What Exactly is an Acceptable
Accounting System?
Kristen Soles, CPA – Member
Stephanie Widzinski, CPA – Senior Manager
September 27, 2012
Agenda
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Review DFARS Business System Rule
What Agency is Responsible for Audits
Criteria for an acceptable accounting system
Material Weakness and Significant Deficiency
definitions
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DFARS Business Systems Rule
• The Business Systems Rule was established in
response to the National Defense Authorization Act
(NDAA), section 893, which set forth statutory
requirements for the improvement of contractor
business systems
• The goal was to ensure timely and reliable
information for the management of DoD programs
Published 18 May 2011 and effective that day
• To be incorporated into the Defense FAR
Supplement (the DFARS) at 252.242-7005
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DFARS Business Systems Rule
• DFARS 252.242-7005 – Contractor Business System
Clause
• Establishes a mechanism that allows the contracting
officer to withhold a percentage of payments when
the contractor’s business system contains significant
deficiencies
• The clause is only included in contracts and
solicitations that are subject to the Cost Accounting
Standards (CAS) and contain one or more of the
business systems clauses
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Business Systems & Clauses
1.
2.
3.
4.
5.
6.
DFARS 252.215-7002 – Estimating
DFARS 252.234-7002 – EVMS
DFARS 252.242-7004 – MMAS
DFARS 252.242-7006 – Accounting System
DFARS 252.244-7001 – Purchasing
DFARS 252.245-7003 – Property Management
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Who is Responsible?
• DCAA
– Accounting (18 criteria)
– Estimating (4 criteria)
– MMAS (10 criteria)
• DCMA
– Purchasing (24 criteria)
– EVMS (2 criteria)
– Property (10 criteria)
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The New Accounting System Audit
Subsystems
of
Accounting
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dcaa.mil
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Business Systems Rule
• Defines accounting systems as:
“The contractor’s system or systems for accounting
methods, procedures, and controls established to
gather, record, classify, analyze, summarize, interpret,
and present accurate and timely financial data for
reporting in compliance with applicable laws,
regulations, and management decisions, and may
include subsystems for specific areas such as indirect
and other direct costs, compensation, billing, labor,
and general information technology.”
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Does This Affect You?
• Does the DFARS Business Systems clause affect
you if you are not CAS-covered?
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The Real Danger
• How FAR does the Business Systems Rule Reach
(get it?)
• 16.104(h) Adequacy of the contractor’s
accounting system – Before awarding other than
a firm fixed price contract, the CO shall ensure
that the contractor’s accounting system will
permit timely development of all necessary cost
data…
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DCAA Response
• Activity Code 11070 Accounting System Audit Work
program – Revised April 2012 to incorporate testing of the
18 criteria defined in DFARS 252.242-7006
• “This program can be used at…
– Major and non-major contractors and
– Contractors that do not have DoD contracts
– And who are not contractually required to comply with the
DFARS criteria
– Nevertheless, the DFARS criteria are standards used in
determining the acceptability of any Government contractor’s
system for the accumulation and billing of cost under
Government contracts.”
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Other Revisions
• Activity Code 11010 – Billing Audit Work program,
Revised June 2012 to incorporate testing of the 18
criteria defined in DFARS 252.242-7006.
• Activity Code 17741 – Post Award Accounting
System Audit and Non major Contractors, Revised
June 2012.
• Activity Code 17740 – Pre-Award Survey of
Prospective Contractor Accounting System, Revised
August 2012.
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Pre-Award Survey of Prospective
Accounting System
• Common misconception:
“I passed my Pre-award Survey (SF1408); therefore, I have an
adequate accounting system.”
• A pre-award audit involves the evaluation of the design
effectiveness, not the operating effectiveness of the
accounting system.
• It involves NO detailed testing of transactions or reperformance of controls and, therefore, CANNOT be relied
upon to determine adequacy. There is no opinion issued.
• It is also only applicable to the prospective contract award
and that award only; it cannot be applied to other
contracts.
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Change in Format of Audit
• Entrance Conference and System Demonstrations
– List of requested items
– Contractor presents an overview of the
• Accounting system
• Processes (policies and procedures)
• Within 2 weeks of entrance conference, the contractor must present
detailed demonstrations of key processes – these presentations must
detail how each of the 18 criteria are being complied with
• Audit Fieldwork
• Draft audit report
• Exit conference
• Incorporate the contractors reaction and auditor response
• Finalize the report
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ACCOUNTING SYSTEM CRITERIA
Is Your System Adequate?
• Don’t think that just because your system has
been operational for X number of years that it is
adequate
• It’s a whole new ball game
• You should use the 18 system criteria as a
checklist to review your system and policies and
procedures
• You should be confident it is compliant before
the auditor shows up
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Policies and Procedures
• You should have written policies and procedures
for each one of the 18 system criteria
• This will be the first thing that DCAA requests
• Document(s) do not have to be long; they just
need to describe, in adequate detail, how your
system operates and who does what
• Refer to the ICQ form for additional policies you
should have in place
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Policies and Procedures
• Make sure your policy documents are up to date
– A revision date of five years ago isn’t exactly current
• Policies should agree to what is actually
happening and agree to your FS
• Distribute them and train your employees
• Good business sense
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The 18 Criteria
1. A sound internal control environment, accounting
framework, and organizational structure:
•
Policies & Procedures/Code of Ethics/Tone at the
Top/Organizational Structure and Assignment of
Authority/Governance
2. Proper segregation of direct costs from indirect
cost;
• Chart of accounts
• Direct cost can’t be charge indirect and vice versa
• Approval by a knowledgeable person
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The 18 Criteria
3. Identification and accumulation of direct costs by
contract:
• Project-based system
• Job cost ledger – ability to accumulate by contract
4. A logical and consistent method for the
accumulation and allocation of indirect costs to
intermediate and final cost objectives.
• Indirect rate structure should provide for a fair and equitable
allocation of cost. Reasonable cost/benefit relationship is
established
• Written description of pools and bases
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The 18 Criteria
5. Accumulation of costs under general ledger
control:
• Frequency of subsidiary ledger posting to GL
• AR, AP, Labor
6. Reconciliation of subsidiary ledgers and cost
objectives to general ledger:
• AP, AR, Project Ledger, Rates
• How often? Monthly, quarterly?
• How are variances corrected? Monitored?
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The 18 Criteria
7. Approval and documentation of adjusting entries:
• Segregation of duties - Entry, approval, posting
• Supporting documentation on entry
8. Management review or internal audits of the system
to ensure compliance with the Contractor’s
established policies, procedures, and accounting
practices:
• Polices and procedures for monitoring
• Who will monitor?
– Audit committee, Senior management
• How will you document this review?
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The 18 Criteria
9. A timekeeping system that identifies employee’s
labor by intermediate or final cost objectives:
• Paper or automated system
• Employee recording hours worked and to what cost objective
• Frequency of time entry, self-certification, supervisory approval
10. A labor distribution system that charges direct and
indirect labor to the appropriate cost objectives:
• Labor is posted to the general ledger (account / project on TS)
• Reconciliation exists between labor and payroll
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The 18 Criteria
11. Interim (at least monthly) determination of costs charged
to a contract through routine posting of books of account:
• Closing the books on a monthly basis
• Project reporting on a monthly basis, billings, financial reporting
12. Exclusion from costs charged to Government contracts of
amounts which are not allowable in terms of FAR part 31
and other contract provisions.
• Separately identified in the chart of accounts
• Ongoing training for employees on unallowable cost, most
importantly A/P folks
• Burden of proof is on the contractor – adequate backup
documentation
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The 18 Criteria
13. Identification of costs by contract line item and
by units if required by the contract:
• Understanding of contract reporting
• Can the system expand to the level of detail required?
• Proper set up of project for billing and reporting
14. Segregation of preproduction costs from
production costs:
• Unique project/accounts for segregation
• Process for communicating actual vs. estimated costs to the
pricing group for use in follow on pricing or re-pricing
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The 18 Criteria
15. Cost accounting information as required for:
a) Limitation of Cost (52.232-20), Limitation of Funds
(52.232-22) and Allowable Cost and Payments (52.2167),
– You must be able to calculate rates /provide cost incurred/billed
information to be in compliance with these clauses
– Who monitors?
– Process for communication between contracts and accounting
b) Readily recalculate indirect rates from books of account
– Calculation of indirect rates based on cost incurred
– Monitor and review of actual against provisional
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The 18 Criteria
16. Billings that can be reconciled to the cost accounts
for both current and cumulative amounts claimed
and comply with contract terms:
• Invoices should tie to/reconcile to project cost reports
• If special contract terms, your system should accommodate this
17. Adequate, reliable data for use in pricing follow-on
acquisitions:
• If you have complied with 1 – 16 your data should be accurate and
reliable
• Use as your basis for forecasting/pricing
• If necessary, incorporate impact on rates for potential win(s)
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The 18 Criteria
18. Accounting practices in accordance with
standards promulgated by the CAS Board and
GAAP
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Policies and procedures
CAS Disclosure Statement, if applicable
Financial statements
CAS 401, 402, 405 and 406 incorporated into FAR
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CAS 401 -> Consistency in estimating, accumulating, and reporting costs
CAS 402 -> Consistency in allocating cost incurred for the same purpose
CAS 405 -> Accounting for unallowable cost
CAS 406 -> Cost accounting period
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Acceptable Accounting System
• Business System Rule defines an acceptable
accounting system as one that complies with:
– Applicable laws and regulations are complied with;
– The system and cost data are reliable;
– Risk of misallocations and mischarges are minimized;
and
– Contract allocations and charges are consistent with
billing procedures
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Now What?
• You have the 18 criteria in place and your system
is operational.
• You are ready for an audit.
• Turns out DCAA disagrees……
• Can you say “Significant Deficiency”? “Material
Weakness”?
• What does that mean?
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Definitions
• The DFARS definition,
– Significant Deficiency: “Shortcomings in the system that
materially affect the ability of officials of the DoD to rely
upon information produced by the system that is needed
for management purposes.”
– Material Weakness: “A deficiency, or combination of
deficiencies, in internal control over compliance, such that
there is a reasonable possibility that a material
noncompliance with a compliance requirement will not be
prevented, or detected and corrected on a timely basis.”
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Guidelines for Determining Materiality
• The nature and frequency of the noncompliance
(extrapolation possible)
• The nature of the compliance requirements
• The root cause of the noncompliance
• Effect of compensating controls
• Possible future consequences
• Qualitative considerations (honoring public trust)
• History of corrections (vouchers, incurred cost
submissions , proposal pricing)
• Noncompliance with FAR 31.2, CAS, FAR part 15
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Is 17 out of 18 Good Enough?
That’s 94%! An “A” in Fairfax County
• DCAA guidance:
“A material noncompliance with any one of the 18
criteria indicates a significant deficiency/material
weakness exists and the contractor has not
complied in all material respects with the DFARS
criteria.”
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Timeline for Potential Withhold
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Coming Soon!
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Contact Us!
Watkins Meegan, LLC
8000 Towers Crescent Drive, Suite 950
Vienna, VA 22182
www.WatkinsMeegan.com
Kristen Soles, CPA - Member
Kristen.Soles@WatkinsMeegan.com
(703) 847-4411
Stephanie Widzinski, CPA – Senior Manager
Stephanie.Widzinski@WatkinsMeegan.com
(703) 342-5951
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