Fix the Pentagon Part I: Create an Independent Audit Agency

The Need for a Federal Contract Audit Agency

Charles M. Smith

Last fiscal year, the United States Government awarded over $535 billion in contracts with private corporations, nonprofits and other entities. A significant percentage of these contracts are awarded not as safer fixed-price contracts or they were awarded without adequate price competition, meaning auditing is the only realistic defense American taxpayers have against contractor overbilling. There is only one agency with the authority and the ability to audit contractor proposals, assist negotiations and audit incurred costs under massive, fraud-prone and complicated cost-type contracts. That agency, despite conducting work across most of the federal government, is located within the Defense Department, underneath several layers of senior officials. The DCAA conducted 76 percent of contracts audits outside of the DoD, according to a recently published Senate fact sheet. But despite the existence of the DCAA as a de facto government-wide contract audit agency, the US government still does not have the complete capability to use audits to help manage and provide oversight on the hundreds of billions of taxpayer dollars that go out the door to contractors every year. Also, the DoD has the worst history of all agencies in knowing where its money is, having flunked many contract audits and having never passed an overall fiscal audit, as required by law. If this trend is allowed to continue, the DoD's tolerance for disastrous contracting habits could infect the rest of the government

On February 1, Sen. Claire McCaskill (D-Missouri) chaired a hearing where she explored this issue in her Senate Homeland Security and Governmental Affairs Subcommittee on Contracting Oversight. She noted that the DoD utilized contract auditing far more than the rest of the federal government – while the DCAA conducts one audit for every $24.7 million, the rest of the US government conducted one audit per every $511 million spent. (Ironically, the DoD contracting officers can ignore the DCAA audit results and billions of dollars are not recovered.)

The reason why the DoD had approximately 15,000 contract audits conducted in 2009, and the rest of our government had 1,800 audits conducted in the same period, is due to DCAA's DoD-centric orientation, the way it is funded and its lack of visibility to the rest of the federal government. A proposed Federal Contract Audit Agency would remedy all of these problems, and bring numerous other benefits, such as greater independence and less pressure from undue agency influences.

Before offering a solution to improving federal contract audits, Let me describe the use of audits in federal contracting. Contract audits involve four main functions:

1. Prior to awarding a contract, audits examine the proposed price or cost of bidders on government contracts. These audits offer an opinion on whether the proposed price or cost is reasonable for the work expected to be performed. The government certainly does not wish to award a contract at too high a price. Also, the government does not want to award at a price which is too low and will prohibit full performance of the contract. A price that is artificially low will generally result in some form of contract failure. The government wants to award at a fair price for both parties, with the contractor supplying honest numbers and costs.
   
2. If the government engages in price or cost negotiations with the contractor, the audit provides an analysis of the contractor's proposal and recommends the price or cost which should be achieved by the government during negotiations. Within the DoD, the contracting officer must document any settlement that does not comply with the audit recommendations. In theory, this is one of the many checks and balances in military contracting, though, at higher levels, contractor influences can improperly enter this equation.
   
3. If the contract is a cost-type contract, the government audits the final costs incurred by the contractor. The audit examines these costs to determine if they were allocable to that contract, allowable under Federal Cost Accounting Standards and whether they have been reasonably incurred by the contractor. The audit will recommend costs unreasonably incurred that should be recovered by the government.
   
4. Auditors will audit contractor business systems such as cost accounting, purchasing, estimating, and other business systems related to government contracting. The Federal Acquisition Regulation stipulates that, if contractor's business systems are inadequate, the contractor should not receive any contracts of a cost type.

The DCAA conducts all of these audits for the DoD. Testimony before Senator McCaskill indicates that other agencies use a variety of sources for their audits. Agencies, such as the Department of Education, the Department of Energy and the General Services Agency (GSA) testified that they use internal contracting personnel for these audits, their agency inspectors general, and more often paying DCAA for audits. However, now these agencies are increasingly using outside contractors to perform audits. But as mentioned, the vast majority of the government outside of DoD heavily relies on DCAA.

Non-DoD agencies have trouble reimbursing DCAA for auditing services; the DCAA is only centrally funded to provide auditing for the DoD. Thomas Skelly, the acting chief financial officer at the Education Department, testified, “The department faces challenges regarding contract audits in deciding whether they take priority over other demands for limited administrative funds.”

Furthermore, DCAA naturally gives the DoD priority on their services. DCAA has a large backlog of final, cost-incurred audits for DoD contracts, often taking years to perform this function. The massive contracting effort to support operations in Kuwait, Iraq and Afghanistan has exacerbated this problem. For this reason, other agencies often find that DCAA cannot meet their expected timeframes for conducting of an audit. So, the other agencies often contract out audit functions to private vendors.

The use of agency inspectors general is also a problem for most agencies. Inspectors general are assigned multiple investigative and management oversight tasks. Their experience and training is not always in financial accounting and auditing. The Education Department's Skelly added, “The department's inspector general has multiple priorities and DCAA cannot always accommodate non-DoD requests for audit support. Obtaining audit support from a nongovernmental firm can be costly and time consuming.”

The use of private contractors for audits is especially troubling. The committee found that a DCAA audit costs approximately $114 per hour. A contractor audit costs approximately $150 per hour, which is a 36 percent cost differential for using contractors. Even more important, contractor auditing involves the delegation of an inherently governmental function to contractors. Only governmental officials should be involved in reviewing the proprietary data of other contractors and making recommendations which lead to contract decisions. Also, contractors providing audit services often try to ascertain the results the agency wants, rather than the factual audit results, because they want to be in favor with the government agency that has hired them. In other words, a contractor performing audits might view the government agency as their customer rather than the US taxpayer. Additionally, there could be organizational conflict of interest concerns if a private sector auditor works for a prime contractor and also works separately for the government auditing a contract of the prime contractors. Such a situation would beg the question: for whom is that private sector auditor working?

What is the resolution of this problem? I would propose the following:

1. The Congress should establish a Federal Contract Audit Agency (FCAA). This organization could be an independent agency which reports directly to the president, such as the Environmental Protection Agency. The organization could also be located in the Office of Management and Budget (OMB), reporting through the director of the OMB to the president, if this is a more efficient way of administratively achieving such a government-wide agency.
   
2. The DCAA should be dissolved with the staff transferred to this new agency and become the nucleus of the FCAA, with new sets of rules that require a new set of loyalty. Additional resources should be provided to this agency to preclude the use of agency contract personnel, agency IGs and contractors to perform contract audit functions. The agency's mandate should be to perform the contract audit functions described above. All agencies would identify their auditing needs and the FCAA would be resourced to the extent it can provide timely services to all of these agencies.
   
3. Agencies should be prohibited from using contractors for any of the audit functions described above.
   
4. There should be a formal adjudication rule for resolving differences between the findings of an FCAA audit and the agency contracting officers.
   
5. The FCAA should present a yearly public report to the president and to Congress on the results of their work. There must be transparency on how their recommendations are treated by the agencies. The government agencies must learn that without a clear audit, their funding may be in jeopardy, and that they ignore negative audits at their peril.

The advantages of such an agency would be:

1. A single agency could standardize audit approaches for all agencies under government best practices and should eliminate the use of contractors for performing audits. This last is very important.
   
2. A single, separate agency would enhance the independence of auditors for DoD work. Now, as part of DoD, the auditors appear to sometimes react to departmental agendas rather than auditing data. For example the DoD is reducing their use of DCAA and transferring actions to the Defense Contract Management Agency (DCMA.) Since the DoD has been a multi year failure with contract and financial audits, a separate and independent audit agency may be the only way to force fiscal reform.
   
3. Budgeting and planning for audit support across the government would be strengthened. Today most agencies, including DoD, short change auditing resources since the recovery of funds does not always accord with the funding for audit resources. For example, in DoD audit resources are paid for by Operations and Maintenance funds, which is an area that is often raided by DoD management when there are overruns or shortfalls in the budget. The money saved is often in procurement appropriation funds that do not provide money for the DCAA.
   
4. The administrative costs would not be much, if any, greater than the costs of a robust DCAA. The GAO has estimated more significant costs of this transition; however, if these costs materialize they would be offset by not paying for higher cost private contractor auditors versus lower cost government auditors. The recovery of additional funds would also offset any increased administrative costs. When true and tough auditing is allowed and audit recommendations are taken, it almost always more than pays for itself several times over from the money that has been saved.
   
5. The current arrangement of other agencies reimbursing DCAA for services would end – and an FCAA would be centrally-funded for audit work across the federal government. All agencies would use one source for audits that is not under their management umbrella and this would also remove the budgetary and conflict-of-interest that arises in using private contract auditing.

I am not the only advocate for a FCAA. Mr. Nick Schwellenbach of the Project on Government Oversight proposed this solution to the McCaskill subcommittee during his testimony. While Senator McCaskill was somewhat apprehensive of creating a new government agency, I believe the currently available data suggest this agency would, in fact, pay for itself and bring a separate and new look at DoD's money.

I personally have had great experience with the government auditors at DCAA during my career in military contracting even when their recommendations have been studiously ignored by the government contract managers. While the agency has had management problems in the far and recent past, the audit products that I received were accurate, comprehensive and indispensable for proper contract management and oversight. This type of auditor should be removed from pressure of the internal DoD politics and pressure and then maybe the DoD will truly find its contract money. With that honest accounting at the base level, the DoD may finally pass an overall fiscal audit. The entire Federal government contracting community should have automatic access to this same level of support and absence of contract politics and influences. Establishing an FCAA will provide that access and promises to save the taxpayers billions of dollars and make a better working government that is free of damaging influences.