What is a business systems audit?
For contractors performing on cost accounting standard (CAS) covered contracts, there are six different business systems that could be subject to a determination of adequacy by the Federal Government per DFARS 252.242-7005. The six systems, and the corresponding government component that most often audits the system, are:
- Accounting system (DCAA)
- Earned value management system (DCMA)
- Estimating system (DCAA)
- Material management and accounting system (DCAA)
- Property management system (DCMA)
- Purchasing system (DCMA)
As the rules currently stand for DOD contractors, only a DCAA or DCMA (or rarely another government component) audited business system is considered an approved business system by the federal government. However, when the new DFARS rule goes into effect government contractors of all sizes with DOD-cognizance will have the ability to receive their business system reviews via third-party independent auditors. Rather than relying on DCAA, DCMA, or similar government components, contractors will gain the ability to control their own timelines and proactively seek business system approval via third-party independent auditors.
Why is this exciting for government contractors?
Currently, DCAA can only perform business system audits on “high risk contractors”, which translates very closely to larger prime level contractors, which in turn make up a very small number of government contractors. In February 2019, a report by the United States Government Accountability Office (GAO) (GAO-19-212) highlighted a deficiency in the number and timeliness of business systems audits performed by DCAA and pointed to insufficient resources as a cause. In Fiscal Year 2019, DCAA planned 50 business system audits and completed 30 of them. In 2020 they increased their planned number to 104, but completed 67. For 2021, they increased that number again to 183, but completed 107. That is an average of 112 audits per year, across all DOD contractors, over the various businesses systems, with a completion rate of 60%. DCAA’s objective for FY 2022 and 2023 are 183 and 200 audits respectively, according to the DCAA’s Fiscal Year 2023 Budget Estimates.
On top of the relatively low completion rate and low number of business system audits performed each year by government components, the chances are very high that if you have not received a DCAA business system audit in the past that you will not receive one in the future. This is especially true if you are considered a non-major contractor. Not receiving a government business system audit may sound appealing, however, having government approved business systems provide many benefits for the contractor.
Benefits of government-approved business systems
Having a government approved business system helps allow government contractors to gain a true understanding of the internal controls of their systems, and can provide valuable insight into where systems are strong and where they can be improved. An approved accounting system has adequate internal controls on 18 system criteria including:
- General accounting policies and procedures
- Misallocation and mischarging risk
- Financial reporting
This system criteria also includes a comprehensive list of other accounting system functions. Strong internal controls are the basis of accurate data, and accurate accounting data is often the basis of good business decisions.
One of the main reasons many contractors want to gain an approved purchasing system is because it can remove “consent to subcontract requirements” for subcontractors not specifically identified by the contracting officer. Per FAR part 44.201-1, if the contractor does not have an approved purchasing system, consent to subcontract is required for all cost-reimbursement, time-and-materials, labor-hour, or letter contracts, and also for unpriced actions (including unpriced modifications and unpriced delivery orders) under fixed-price contracts that exceed the simplified acquisition threshold. However, this is not the only reason that contractors should be seeking an approved purchasing system. Similar to an approved accounting system, an approved purchasing system will give contractors valuable insight into the internal control environment of their procurement systems. With good data and sound controls contractors will gain assurance that they are making purchases based on authorized requisitions, maintain complete transactional support for vendors and document subcontract and purchase orders, which are all subject to government review. Establishing this documentation process will also benefit internal audits, management reviews, trainings, and will help ensure that quality materials and subcontract services are purchased at the best value from vendors vetted as being responsible and reliable sources.
The estimating system is the contractor’s system which is responsible for generating acceptable and accurate proposals. Maintaining an approved estimating system will help contractors produce verifiable, supportable, documented, and timely cost estimates that are an acceptable basis for negotiation with the government. The estimating system must be integrated with the contractor’s related business management systems, such as the accounting system, thus it is of high importance to have an approved system with both strong internal controls and reliable data that can be relied upon for producing accurate proposals and which keeps the internal control system of their accounting system sound. An approved estimating system is one of the foundations of negotiating fair and reasonable proposals with the government and may result in lesser government scrutiny over certain pricing actions.
Material management and accounting system (MMAS)
The MMAS is the system used for planning, controlling, and accounting for material; it covers all phases from acquisition to use to disposal of materials. The MMAS is the heartbeat of the material system and an approved system that meets all system criteria will provide major benefits beyond simply having a system. The internal controls which are audited in an MMAS audit include ability to reasonably forecast material requirements, an accurate bill of materials (BOM), master production schedule (MPS), time-phasing of materials, strong controls on physical inventories, material transfers, cost benefits of direct materials, and logical allocations of common materials. An approved MMAS system should provide for complete transparency from the beginning of acquisition until use or disposal; cut down on waste, material fraud, and theft; and help identify efficiencies and inefficiencies in the entire supply chain.
Government property management system
The government property management system, described in layman’s terms, is very similar to a combination of an accounting system and an MMAS system that a contractor must maintain if they have property in their possession that was acquired by the government and subsequently furnished to the contractor. Per FAR 52.245-1(f) a property management plan, systems, and procedures must be developed by a contractor that covers:
(i) Acquisition of property
(ii) Receipt of government property
(iii) Records of government property
(iv) Physical inventory
(v) Subcontractor control
(vii) Relief of stewardship responsibility and liability
(viii) Utilizing government property
(x) Property closeout
Earned value management system (EVMS)
In order to assess cost, schedule, and track technical progress on programs to support joint situational awareness and informed decision-making, government and industry program managers utilize EVM. To be effective, EVM practices and competencies need to be integrated into the acquisition decision-making process. Furthermore, the data provided by the EVM system (EVMS) must also be timely, accurate, reliable, and auditable.
Once this new DFARS rule goes into effect, third-party independent auditors will be able provide attestation services related to any of the aforementioned contractor business systems.
Be proactive rather than reactive
Now is the best time act. Having your company’s business systems audited will help improve your systems internal controls, which are the drivers of accurate data and good business practices. An approved system with strong internal controls can help make the bidding, proposal, and follow-on processes easier, and can help to improve overall business functions.
Once the DFARS rule goes into effect, there will be a marked increase in the number of businesses looking to have business system audits completed, and those that are done first will gain a competitive edge.
Be ready to reach out to a CPA firm, like CohnReznick, that has been doing these types of audits for the government for a number of years.
Subject matter expertise
CPA, Partner - Managing Partner, Advisory - Global Consulting Solutions and Government Contracting Industry Leader
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