DCAA Changes the Grading Scale

Many companies have been “getting by” for years with systems that are generally OK, but have issues. DCAA would issue a report with a finding that the system was “deficient in part” and make suggestions for improvement. For the most part, as long as the contractor promised to make the suggested improvements they could continue to operate. They may not be able to do that for much longer.

Under the old scale, grades for systems reviews ranged from “A” (we really couldn’t find anything worth writing up) to “F” (completely unacceptable for use on Government contracts). But there were plenty of grades in between. A minor deficiency would get you the equivalent of a “B” or a “C+” and ordinarily you could keep using the system for as long as you kept promising to fix it. If you never really got around to fixing it, nothing much happened. Even a material deficiency only got you a “C-“ or a “D.” Fixing that kind of problem had a little more urgency to it, but you could take a reasonable amount of time to get it done and you could usually rely on the recommended improvement in the audit report.

On December 19th, 2008, the Defense Contract Audit Agency (DCAA) issued new audit guidance to clarify what constitutes a significant deficiency or material weakness and to establish new guidance on reporting audit opinions on contractors systems. DCAA’s new posture is that a system review may ONLY result in a finding of either “wholly adequate” or “inadequate.” And, they will no longer make ANY suggestions for improvement. In addition, the guidance memo directs that all reports with a finding of inadequate should include a recommendation to the Administrative Contracting Officer (ACO) that payments to the contractor be suspended on all cost-type contracts and fixed price contracts with progress payments until the problem is fixed. Click this link for a copy of the letter from the DCAA web site.

It looks to me like DCAA’s grading system just became pass/fail! The only grades now are “A” and “F.” And, if you get an “F,” your cash flow could dry up until you fix the problem. And, of course, under the new ban on suggestions for improvement, how you fix it is up to you.

Of course, fixing the problem really isn’t the issue. Assume you could remedy the problem instantly – despite the fact that DCAA is refusing to make any suggestions. It could still take weeks or even months to get DCAA to conduct a follow-up review, write a new report and then get the ACO to reverse the suspension of payments. And, if that wasn’t enough, an audit report concluding that a contractor’s system is “inadequate” could preclude award of new cost-type contracts until the report is rescinded or superseded.

Being ineligible for new contract awards is a bad thing, but months under a payment suspension could be fatal. With today’s credit constraints, most small and mid-sized firms’ wouldn’t last that long without cash flow. Companies might think they could survive a temporary payment suspension, but many wouldn’t. And, with no receivables to secure additional financing, the banks aren’t likely to be willing to help.

So where did this new attitude come from and what’s a company to do?

The guidance appears to be a knee-jerk reaction to a GAO report from last summer that concluded that some DCAA audit reports did not meet professional standards and, that in some cases DCAA was much too close to the contractors they were auditing. To be fair, it also concluded that DCAA was too close to the Government Program Offices on whose behalf they were conducting the audits! In short, they were just being too cooperative, too collaborative and TOO NICE! Click here for a copy of that report.

I’m sure the Agency saw this new guidance as necessary to address perceived auditor independence and GAGAAS compliance issues, but collaboration and cooperation weren’t the problem. I worked in the industry when the relationship between DCAA and contractors was extremely adversarial and it did NOT produce a better result.

This seems like a return to the bad old days and unnecessary to boot.