COVID-Related Audits and the DCAA’s New Audit Direction

Merle M. DeLancey Jr. and Craig Stetson*

This is the third in a series of posts regarding what we believe will be an onslaught of government investigations and audits of COVID relief funds and contracting. Previously, we identified likely categories of programs, contracts, and companies the government might investigate or audit. Below, we discuss the Defense Contract Audit Agency’s (“DCAA”) current direction, interests, and initiatives related to contractors’ receipt of COVID relief funds and the impact an uncertain business environment may have on government contract pricing and costing forecasts.

COVID Relief Funds

The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) funding opportunities come with unique government contract compliance requirements and financial reporting obligations. The funding is not “free” and may result in financial consequences to unwary contractors. DCAA knows this and will be conducting audits to test contractors’ compliance with unique relief fund requirements. Contractors unaware of these accounting and reporting requirements risk DCAA questioning or denying costs.

In January 2021, DCAA issued an audit alert to its regional offices pertaining to COVID relief legislation and regulation.[1] The audit alert includes frequently asked questions and answers (“FAQs”) concerning contractors’ request or receipt of COVID relief funding. Originally released last summer, the FAQs have been revised and expanded several times. The FAQs telegraph DCAA’s position on various instances where COVID relief funding intersects with or impacts government contract cost accounting and compliance.

It is clear that COVID-related audit procedures will now be included in routine annual incurred cost proposal audits. Contractors are contractually required to submit to the DCAA incurred cost proposals in conjunction with performance under cost reimbursement contracts. Specifically, two COVID-related funding opportunities will be included in DCAA incurred cost proposal audits: (i) loans received and forgiven under the Paycheck Protection Program (“PPP”)[2]; and (ii) reimbursements sought under Section 3610 of the CARES Act.

Forgiven PPP Loans: The Department of Defense and DCAA consider forgiven PPP loans to be credits under Federal Acquisition Regulation (“FAR”) 31.201-5, Credits. Thus, some or all of the forgiven amount may be due the government in the form of a cost reduction or cash refund if the loan proceeds were used to pay a contractor’s incurred allowable costs that were reimbursed by the government under a flexibly-priced contract.

DCAA will likely inquire about contractors’ PPP loan status when conducting incurred cost proposal audits. If the loan has been forgiven, a contractor will need to demonstrate how the loan proceeds were used and if any of the costs paid with the proceeds are allocable to flexibly-priced government contracts. If use of the proceeds aligns with costs allocable to a government contract, DCAA may question the costs in its audit report and recommend reimbursement to the government. A contractor would then be required to agree or not with the DCAA audit findings and negotiate a resolution and settlement with its contracting officer. Contractors need to be aware and able to demonstrate the use of these funds to determine if the government is due potential credits under applicable contracts.

Section 3610 Reimbursement Requests: Contractors may seek reimbursement under Section 3610 of the CARES Act for costs incurred related to paid time off for employees who could not report to work or work on a remote basis. Typically, contractors will seek reimbursement through a request for equitable adjustment (“REA”). When seeking reimbursement under Section 3610, a contractor will need to report these costs and potential REAs in its annual incurred cost proposal. The form in which these costs are to be reported is not discretely defined and is subject to discussion and agreement with the contracting officer.

DCAA likely will ask questions regarding the REA and request explanation and documentation to determine if these costs have been accumulated and accounted for in accordance with the government’s extensive proposal submission and cost accounting requirements. DCAA will likely delve into the (i) contracting officer’s initial determination of the contractor’s “affected contractor” status; (ii) discrete capture of specific costs and separate contract line item reporting; (iii) comprehensive rationale and clear entitlement arguments regarding the paid leave situation; (iv) various representations regarding notification to the government if credits are received in the future; and (v) review and opinion on the adequacy and compliance of REAs received from subcontractors. These are simply examples; other reporting requirements exist and may be the subject of audit procedures performed by DCAA.

Contractors seeking reimbursement under Section 3610, whether related to fixed-price or cost reimbursement contracts, need to understand the reporting and accounting requirements. The first step to a favorable settlement with the government is a successful DCAA audit. The government has wide discretion to pay costs claimed under Section 3610 but it is not mandated to pay anything. Be proactive, communicate with your contracting officer and DCAA frequently. Thoroughly document all aspects of DCAA’s requests and maintain contemporaneous, clear, and proper supporting documentation to maximize the likelihood of favorable settlement.

Pricing and Costing Forecasts

DCAA will also be looking at forward pricing proposals or other similar arrangements to determine if revisions to these forecasts may be recommended due to a variety of circumstances arising from COVID. Examples of COVID-related factors that may impact financial forecasts include fluctuating sales volumes due to changes in customer demands, employee headcount and availability of resources, changes in overall budgets and spending patterns and ongoing disruptions in general related to as-planned performance and execution of contracts.

The results of a DCAA audit of forward-looking financial models may lead to contracting officer requests for contractors to revise pending proposals or renegotiate existing agreements to incorporate the estimated financial effects of the current and short-term business environment. Outstanding price proposals subject to the submission of certified cost or pricing data should be reviewed to determine if applicable disclosures to the government are required to avoid or mitigate defective pricing risks. The ultimate effect of these types of DCAA audits will not likely result in the questioning or denial of incurred costs; rather, the more likely result will be a change in the estimate of future costs.

Follow Merle’s and Craig’s blogs for posts on other issues concerning to government audits and investigations arising from the pandemic:

Government Contracts Navigator | Blank Rome
GovCon Blog | Capital Edge Consulting

Merle DeLancey is a partner with Blank Rome LLP where his practice focuses on a wide variety of government procurement law. He represents clients contracting with federal and state governments, with an emphasis in the healthcare industry. Merle has experience in a broad spectrum of government contracting issues and litigation.

*Craig Stetson is a partner with Capital Edge Consulting where he focuses on assisting contractors interpret and apply the accounting and regulatory compliance requirements associated with federal government contracts. Craig routinely deals with a wide range of compliance matters related to accounting, pricing, contract administration, business systems, financial reporting and interpreting the requirements of the Federal Acquisition Regulation (“FAR”) and Cost Accounting Standards (“CAS”). Craig frequently speaks and writes on a wide variety of government contracting compliance matters, regulatory updates and current events.

[1] See MRD 20-PIC-006(R) Revised here.

[2] Note: Contractors are eligible to receive PPP loans only if certain small business size standards are met; conversely, large businesses should not have received any PPP loans.

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