled dates, we can expect the DCAA to rely on other methods, including practices from the commercial sector, to maintain the throughput needed by the agency to meet its objectives. For example, the DCAA has advised of its intention to use working papers in connection with a contractor’s Sarbanes-Oxley testing efforts to facilitate the audit process. Given the courts’ general prohibition that the DCAA may not obtain access to contractors’ internal work product absent a compelling justification for the materials, it is questionable whether such an approach is appropriate, but the DCAA may have no choice but to pursue this approach in order to enhance throughput, especially given recent decisions that have rebuffed the DCAA’s efforts to shift audit burdens to contractors. Rather than alleviating the DCAA’s responsibilities, recent cases have placed more scrutiny on the DCAA’s practices and determinations. Based on the DCAA’s intention to support both defense and civilian contracting activities with the limited workforce at its disposal, the DCAA not only has a strong incentive, but the need, to innovate its audit approach while balancing its priorities. As we have already seen in 2017, we can expect the DCAA to continue with greater outreach to industry, better communication and coordination with contractors, reorganizing staff into dedicated audit teams for contractors, and greater reliance on third-party audit assists, in order to keep pace with its responsibilities.

Nevertheless, even with innovation, the DCAA may still fall short of its burgeoning workload. Even with the adoption of new and more efficient techniques, the current hiring freeze casts doubt on the DCAA’s ability to keep its incurred cost audit backlog below Congress’ 18-month requirement unless more attention is dedicated to clearing the backlog. While the figures in the report show that the DCAA has made progress in closing incurred cost audits, both the number of pending audits and the chances that they soon will be at or exceed 18 months are unclear due to how the agency counts incurred cost audits. The DCAA noted the issue in its report, stating that the agency does not consider an incurred cost audit to be backlogged unless it has been pending for more than two fiscal years, but that, for inventory purposes, the DCAA starts counting the date from when the submission was made and not when the costs were incurred. Thus, although the report states that at the end of 2016 the DCAA has 4,677 incurred cost submissions in inventory, the overall number of incurred cost submissions received by the agency that presently are in queue remains unclear.

Moreover, the DCAA’s two fiscal year benchmark and the manner in which it counts its audit backlog are inconsistent with Congress’ 18-month mandate, and both potentially increase the population of aging audits that the agency must close out. Audit closures will only become more difficult to accomplish over time because documents, personnel, and other relevant information will become less available with every year the audit remains pending. While the DCAA has over the past year employed multiyear, risk-based close outs for this reason, this broad-brush approach has the propensity to gloss over specific costs in lieu of evaluating the propriety of total costs, which may miss particular areas of cost concerns and skip smaller dollar contracts altogether. In addition, unless other changes in priorities are made, this approach will not significantly promote the DCAA’s ability to clear out other important areas such as forward pricing rate audits or the approval of contractor business systems. This would be unfortunate as forward pricing audits have the shortest audit cycle, yet offer the highest return on taxpayer investment, and more approved business systems will facilitate contract management, cost containment, and ultimately contract performance.

In sum, the level of detail in the DCAA’s report makes it difficult to gauge the agency’s true progress and challenges. Unless the DCAA commits to deadlines for audit completion and reduces its footprint in civilian activities and in performing incidental audit functions, such as ad hoc contract reviews on behalf of contracting activities or special audits, not only can we expect continued delays with regard to the DCAA’s core mission of supporting incurred cost and forward pricing rate audits for defense agencies, but another potential loss of civilian audit authority if the agency’s incurred cost backlog rises back to 18 or more months.

"Report to Congress Paints Difficult Landscape for DCAA," by David Nadler and David Yang was published in Law360 on July 31, 2017. To read the article online, please click here