dcaa/dcma compliance & audit changes facing all government contractors and recent trends in irs...

DCAA/DCMA Compliance & Audit Changes Facing All Government Contractors & Recent Trends in IRS Audits

Dusty Faske, CPADenise MetivierRichard Krucher, CPAInsero & Company CPAs, P.C.

August 27, 2013

Insero & Company presents

DCAA/DCMA Compliance & Audit Changes Facing All Government Contractors

Overview

1. Federal Procurement

2. Federal Contract Compliance Agencies and FAR Regulations

3. What Has Changed in Recent Years

4. Are You a Federal Contractor? Where Are You in the Federal Supply Chain?

5. Review of DCAA Compliance Basics

6. What This Means to Contractors

7. Strategies for Success

Federal Procurement

• The Federal Government is the largest buyer of goods and services in the world

• Department of Defense is the single largest government procurement agency

• 2014 DOD Budget = $526 Billion

• $8.4 Billion for 29 Joint Strike Fighters

Compliance Agencies

Defense Contract Audit Agency (DCAA)History:• Established July 1, 1965• Provides audit and financial advisory services to Department of

Defense (DOD) and other federal entities responsible for acquisition and contract administration

• Operates under the authority, direction and control of the Under Secretary of Defense Chief Financial Officer

• Vision: to protect the taxpayer’s interest• Mission: perform all necessary contract and subcontract audits in

connection with negotiation, administration and settlement of contracts and subcontracts to ensure taxpayer dollars are spent on fair and reasonable contract prices

• DCAA provides contract audit services to all federal agencies

Defense Contract Management Agency (DCMA)

• Vision: To provide DOD with leading experts in quality assurance; cost, schedule and supply chain predictability; and contract administration enabling supplier partners to achieve contract objectives

• Mission: To provide contract administration services to the DOD Acquisition Enterprise and its partners to ensure quality products and services to the warfighter on time and within projected cost

Federal Acquisition Regulation

• The principal set of rules in the Federal Acquisition Regulation system consists of sets of regulations which govern the acquisition process through which the government purchases (acquires) goods and services

• The FAR system regulates the activities of government personnel in carrying out the acquisition process

• The single largest part of the FAR is Part 52 which contains standard contract clauses and “solicitation provisions”

• Issued in 1983 and took effect in 1984

What Has Changed In Recent Years

• All federal contracts exceeding the $700,000 TINA (Truth in Negotiations Act) threshold require a compliant DCAA accounting system and operations

• Accurate reporting (typically certified cost and pricing)• Onerous recordkeeping• Strict management of intellectual and proprietary information regarding

disclosure• Need for federal contract specialists with current federal knowledge

and experience in a quickly changing compliance environment• Case by case understanding of requirements of each contract and

FAR flow down clauses• Understanding of contractor options and rights during audit and audit-

assist events• Understanding of exemptions to certified cost and pricing

Accurate Reporting

• Federal Funding Accountability and Transparency Act (FFATA) and Federal Subaward Reporting System (FSRS) are subject to:FAR 52.204-10 Reporting Executive Compensation and First-Tier Subcontract Awards, is inserted into all federal prime contracts and requires all federal prime contractors to identify in an annual report its first-tier subcontracts of $25,000 or more issued after August 27, 2012

• E-Verify federal contractor rule (2009)• Free, internet based system operated by US Department of

Homeland Security and Social Security Administration• Requires all federal contractors to confirm the employment

eligibility of all persons they hire during a contract term as well as their current employees who perform work under a federal contract within the US

What Has Changed In Recent Years

F-35 Contractor Supply Chain Statistics

• 32,500 people across 46 states work on the program

• 1,400 companies directly supply the four major contractors

• 600 of these companies are considered small businesses

• Supplier stability is critical to avoid supplier disruptions and the ability of the defense contractor industry to deliver

Are You A Federal Contractor?

DOD Program ContractF-35 Joint Striker Fighter

Prime ContractorLockheed Martin

1st Tier/Teaming Partners

BAE Systems Northrop Grumman

1,400 Smaller Companies

Pratt & Whitney

Are You A Federal Contractor?

Credit: National Journal Article 7-31-2013

29 Planes$8.4 Billion

Are You A Federal Contractor?

DODF-35 Contract

Prime ContractorLockheed Martin

Pratt & Whitney (Engine)

140 suppliers including:New Hampshire Ball Bearings

Who uses an additional 25 suppliers including:Latrobe Specialty Metals

DCAA ComplianceAccounting System

Key Elements of Accounting System:• In accord with GAAP (i.e. accrual basis)• Proper segregation of direct and indirect costs• Accumulation of direct costs by contract• Proper timekeeping and labor distribution systems• Costs, which are not allowable in terms of FAR 31 or other

contract provisions, are excluded from costs charged to government contracts• Examples of costs that are generally not allowable:

• Advertising• Bad Debts• Entertainment• Interest/Financing Costs

• In full operation, or in the process of becoming fully operational

Internal Controls, Policies and Procedures

Written Policy and Procedures Manual that covers, among other areas, the following:

• Accounting System (Control Environment)• Integrity and Ethical Values• Information Technology• Budget and Planning• Purchasing• Material Management• Estimating• Compensation and Benefits• Labor• Billing

DCAA ComplianceAccounting System (Cont.)

What this Means to You as a Federal Contractor

• Contract pricing is the single most regulated aspect of acquisition

• Increased risk of being subject to a DCAA audit or a DCMA audit-assist

• Federal procurement agencies are still the largest buyers of goods and services in the world

• Compliant suppliers gain a tremendous market advantage and long term contracts throughout the federal supply chain

• Remains a consistent and methodical path to new business development once established

Strategies For Success

• Comply with federal requirements to ensure contract performance and prompt invoice payment

• Protect your business, intellectual property and proprietary information

• Retain opportunity to participate in federal contracts and sub-contracts

• Seize opportunities for new business development in federal market - largest procurement agency in the world

• Bring added value to overall business valuation

Questions ?

Recent Trends in IRS Audits

IRS Audits - Topics

1. History of the IRS2. How is the IRS Organized?3. Review of Four IRS Divisions4. Types of Audits5. What’s the Purpose of the IRS audit?6. Who Will Represent the IRS in the audit?7. The Life Cycle of the Audit8. What Has Changed in Recent Years?9. Common Myths10. Tips

History of the IRS

1. First income tax passed in 1862

2. Created a Bureau of Internal Revenue

3. We have a picture of the first employee

History of the IRS

4. Al Capone is convicted of income tax evasion in 1931

History of the IRS

5. The 1942 Revenue Act increased the percentage of people paying income tax from 5% to 75%

6. Name changed to the Internal Revenue Service

7. 1943 - Employee withholding began

8. 1954 - the filing deadline was switched from March 15th to April 15th

History of the IRS

9. In 2000, the IRS reorganized into four major

operating divisions:

Wage and Investment Division Small Business/Self-Employed Large and Medium-Sized Businesses Tax-Exempt and Government

History of the IRS

10. Almost 98,000 employees in 2012

11. Trying to make the IRS one of the best places to work in the Federal Government

12. Spent 48 cents to collect $100 of revenue

How is the IRS Organized?

Four Divisions of the IRS

1. Wage and Investment

2. Tax-Exempt and Government Entities

3. Small Business and Self-Employed Division

4. Large Business and International Division

Wage and Investment – Taxpayer Profile 1. Most pay taxes through withholding

2. More than half prepare their own returns

3. Most interact with the IRS once a year

4. Most receive refunds

Tax-Exempt and Government

1. Includes non-profits, employee pension plans,

municipalities, tax-exempt bonds and over 550 recognized Indian tribes

2. Three million “customers”

3. Controls more than $8.2 trillion in assets

Tax-Exempt and Government

4. Their stated mission: “To provide customers top quality

service by helping them (their customers) understand and comply with applicable tax laws and to protect the public interest by applying the tax law with integrity and fairness to all.”

5. They have had a problem with being fair…

6. Have had retirements and resignations

7. On the website, in the Leadership section, 4 out of 5 people listed are listed as “acting” (not permanent in their roles)

Small Business / Self-Employed

1. 9 million businesses – each with less than $10

million in assets

2. 41 million self-employed persons

3. 7 million excise, estate and gift tax returns

4. I have a photo of the person in charge

Small Business News

1. The IRS is mailing 20,000 letters to small businesses questioning whether the taxpayer is reporting all of their cash receipts (Wall Street Journal 8/10/13)

2. The letter is computer-generated, using credit card transaction data supplied to the IRS

3. The letter is entitled “Notification of Possible Income Underreporting”

4. Most of these notices are probably going to law-abiding small businesses

Large Business and International (LB&I) 1. Formerly Known As Large and Medium-Sized

Businesses

2. Corporations, S Corporations and Partnerships with assets greater than $10 million

3. Organized into six domestic industries and four international functions

LB&I - Industries

• Communications, Technology and Media (CTM)• Financial Services (FS)• Heavy Manufacturing and Pharmaceuticals (HMP)• Natural Resources and Construction (NRC)• Retailers, Food, Transportation and Healthcare

(RFTH)• Global High Wealth (GHW)

LB&I - International Functions

• Assistant Deputy Commissioner, International

(ADCI)

• International Individual Compliance (IIC)

• International Business Compliance (IBC)

• Transfer Pricing Operations (TPO)

What’s the Learning Point?

The IRS has become much better organized and can now take advantage of highly specialized, highly qualified audit personnel.

Types of Audits - 4 Types

1. Correspondence audit

2. Field audit

3. Office audit

And my personal favorite:

4. The “This isn’t really an audit but we really would like to ask you a question or two and we have already decided that you are wrong” audit

What’s the Purpose of an Audit?

From the Internal Revenue Code (Sec. 7602)

1. To “ascertain the correctness of any returns”

2. “determine the liability of any person”

3. “collect any such liability”

What’s the Purpose of an Audit?

From the Internal Revenue Manual

1. Reach a conclusion based on a balanced and impartial evaluation of all the evidence

2. “Determine the facts and apply the law as interpreted by the Commissioner”

Who is on the IRS Team?

1. Revenue Agent

Who is on the IRS Team?

2. If someone from the IRS visits you and he/she

has:

Who is on the IRS Team?

2. And

Who is on the IRS Team?

You have two phone calls to make:

1. Your attorney

2. Your spouse because you are not going to make it home for dinner

IRS Team of Specialists

1. Computer Audit Specialists (CAS)2. Employment Tax3. Engineering (R&D and Asset Allocation)4. International5. Excise Tax6. Employee Plans7. Economists (Transfer Pricing)8. Exempt Organizations9. Financial Products10. Entity Type Specialists (e.g. Partnerships)

Life Cycle of the Audit

1. Congratulatory letter - you are under audit

• Sets the years under audit• Sets up the first appointment

2. First Meeting• Can be a meeting with a lot of people• Almost always at the taxpayer’s location• Go over taxpayer rights• Agent(s) issue the first set of Information Document

Requests (IDR)• Generally several opening IDRs from each of the specialists

Life Cycle of the Audit

3. Subsequent Meetings and Discussions

• A lot of back and forth discussions both verbal and written

• The list of issues gets smaller as items are handled

4. Final Settlement• Eventually we have an agreed case or an unagreed

case• IRS agent wants an agreed case if possible but you

never know what they will do• If you don’t agree you can go to “Appeals”

Life Cycle of the Audit -

5. Appeals

• Try to settle tax disputes to avoid going to court• The Appeals Officer gives an “independent” review of

the positions taken by both the IRS and the taxpayer• Usually the taxpayer is represented by a CPA or a tax

attorney• 90% of the disputes that are brought to Appeals are

settled at that level6. Final step would be going to court

What Has Changed with IRS Audits?

1. The audit is more of a team effort using technical

specialists

2. Trying to focus on the substantive issues rather than “little things”

3. Transparency – with computer matching, FIN 48, Schedule M-3, Schedule UTP, etc., the IRS knows a lot more before the audit even starts

What Has Changed with IRS Audits?

4. The internet provides current information on the

taxpayer (e.g. review the company’s home page) and prior news about the taxpayer

5. Finally, the IRS seems more combative and more willing to temporarily take “ridiculous” positions to get a reaction from the taxpayer

Common Myths Re: IRS Audits

1. “You can’t audit me on this issue because the last

IRS agent did not have any problem with it.”

2. “I’ll just negotiate with the IRS when the time comes.”

3. “If I am audited, I will treat the IRS agent in the worst possible manner.”

Common Myths Re: IRS Audits

4. “The IRS agent will always take a reasonable

viewpoint.”

5. “The IRS agent is the bottom of the barrel – someone who couldn’t get a real job.”

Tips for Handling Audits

1. Generally, don’t represent yourself2. Be as professional as possible with all of the IRS

representatives3. You may need to book some sort of additional tax

liability once the issues get narrowed down a bit4. Be patient

And finally - although it may be hard to believe…

5. Remember the IRS people are people too

Questions ?

Thank You

Thank you for your attendance at today’s program.

For more information regarding the topics discussed today, please feel free to contact:

Rick Krucher, CPArichard.krucher@inserocpa.com

585.697.9604

Insero & Company CPAs, P.C.www.inserocpa.com

Dusty Faske, CPAdusty.faske@inserocpa.com

585.697.9619

Denise Metivierdenise.metivier@inseropa.com

585.697.9695

Insero & Company CPAs, P.C.Certified Public AccountantsBusiness & Financial Advisors

Rochester >> 585.454.6996Corning >> 607.973.2075

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