Department of Defense Procedures to Determine Contractor Compliance with Cost Accounting Standards

Published by the Government Accountability Office on 1977-06-08.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                          DOCUMENT RESUME
02619 - [A17126891

[Department of Defense Procedures to Determine Contractor
Compliance with Cost Accounting Standards]. PSAD-77-125;
B-39995. June 8, 1977. 5 pp.
Report to Frederick Neuman, Director, Defense Contract Audit
Agency; by Richard W. Gutmann, Director, Procurement and Systems
Acquisition Div.
Issue Area: Federal Procurement of Goods and Services:
     aea onableness of Prices Under Negotiated Contracts and
     Subcontracts (1904); Accounting and Financial Reporting
Contact: Procurement and Systems Acquisition Div.
Bua&get FuL'ction: National Defense: Military Assistance (052);
     miscellaneous: Financial Management and Information Sys t ems
     (1007 .

         A limited evaluation of the adequacy of Department of
Defense procedures to determine contractor compliance with cost
accounting standards and regulations disclosed numerous
instances of contractor noncompliance. Findings/Conclusions:
The evaluation was directed toward the work of the Defense
Contract Audit Agency, which has basic responsibility for
ensuring contractor compliance. In addition to num¢:ous
identified instances of noncompliance, some have gone undetected
because the Agency does not have adequate controls to ensure
that all significant provisions of the standards hate been
included in the reviews of contractor compliance. The Agency is
considering a "control schedule for compliance reviews" which
would identify cost accounting standard provisions significant
to a particular contractor based on potential for impact on
contract costs, and which would signif-cantly improve the
planning of Compliance reviews. Recommendations: The Agency
should proceed with the further development and implementation
of the controls needed to assure that sufficient audit coverage
is given to contractor compliance with cost accounting
standards, rules, and regulations. (DJM)
                                      UNITED STATES GENERAL ACCOUNTING OFFICE
                                              WASHINGTON, D.C.   0548

      P"OlRM1MZ        ANA SIYI'MS
                         CM830ftJUN                                                0 8 197?
_-'         6-39995

            Mr. Frederick Neuman
            Director, Defense Contract
              Audit Agency
            Cameron Station
            Alexandria, Virginia 22314

            Dear Mr. Neuman:

                 We completed a limited evaluation of the adequacy of
            procedures and practices followed by the Department of
            Defense to determine contractor compliance with cost
            accounting standards, rules, and regulations. i;ithin the
            Department, admi.s.strative contracting officers are
            responsible for administering cost accounting standards and
            determining contractor compliance. Although the final deci-
            sion regarding contractor compliance rests with the contract-
            ing officers, basic responsibility for ,,valuating contractor
            compliance was delegated to the Defense Contract Audit Agency
            as part of its audit activities. Therefore, we primriily
            directed our evaluation toward the work performed by your
            Agency. In a separate review, we are ?valuating the Depart-
            ment's settlement of noncompliance cases identified and
            reported by your auditors to the contracting officers.
                 We examined the work performed by your Agency at three
            contractors. These contractors were selected because they
            represented a diversified universe--two were major, large
            volume suppliers to the Department while one was a relatively
            smaller supplier. At two of the locations, contracts were
            administered by the Defense Contract Administration Service
            offices, while at the other they were administered by an Air
            Force plant representative office.  Further, the two larger
            contractors were audited on a continuous basis by a resident
            staff while the smaller contractor was audited on an as-needed
            basis by auditors assigned to a nearby branch office. The
            auditors responsible for review of the three contractors'
            activities were assigned to two different Audit Agency reqional

                 We found that the procedures and practices followed by the
            auditors have resulted in their identification of numerous


instances where the contractors were not in compliance with the
cost accounting standards.  However, some instances of noncompli-
ance have gcae undetected because, in our opinion, your Agency
did not have adequate controls to insnre that all significant
provisions of the standards have been included in the reviews
for cont:actor compliance.

       Your Agency is considering implementing a procedure w:ich
couldt provide tne type of control we believe is essential.   As
discussed on page 4, we recommend tnat you further develon and
implement tne needed controls.


     Sour Agency's pr.cedures provide for reviews of a
contractor's initial disclosure statement of cost accounting
practices and subsequr?nt changes to determine compliance with
cost accounting standaras.    In addition, audits are to be
accomplished during the performance period of covered contracts
to ascertain that e contractor's practices coriply with its
disclosure statement and cost accounting standards.    The oro-
cedures state that a determination of compliance will be made
ducing the auditor's normal reviews of a contractor's incurred
costs, price proposal  evaluations, and functional audits which
evaluate a system or cost account for propriety of charges and
equity of allocations.   hIowever, the procedures provide for
separate audits to determine conpliance when there are little
or no usual audit requirements for a particular contractor.

     The auditors had ioentified and reported 30 instances where
the 3 contractors were not in compliance.   Noncomplianrce was
found most frequently witn respect to Standards 401, Consistency
in Estimating, Accunulating and Reporting Costs and 402, Consist-
ency in Allocating Costs Incurred for the Sair- Purpose.   The
auditors identitied 14 instances of noncompliance during reviews
of initial or revised disclosure statements and 7 instances of
noncompliance during reviews of contractor proposals. Other
noncompliance determinations resulted from reviews of contractor
oillings, progress payments, projected overhead rates and incurred

     We found that orescribed audit procedures generally had
been followed.  when the contractors initiated accounting system
changes, or new standards were issued, compliance was ascertained
primarily through reviews of the contractors' published account-
ing procedures.  Evaluations of the contractors' practices to
determine compliance were integral darts of all audit efforts.

                                   - 2 -

      However, our evaluation of planning for detailed examinations
revealed that your Agency did not have a control system that
separately identifies the extent to which contractor practices
had been evaluated for compliance with provisions of the
standards. Planning of future audits was accomplished by the
auditors considering the magnitude of expenditures, historical
audit experience in the specific area, and how recently the
particular cost area had been audited. Although this process
did consider to some extent the results of prior reviews, it
did 'oc assure that sufficient audit work was done to determine
whether the contractor fully complied with cost accounting
standards, rules, and regulations.

     Our review of the detailed audit work for selected
standards indicated that the auditors evaluated the contrac-
tor's compliance with many of the provisions in the selected
standards. However, some cost accounting standard provisions
were not addressed.
     At two of the contractors we made limited tests of
selected accounting practices not addressed Dy the auditors.
We found Instances at eacn of the contractors where existing
accounting practices did not comply with the standards. Because
of the limited scope of our examination, we did not attempt to
measure the significance of the noncompliances.

     Your headquarters representatives told us that audit
effort was directed to those areas believed to have tale greatest
potential for cost savings. Further, they said that since effec-
tive coverage of the contractor's compliance with cost accounting
standards is inherent to this system of planning, it is unnecessary
to give it special consideration in the planning process.   However,
with the increasing number of standards, the possible value of a
supplemental management tool to assist in monitoring compliance
tests is recognized.

     Agency officials showed us a relatively new management
control procedure which is being considered by headquarters
personnel and is being tested at selected sites. Under this
new procedure, the auditor determines which cost accounting
standard provisions are significant concerning the particular
contractor based on a materiality criterion. A provision is
considered material if noncompliance would have a significant
impact on Government contract costs or the administrative and
audit efforts. Planned audits are reviewed to determine if
compliance reviews can be included as a part of these audits.
If the compliance reviews cannot be included, seoarate audits
are to be programed. A control schedule will show the planned

                             - 3 -

review of each cost accounting standard and whether the
contractor complied or aid not comply with the standaid.


     Yout Agency Jeviews have included evaluations of the
contractors' operations for compliance with cost accounting
stanaards, rules, and regulations.   This effort has resulted
in numerous violations being id.ntifie' and tepoLted.   However.,
systematic contl.ols to provide for etfective evaluation ot
contractor practices foi compliance with provisions of the
standards shoula be improvea.   Further, out tests of contracto,
practices Levealea noncompliance in areas not adclressed ny
you! Agency. Since the auait proceauLes ana practices followeU
by youL auditors were genelally plescti !ed toL agency-wide
application, we would not expect this situation to vary
substantially at other locations.

     Your Agency is consiael.ing a "control scheaule for
compliance reviews" which would identify cost accounting
standard provisions significant to a particulai contractor
based on potential for impact on contract costs.   'his
schedule would show the !esults of audit woik accomplishea
and provide a basis fo,. planning additional work necessary.
We believe implementation of this proceaule woula signifi-
cantly improve the planning of compliance reviews, providing
the critelia established to iaentify significant standaid
provisions include all provisions that materially affect the
contLacto 'b accounting system.


     We recommend that you proceea with tne £uLthei aevelopment
and imple:nentation of the controls needed to assure that
sufficient audit covetage is given to contiactoL compliance
with cost accounting standaids, rules, and IecJulations.

     We would appreciate youL comments on this matter and
would be pleased to discuss any questions that you may nave.

     We ate furnishing copies of this leport to the SecLetaiy
of Defense, Office of Management and Budget, and interested
congressional committees.
                                3incel ely yours,

                                R. w. Gutmann
                                DiL ectot