In its annual report to Congress, the Defense Contract Audit Agency (“DCAA”) released impressive metrics about its progress during the 2017 fiscal year. For many years, DCAA has struggled to manage a substantial number of backlogged incurred cost audits—most of which extended back several years, including some which extended back almost a decade. However, according to DCAA’s March 31, 2018 report to Congress (which was recently made available to the public), DCAA examined $281 billion in contract costs, identified $7.1 billion in audit exceptions, and reported $3.5 billion in net savings, all of which produced a return on taxpayer investment of approximately $5.20 to $1. Notably, DCAA advised that it had only 2,860 incurred cost audits in backlog at the close of 2017 and that DCAA expected to clear this inventory in 2018. While DCAA does not consider an audit to be backlogged until the submission has been pending for two or more years, the reported statistics mark a significant milestone for the agency. Indeed, going forward, DCAA advised that it expects to be fully compliant with Congress’s mandate in the 2018 National Defense Authorization Act (“NDAA”) that DCAA’s audit backlog inventory must not exceed one year.
DCAA’s 2018 annual report paints a far different landscape than those in DCAA’s prior reports to Congress. For example, in 2011, at the height of the audit backlog, DCAA had over 21,000 open audits in incurred cost submissions alone and immediate, subsequent years did not meaningfully reduce that caseload. Accordingly, just a short time ago, DCAA had nearly 10 times the number of open incurred cost audits that it had pending as of the close of 2017. This represents only 14.3 months of outstanding inventory, which is a substantial improvement over the 17.6-month average in 2016, many times the average in 2011, and just shy of the one-year backlog requirement newly imposed by Congress for 2018.
How did DCAA get from there to here? According to its March 2018 report, DCAA continued the innovative approaches that it had adopted in 2016 to streamline the audit process, which with the addition to the hiring of nearly 400 additional auditors, have continued to allow DCAA to clear its backlog much more rapidly. DCAA also continued to use a multi-year, as opposed to single year, risk-based approach to prioritize close outs of aging and larger incurred cost audits to great effect. 2017 also marked the first year of DCAA’s organizational realignment to create dedicated offices for major contractors (which comprised the bulk of the backlogged dollars that were outstanding) and other offices for large, medium, and small contractors. These dedicated engagement teams have apparently had great effect due to their ability to obtain and retain operational knowledge and experience with each contractor’s unique business systems and practices. DCAA further also has increased its use data analytics and statistical sampling techniques to speed up the audit process particularly in cases where labor-intensive manual reviews such as cost reasonableness analyses would otherwise be required. These initiatives, when combined, allowed DCAA to focus its resources on those contractor costs that present the greatest risk potential, including issues regarding cost allowability, allocability and reasonableness. DCAA has also requested that Congress continue to authorize hiring authority and also advised that DCAA will continue its use of data analytics to streamline the audit process.
What does this mean for contractors in 2018 and beyond? With its incurred cost audit inventory under control, we can expect DCAA to focus more attention on forward pricing rate audits and business system reviews. These areas are important to the government as forward pricing audits have the shortest audit cycle, yet offer the highest return on taxpayer investment, and more approved business systems should facilitate contract management, cost containment, and ultimately contract performance. Accordingly, contractors should expect increased engagement by DCAA in pending forward pricing and business system audits in 2018 and beyond. And, because much of the backlogged incurred cost audits had pertained to submissions by major contractors, which have now been mostly cleared, medium and small contractors may receive more attention from DCAA. Finally, because of the substantial progress DCAA has made in reducing its incurred cost audit inventory, the agency may re-prioritize its review of contract pricing adjustments, contractor disclosures, and False Claims Act investigations. Indeed, with more resources at its disposal, we may see a shift by DCAA in conducting these types of other and special audits back to 2011 levels, when DCAA conducted five times as many of them as it does now.
In sum, as industry prepares for more regular engagement with DCAA, contractors should proactively: (1) ensure that their files and systems are properly organized and designated so that only relevant data is provided to DCAA during an audit, (2) be prepared to challenge any improper data requests or audit findings, and (3) be mindful of any data analytic techniques used by DCAA, as they may not always be suitable or appropriate in all instances, or for all purposes, and can arrive at incorrect or misleading conclusions about a contractor’s business systems or practices.