DCAA Backlog: What It Means for Industry

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The Defense Contract Audit Agency’s audit backlog is old news, but Congress’s recent attempt to cure that backlog has garnered industry attention — and more than a few raised eyebrows. In an apparent effort to redirect resources toward alleviating the problem, Congress has prohibited DCAA from providing audit support for non-defense agencies.  But what does this mean for contractors?  

Section 893 of the 2016 National Defense Authorization Act aims to improve DCAA’s audit support function and resolve the backlog by prohibiting it from providing audit support for non-defense agencies until its “backlog for incurred cost audits is less than 18 months of incurred cost inventory.”  

The provision also attempts to remove any financial incentive for DCAA to flout this restriction; beginning in fiscal year 2017, it reduces the agency’s appropriated funding “by an amount equivalent to any reimbursements received by” DCAA for audit support provided to non-defense agencies.

In a Jan. 7 memorandum, DCAA narrowly construed Section 893’s reach. As an initial matter, it interpreted the restriction as pertaining only to audit support, concluding that the agency remains available to provide other services such as negotiation support, litigation support, investigative support and non-audit services to civilian agencies.  

In addition, DCAA has determined that it may continue performing audits that contain a mix of Defense Department and non-DoD contracts under certain conditions. Audits of indirect cost rates, also known as incurred cost audits, necessarily require auditing of all the indirect costs incurred by the contractor to determine a rate to be charged to all contracts.  Because these audits cannot be segregated by a contracting entity, DCAA reasoned that such audits should remain within its purview. And although direct costs can be segregated by contract, the agency further concluded that its auditors may retain that work as long as including the non-DoD contracts in the audit requires only “de minimis additional effort.”  

In either kind of blended audit, the benefit received by the non-DoD agency will remain reimbursable to the Defense Contract Audit Agency; however, any reimbursement received from the non-DoD agency will reduce the appropriated funds available to DCAA.

While DCAA and procuring agencies figure out how to work with and around Section 893’s constraints, contractors are left to wonder what this means for them. Below are some immediate considerations for contractors with Defense contracts, non-Defense contracts, or both.

For contracts with defense agencies, expect more attention from DCAA, which is now under even more pressure to resolve its audit backlog, but with fewer resources to accomplish that goal. Congress is stripping the agency of the revenue it otherwise would generate from its audit services for civilian agencies, leaving it in a circular funding crunch.  

DCAA is likely to keep concentrating its limited resources on high-risk, high-value audits and expedite lower-risk, lower-value audits. While this carries the potential of smaller audit matters falling through the cracks, contractors with high-risk, high-value matters should anticipate DCAA’s full attention.

For contracts with civilian agencies, expect less attention from DCAA, but not radio silence. Although it already has started terminating its audit services for civilian agencies, it has made clear that it does not plan to cut off those agencies entirely.  

DCAA has carved out two areas where it will continue working with civilian agencies: services other than audit support; and audits with a mix of DoD and non-DoD contracts for indirect cost rate proposals, or for direct cost audits.  

Thus, contractors that operate largely, but not exclusively, in the defense space should not expect the agency to disappear entirely, even with regard to their non-DoD contracts. Contractors in the inverse situation, however, may encounter dissected audits, with DCAA leaving to civilian auditors the non-DoD portions of audit cases that it historically would have handled.

Be prepared for some growing pains with civilian agencies that have come to rely on DCAA for cost expertise. While civilian agencies are figuring out a new supply chain for their audit support services, there may be a lull in audit activity. Civilian agencies likely will use both in-house staff and private contractors to pick up where DCAA left off.  

Pay attention to record retention requirements and statutes of limitations. To the extent that civilian-agency audits slow down as DCAA chips away at its defense-agency audits, contractors on the civilian side should remain particularly vigilant about the Contract Disputes Act’s six-year statute of limitations — both in terms of the timeliness of their own claims against the government and as an affirmative defense against any claims the government might assert against the contractor. Contractors also should closely review their record retention requirements in light of any stale contracts or contract years that have not been closed out.  

Section 893 is unlikely to be the silver bullet. For the same reason that DCAA likely will continue prioritizing high-risk, high-value audits in an effort to get the most bang for its buck, Section 893 is unlikely to solve its backlog. The agency estimated in 2014 that only 10 percent of its budget was for civilian agency audits, so it is unclear whether sufficient resources will be freed up by the new restriction to make a meaningful impact on the backlog inventory. And even if that theoretical 10 percent could be entirely redirected to the incurred cost backlog, it is similarly uncertain whether the corresponding lack of civilian-agency revenue would undercut the utility of that otherwise available workforce.

Congress may revisit the restriction on non-DoD audit support next year if DCAA successfully eliminates the backlog, the restriction proves ineffective or becomes disruptive to contract administration and payments.  

Scott Freling, Kathy Brown and Kayleigh Scalzo are government contracting attorneys at Covington & Burling LLP.

Topics: Business Trends, Doing Business with the Government, Defense Department