oversight

EPA's Contract Management: Audit Backlogs and Audit Follow-up Problems Undermine EPA's Contract Management

Published by the Government Accountability Office on 1990-12-11.

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

                   United States General Accounting Ofllce
                   Testimony




For Release
on Delivcty         EPA’S CONTRACT
Eqxcted at
10 am. EST          MANAGEMENT
Tuerdoy
December 11,199o
                    Audit Backlogs and Audit Follow-
                    up Problems Undermine EPA’s
                    Contract Management


                    Statement of
                    Richard L. Hembra, Director
                    Environmental Protection Issues
                    Resources, Community, and Economic
                    Development Division


                    Before the
                    Subcommittee on Oversight and Investigations
                    Committee on Energy and Commerce
                    House of Representatives




GAOIT-RCED-91-5                                                    GAO Form 160 W/87)
Mr.   Chairman    and Members of the Subcommittee:

        We appreciate     the opportunity     to discuss     the auditing   of
contracts    awarded by the Environmental          Protection    Agency (EPA).
My testimony      today presents      the results    of our review,     made at the
Subcommittee's       request,   of the timeliness       of EPA's audit coverage
and follow-up       on audit  findings.      Our review included       an overview
of auditing     in general    and a detailed      review of the recent audit
histories    of six of EPA's ten largest          contractors.

        In summary, audit backlogs              and inadequate      audit follow-up       are
serious      problems at EPA because they increase                the vulnerability         of
EPA's contracting            dollars     to waste, fraud,     and abuse and make the
job of cleaning          up the environment         that much harder.       We found that
EPA has a large backlog of requests                   for audits    on its contracts,!
with audits        of funds paid to contractors            being delayed for years.
From fiscal        year 1983 through         fiscal    year 1990, the six contractors
we reviewed        received       contract   payments totaling       over $1 billion,
but most of these costs have not been audited                     despite    requests     from
EPA procurement          officials.        Delays in audits      of contractor      costs
have resulted         from decisions        by the Defense Contract        Audit Agency
 (DCAA)~ and EPA'S own Office               of the Inspector      General (IG) to use
their     limited     resources       for other types of audits.

       Under the present       system, the timeliness            of many audits      is
not completely      within    EPA's direct      control.       DCAA, which audits
most of EPA's contractors,          has a large backlog of cost audits                 and
has not kept up with EPA's requests.                EPA's IG devotes most of its
resources   to reviews of agency programs and has extremely                    limited
in-house   expertise       to audit  contracts;       therefore,     it uses

1~s the audit arm for the Department           of Defense, DCAA has as its
mission   to audit contracts       for Defense and provide      accounting    and
financial   advisory   services      for the negotiation,     administration,
and settlement     of contracts      and subcontracts.      DCAA also provides    a
range of contract     audit    services    to other federal    agencies,
including   EPA.
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independent     accounting     firms    to do most     of   its   own contract     audit
work.

         Audits   are necessary       for effective      management and are a
primary      tool for deterring        and detecting       waste, fraudr      and abuse.
Thus, we believe          this inattention       to contract     auditing     must be
corrected,       especially    since completed        audits    have uncovered
significant       problems with contractor           costs.     EPA contracting       and IG
officials,       understanding      the need for more timely             EPA contract
audits,      have requested      increased     contract     audit staffing,        and have
recently       begun to consider        ways to expedite       auditing.

        Even when audits        are done, EPA cannot be sure that identified
problems have been corrected             because it has not developed              a
reliable      audit follow-up      system.      The current       system     does not
contain     all audit reports       and findings        and contains       inaccurate
information       on corrective     actions.        Follow-up     can serve as an
effective      internal   control    mechanism for identifying               weaknesses to
senior    management and tracking           corrective      action     progress.

BACKGROUND

        Before discussing          our findings       in more detail,       I would like to
briefly     describe       EPA's contracting        program and the kinds of audits
that are performed           on federal     contracts.         EPA depends heavily      on
contractors       to operate       its programs.        About     20 percent    of EPA's
$5.1 billion        fiscal     year 1989 budget authorization             was obligated
for about 1,000 contracts.                The Superfund        program for cleaning       up
the nation's        worst hazardous        waste sites       accounted    for about    60
percent     of those contractual           obligations       in fiscal    year 1989.
Nearly     90 percent       of EPA's contracting          dollars    are spent on cost-
reimbursable        contracts,       which, compared to fixed price contracts,
provide     fewer incentives          for contractors        to control     costs and
require     more oversight         by the government.           As I testified     in
February      1989 before       the Subcommittee         on the Civil     Service,    House
                                            2
Committee on Post Office        and Civil    Service,     GAO has identified
numerous weaknesses in EPA's contract            management, in such areas                   as
Cost   COntrOlS,    the oversight      of subcontractors,     and the quality                of
contractors'     performance.2       In view of these weaknesses,         audits             can
play a critical       role in deterring     waste, fraud,     and abuse.

        Audits    can occur throughout       a contract's      life    cycle and can
serve a variety        of purposes.     Prior   to a contract        award, a preaward
audit    reviews the prospective        contractor's       cost estimates        or
prices.       Preaward audits     may also assess the contractor's              systems
for accounting,        procurement,   and property        management.       Although
preaward audits        are not required      by the Federal Acquisition
Regulation       (FAR)3 these audits     help ensure better          award decisions
by identifying       early any weaknesses in financial              systems    or
problems      with proposed costs,      according     to an issue        paper by a task
force of EPA IG staff.

        During the life         of a contract         or at its expiration,          a number
of audits,       collectively      called       incurred     cost audits,      review direct
or indirect        costs charged to a contract.                  Indirect  cost rate audits
review whether a contractor               has properly         allocated   overhead costs;
interim      audits    verify    whether the costs claimed are allowable;                    and
final    audits     help establish         proper final        payment amounts and help
allow the contract            to be closed out.           Audits of each year's
indirect      cost rate are required              by the FAR. The timing            of these
audits     is not specified        in the FAR, but they must be done before
final    audits     are completed.           Interim     audits     are done at the
discretion       of procurement        officials.         Final audits      are done for


2Sound Contract  Management Needed                 at the Environmental         Protection
Agency (GAO/T-RCED-89-8,   Feb. 23,                1989).
3Field   pricing  support   is required  for proposals    valued at more
than $500,000,    but preaward    audits are not required      if adequate
data are available     from other sources to determine       the
reasonableness    of the proposed contract    cost.

                                               3
contracts   over $1 million,           and final      in-house     desk audits      are done
for smaller   contracts.

        After    a contract      expires,      it must then be formally       closed
OUtr    which involves       determining         that contract     work has been
completed,       receiving     pertinent       bills   and other paperwork      from the
contractor,        and having a final          audit done if needed.       The FAR
requires      closeout     of fixed      price contracts       within  6 months, and of
cost-reimbursable          contracts      within     36 months, of the time when the
agency receives         evidence      that work has been completed         and receives
pertinent      paperwork     from the contractor.

       In auditing        its contracts,         EPA relies     largely      on assistance
from other agencies,            especially       DCAA. Although         not explicitly       set
forth    by federal       regulations        or Office     of Management and Budget
 (OMB) guidance,         customarily       the federal      agency having the most
business     with a contractor           usually     performs     audits     for all federal
agencies     that hold contracts             with that contractor.             DCAA currently
audits    three of the six case study contractors                      (Ecology    and
Environment,        Inc.;     ICF, Inc.;      and Roy F. Weston, Inc.);            EPA's IG
audits    two others (CH2M Hill,              Inc.;    and Riedel Environmental
Services,      Inc.);     and the Department           of Energy's       (DOE) IG audits       one
 (Ebasco Services,          Inc.).     These six contractors             currently     hold 44
EPA contracts         with a maximum potential             value of $3.7 billion.             The
staff    of EPA's.Procurement            and Contracts        Management Division          (PCMD)
requests     preaward and incurred              cost audits     directly       from the
appropriate       EPA divisional         IG office,       DCAA branch office,          or DOE
regional     IG office.          Under interagency         agreements the IG reimburses
other federal         agencies     for audits       of EPA's contractors.

AUDITS ARE UNTIMELY

        I would like to turn now to our first  issue--contract
auditing    at EPA. We found that,   with the exception     of preaward
audits,    which are generally being done, contract     audits  are
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backlogged.        Incurred     cost audits    and final        audits    have often been
delayed     for at least       4 years.    Such audit backlogs            contribute    to
untimely     contract     closeouts.      Without     effective       audits,     EPA's
contracting      dollars     are at increased       risk because audits            are a
primary     tool for deterring         and detecting      waste, fraud,         and abuse.

Incurred  Cost and
Final Audits Are Backloqged

       We found that incurred       cost audits    for the six case study
contractors      are backlogged.      These contractors     collectively
received     over $1 billion     in EPA contract     payments in fiscal         years
1983 through       1990, most of which remains unaudited.             Incurred     cost
audits    have been completed      only through    fiscal   year 1986 for CH2M
Hill,    Riedel,    and Roy F. Weston and only through fiscal             year 1985
for Ebasco, Ecology and Environment,           and ICF.     DCAA officials         said
they have work in progress         and expect to complete audits            through
fiscal    year 1989 for ICF and Weston and through fiscal                year 1988
for Ecology and Environment         by the end of fiscal       year 1991.

        We also found that incurred             cost audits       for EPA's contractors
overall     are backlogged.        As of November 30, 1990, PCMD data showed
273 outstanding        requests     for incurred       cost audits,      about 40 percent
of them over 2 years old.               The majority      of PCMD's audit       requests
are to DCAA, which audits             these contractors.            EPA'S outstanding
requests     are part of a substantial             backlog     at DCAA of incurred       cost
audit    requests    on defense and nondefense              contracts    that had grown
from about $33 billion          worth of contracts           in fiscal     year 1981 to
nearly    $170 billion       in fiscal      year 1989, according         to DCAA. In
fiscal    year 1990 DCAA reduced this backlog                  somewhat from the
previous      fiscal   year:    the dollar        value of contracts        for which
there were outstanding          audit      requests    decreased by $9 billion,          and
the number of backlogged            audits     decreased     by about 640 from their
fiscal     year 1989 peaks.


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      Backlogs of annual incurred     cost audits  contribute to delays
of final   contract  audits.    As of August 1990, PCMD had a backlog   of
85 final   audit requests,   all of them to DCAA.4

Contract    Closeouts     Are Untimelv

       Partially    because    of the audit    backlogs,    EPA does not always
meet time frames imposed by the FAR for closing                out contracts       (6
months for fixed price and 36 months for cost-reimbursable
contracts).       Contracts    cannot be closed out before annual indirect
cost rates are verified         and final    audits   completed.    The six
contractors      we reviewed hold 47 contracts         that have expired       but
have not yet been closed out.             EPA has not even initiated        closeout
or requested      audits    on about half of the 47 contracts.

       An internal       study by PCMD of selected         cost-reimbursable
contracts      closed in fiscal        years 1987 and 1988 found.similar
problems     with the timeliness           of PCMD's contract     closeouts.          As of
October 1990, EPA had almost 2,400 expired                 contracts      worth nearly
$4.1 billion       that have not yet been closed out.               EPA has not even
begun closing        out over 1,000        of these 2,400 contracts          although
some were completed            as many as 19 years ago.        EPA's problem with
untimely     contract      closeouts     is not unique.     According        to documents
from DOE, as of June 30, 1990, about                47 percent     of the agency's
contract     closeouts       in fiscal     year 1990 exceeded federal           time
frames.

        The FAR time frames for closing         out contracts    begin only after
the agency receives        evidence    that the contract    has been completed
and obtains     pertinent     paperwork    from the contractor.      Because these
actions    frequently     are not performed     promptly,   closeout   delays do

4PCMD's data include         audit  requests from EPA headquarters,      but not
from EPA's Cincinnati         or Research Triangle    Park contracts
management divisions,         which also request   final  audits    and close
contracts.
                                             6
not necessarily     violate      the FAR. But delays of years before
closing   out expired     contracts     run counter   to good management.
According    to EPA's IG, when contracts          are not closed on time,  funds
are not deobligated,        thus increasing     the federal   government's need
to borrow and reducing         the interest    on funds due the government
from any contract      overpayments.

Audit   and Closeout Delays
OCCUr   for Various Reasons

         The audit and closeout           delays occur in part because agencies
auditing     EPA contracts        place low priority       on incurred    cost audits.
EPA's IG, DCAA, and DOE's IG all give the highest                    contract    audit
priority     to preaward audits           because they help ensure better         award
decisions      by verifying       contractor      cost projections,    according     to
agency officials.           Additionally,       problems   with EPA IG's
coordination      and managing of audits            have contributed     to some
delays.

         The agencies have cited           resource      limitations       as affecting     the   -
timeliness      of contract       audits     done.      Of the staff       years expended on
audits     by EPA's IG and its contracted                auditing      firms,    about 3
percent      were charged to contract            audits      in fiscal     year 1989.
According      to EPA's IG, adequate            resources       have not been available
to perform       all essential       audits.       DCAA has had backlogs           of incurred
cost audits        for years,     in part as a result             of increasing      work loads
during     the military      buildup     of the 19809, according               to DCAA
officials.        Although    DCAA's audit         staff     has grown, increasing         work
loads and a hiring         freeze produced an increasingly                    unmet demand for
 incurred     cost audits.        DCAA has begun to reduce its audit                  backlog,
but expects elimination             of the backlog         to take several        years.

       Priorities      for conducting    audits   and the limited   resources
delayed    audits    for the contractors       we reviewed.    For example,
between March       1988 and September      1989, PCMD requested    five audits
                                              7
Of CH2M Hill      and Riedel that the EPA IG's Western Audit Division
did not begin because the division          gave priority    to internal    and
construction      grant audits    and because additional     funds were not
available     to meet the requests.       During this period,     four major
Superfund     cleanup contracts     with a maximum potential      value of $664
million     were awarded to CH2M Hill      with internal   reviews of proposed
costs by PCMD instead        of the usual preaward audits       by independent
auditors.       According  to a PCMD official,     these audits     were not
requested     because the IG had told PCMD that funding          was not
available.

      Delays     in funding    audits    by other agencies,        communication
problems    with other federal        audit groups,       and changing the private
accounting     firms performing       audits     also contributed      to delays     in
auditing.      For example,     PCMD's requests        for incurred      cost audits    of
Ebasco were not done for several              years by DOE, the agency which
performs    audits    of Ebasco, in part because setting              up an
interagency      agreement to reimburse          DOE for audit services,
previously     provided    free to EPA, took the EPA and DOE IGs more than
a year.     In another case, misunderstandings               between the EPA IG and
DCAA about which agency would audit                ICF in the future       led DCAA to
suspend for 2 months 12 audits              of the contractor      that were in
progress.      An 8-month delay in audit work on Riedel and CH2M Hill
resulted    when EPA IG switched          independent     accounting     firms in 1989,
which compounded existing           delays on these contractors.

        While the incurred     cost audit backlog     has delayed closing    out
contracts,      closeout delays also have been caused in part because
EPA does not have procedures          that identify   who is responsible   for
specific     steps in contract     closeout   or establish   time frames for
performing      them.

       EPA IG and PCMD officials  have recognized  the problems with
backlogged   audits.  To address them, EPA's IG is contemplating
doing the auditing   of several  major contractors   instead  of relying
                                           a
on other agencies to perform    the audits.   Although    this proposal
may help,  audit delays could result    if EPA does not expend more
resources   for contract audits   and does not coordinate     closely   with
other federal   agencies that use these contractors.

More Timely     Audits Are Needed
for Several     Reasons

        According      to the Director          of PCMD, unfulfilled      audit requests
make it difficult          for EPA to effectively           manage its contracts.       He
added that unfulfilled               requests    can result    in added costs,    waker
negotiating       positions,         and the failure      of EPA to live up to its
contractual        responsibilities.            When annual incurred      cost audits   are
delayed,      contractors        may lose or misplace        records,    making the
audits    more difficult          to perform.       For the Super-fund program,       such
missing      records can hinder            the documentation      of costs and can
affect     the government's            attempts   to recover cleanup costs from
parties      responsible       for cleaning       up hazardous     waste sites.

         The problems identified         by audit   reports   and PCMD's       internal
reviews of the six case study contractors                also demonstrate         why more
timely     audits   are needed.      For EPA contracts       held by each        of the
contractors,       we reviewed all 68 audit         reports   provided    by     EPA and
DCAA, and 29 financial          monitoring     reviews (FMRI.5       These     reports
identified       some recurring    problems.

        For example, commonly cited       problems    in FMR reports      included:
unallowable,    unauthorized,      or unsupported     charges;  deficient
billing    and accounting     systems;  failure    to submit required
documentation;     potential    cost overruns;     inadequate   administrative

SFMRs, which are internal            reviews performed        by PCMD staff      of large
ongoing Superfund contracts,             cover billing      and accounting       systems,
direct   contract     costs,    costs billed     by subcontractors,         indirect
costs,   and other aspects of these contracts.                  Although    FMRs are not
independent     audits,     they can identify        contract     problems that are
current,    which may prove especially           important      in the absence of audits.
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procedures;    and deficient  timekeeping.               More specifically,   audits
of one contractor    over several    years           revealed  ongoing timekeeping
problems:

      --    A 1990 audit by DCAA questioned       approximately      $180,000 in
            labor costs from fiscal      years 1986 to 1989 because the
            contractor    charged EPA for about 11,000 hours of employee
            time off in excess of earned time off and holidays.               This
            time off was in addition      to time provided      for in the
            contractor's    policy,  and, according    to the audit      report,
            the contractor     could not adequately    explain     why the
            government    should pay for these costs.

       --   During    a "floor   check" to verify    that employees were
            actually    working on the projects      assigned,   which DCAA
            conducted     as part of a special    interim    1989 audit, the
            contractor      was unable to locate    over half of the employees
            selected    for checking.

AUDIT FOLLOW-UP IS INADEQUATE

        The second contract           auditing     area we reviewed was audit
follow-up.           Agencies are required         by OMB to establish        a system        to
track    whether problems identified               in audit    reports    are corrected.
EPA's system          is not effective.          EPA's IG reported      in September 1989
that the agency did not have an effective                     audit follow-up       system.
The report         noted that the system          was not producing       accurate          .
information          on what, if anything,         was being done to correct            the
problems       uncovered by audits.            According    to the report,        in one EPA
region,      officials       responsible      for reporting     on corrective       actions
considered         the process nothing         more than a "paper shuffling"
exercise       and did not check the accuracy              of the information         that
program officials           gave them.        As recommended by the IG, EPA listed
audit    follow-up        as a material       weakness in its Federal         Managers'


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Financial   Integrity Act of 1982 (FMFIA)              report    to the President        and
the congress for fiscal   year 1989.

       In   1990   EPA initiated       a new audit       follow-up   system, but an
August 1990 IG report           concluded     that it was still        unreliable.      For
example,      several  corrective       actions     shown as completed        in the audit
follow-up      data base were not completed.                 Because of these ongoing
deficiencies,       EPA is considering          reporting      audit follow-up     as a
material      weakness again in its fiscal              year 1990 FMFIA report.

        In addition    to containing    inaccuracies     about action   on audit
findings,     the follow-up     system,   we noted,   is incomplete--it    did not
include    some audit reports       on EPA's contractors      or any GAO reports.
The contractor      audit reports     were omitted   because they were not
included    in the IG's data base of completed           audit reports.

        The data base maintained        by EPA's IG logs completed             audit
reports      and is used to compile       the IG's semiannual          reports    to the
Congress.       The IG's data base is the primary           source      of information
on completed        audits   for EPA's audit    follow-up     system.       The IG's
data base also records whether agency officials                 develop corrective
action     plans within      180 days of receipt      of the audit report.           Once
the IG receives         the plans,   the agency follow-up        official,      using the
audit    follow-up      data base, is supposed to track          them to ensure they
are actually        implemented.     Omissions    from the IG's data base cause
the audit      follow-up     system  to be incomplete.


         In reviewing        data pertaining      to the six case study
 contractors,        we found the IG's data base did not contain              three
 reports     by DOE on Ebasco and three reports               by DCAA on ICF.
 Because of these omissions,              questioned    costs totaling    about $7.6
 million      from the DOE reports         and several    problems requiring
 resolution       identified      in the DCAA reports        were not tracked    in the
'EPA follow-up        system     nor reported     semiannually    to Congress by the
 IG, as required          by the Inspector       General Act of 1978, as amended.
                                            11
      Collectively,         these omissions  result in incomplete    reporting
on audit    follow-up       to the agency head and, in turn,    to the
Congress.

SUMMARY

       To recap, Mr. Chairman,       in an era of large federal                    deficits,
good contract    management and auditing       help ensure that                   EPA wisely
spends its limited      funding   for environmental     programs.                  This is
especially    important    because the nation     faces hundreds                  of billions
of dollars    of unmet environmental      needs.

        EPA has recognized         problems       with audit backlogs           and follow-up
and is acting        to correct      them.       However, obtaining          timely    audit
coverage of contracts           is not completely            within    EPA's direct
control     under the present          system of having the agency spending                    the
preponderance        of the federal        dollars      with a contractor          perform the
audits    of that contractor.             The full      resolution        of these problems
requires      the involvement       of other federal            agencies,      as users and
suppliers       of audit services,         and OMB, which establishes                various
audit    policies.        In the interim,         however,      EPA can take more
aggressive       actions    to expedite         audits    of those contractors            that it
audits.       Because it will        undoubtedly        take years to eliminate,              we
believe     the Congress should be apprised                  periodically       of the status
of the audit backlog of EPA contracts.                       The IG's semiannual
reports     to the Congress provide              a means for doing this.              EPA can
also take steps to improve the timeliness                       of contract       closeouts      and
the reliability          of its audit       follow-up       system, including         the IG's
data base for tracking            completed       audit     reports.

RECOMMENDATIONS

       We are recommending           that,   to address more fully             problems      of
contract   auditing, EPA's           Inspector   General
                                                12
     --   report    the problem of obtaining     timely  audits     of EPA
          contracts    and any progress    toward correcting      it in the
          Inspector    General's  required    semiannual   reports    to the
          Congress;

     --   develop a plan for auditing        contracts     that EPA audits,
          including   identifying   and requesting       the resources      required
          to reduce the audit     backlog within       a reasonable    period     and
          keep abreast of future      requirements;      and

     --   correct     and accurately       maintain    the Office's      data    base that
          tracks    completed     audit    reports.
                    .

     We are also       recommending       that   the Administrator,       EPA,

     --   work with the other federal      agencies,    including OMB, to
          develop ways to expedite    audit   coverage of contractors     for
          which EPA relies  on other agencies        to audit and

     --   develop written          procedures    for closing       out expired
          contracts,       including     better    defining     closeout
          responsibilities          and establishing        time frames for      meeting
          them.

      Mr. Chairman,      this concludes   my prepared statement.     I will
be glad to respond       to any questions   that you or Subcommittee
Members may have.




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