Defense Contracting: DOD Initiative to Address Audit Backlog Shows Promise, but Additional Management Attention Needed to Close Aging Contracts
Published: 2012-12-18T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: DOD has a large volume of contracts that have not been closed on time. Closing a contract includes tasks such as verifying that the goods and services were provided and making final payment to the contractor. Closing contracts within required time frames can limit the governments exposure to certain financial risks. One reason why some contracts are not being closed is the large backlog of incurred cost audits that must first be completed. These audits, conducted by DCAA, ensure that the costs contractors have incurred are permissible under government regulations.
The Senate Armed Services Committee report accompanying the National Defense Authorization Act for Fiscal Year 2012 directed GAO to review the criteria and procedures for conducting incurred cost audits, among other things. In response, GAO assessed (1) efforts to reduce the backlog of incurred cost audits and (2) the challenges DOD faces in addressing the contract closeout backlog. GAO reviewed DCAAs policies and procedures for incurred cost audits; analyzed data on the audit and contract closeout backlogs; and interviewed officials in the military departments and agencies.
section_title: What GAO Found
paragraphs: To reduce the backlog of incurred cost audits, the Defense Contract Audit Agency (DCAA) implemented an initiative to focus its resources on auditing contractors' incurred costs that involve high dollar values or are otherwise determined to be high risk. Incurred cost audits are conducted on a contractor's annual proposal that includes all costs incurred on certain types of contracts in that fiscal year. Under the initiative, DCAA raised the dollar threshold that triggers an automatic audit on a contractor's incurred cost proposal from $15 million to $250 million, revised the criteria used to determine a proposal's risk level, and significantly reduced the number of low risk audits that will be randomly sampled. This initiative appears promising, and DCAA plans to track certain characteristics, such as the number of risk determinations made and audits completed. But DCAA has not fully developed the measures by which it will assess whether the initiative reduces the backlog in a manner that protects the taxpayers' interests. Specifically, DCAA does not have a plan for how it will determine whether key features of the initiative, such as the revised risk criteria and the revised sampling percentages, should be adjusted in the future. By 2016, DCAA estimates it will reduce the backlog and reach a steady state of audits, which it defines as two fiscal years of proposals awaiting review. DCAA's ability to achieve this goal will depend on a number of factors, including the number of proposals determined to be high risk, which as of September 2012 was about two-and-a-half times more than anticipated.
Reducing the backlog of incurred cost audits will ease one obstacle to closing over-age contracts, but other obstacles, such as limited data and performance metrics, must still be overcome. The military departments have limited data on the extent and nature of their contract closeout backlog, and the Defense Contract Management Agency (DCMA)--which performs contract administration services for the Department of Defense (DOD)--is missing information that would allow it to identify contracts that it could act on. Such data can cue agencies on how to identify or tailor approaches to address the backlog. Further, the military departments generally do not have performance metrics to measure progress in closing out contracts. The Army recently announced a goal of closing over 475,000 contracts by September 2014; however, it does not yet have the information necessary to know if it can reach this goal and does not have an implementation plan. The Navy and the Air Force had not established any department-wide performance metrics for contract closeout. In contrast, DCMA has established two agency-wide performance metrics related to contract closeout that are regularly monitored. While many officials said contract closeout was not a priority, GAO found some local contracting activities taking action to bring attention to contract closeout.
section_title: What GAO Recommends
paragraphs: GAO is recommending that DCAA develop a plan to assess its incurred cost audit initiative; that DCMA improve data on over-age contracts; and that the military departments develop contract closeout data and establish performance measures. DOD concurred with the recommendations and identified ongoing and planned actions to address them.

section_title: Letter
paragraphs: The Department of Defense (DOD) obligated more than $3 trillion over  the last 10 years on contracts to acquire goods and services needed to  support its mission. Once performance on these contracts has been  completed, they must be closed as the final step in the acquisition  process. DOD currently has a large backlog of both flexibly priced and  firm-fixed-price contracts—reportedly numbering in the hundreds of  thousands—that have not been closed within the time frames required by  federal regulations. Closing contracts within required time frames can  help to limit the government’s exposure to certain financial risks by  identifying and recovering improper payments and avoiding paying  interest fees when the government does not pay contractors on time.  Timely closeout also ensures that DOD deobligates and uses unspent  funds from completed contracts before the funds are canceled and  returned to the U.S. Department of the Treasury. In addition, closing a  contract years after the performance is complete can present challenges  because key documentation and contracting personnel with firsthand  knowledge of the contract may no longer be available.
One of the key factors affecting DOD’s ability to close out flexibly priced  contracts is the Defense Contract Audit Agency (DCAA) backlog of  approximately 25,000 incurred cost audits as of the end of fiscal year  2011, some dating as far back as 1996. This backlog represents  hundreds of billions of dollars in unsettled costs, and according to DCAA  has quadrupled over 10 years. DCAA conducts incurred cost audits to  identify whether all costs incurred on flexibly priced contracts are  allowable, allocable, and reasonable—information that contracting officers  need to close flexibly priced contracts. Contracting officers also use  information from incurred cost audits to help determine final indirect cost  rates for a contractor. Indirect cost rates are a mechanism for establishing  the proportion of indirect costs—or costs that are not directly attributable  to a specific project or function such as a contractor’s general and  administrative expenses and health benefits—that can be charged to a  contract. Because of the need to settle indirect cost rates, flexibly priced  contracts can be more difficult and time-consuming to close than firm- fixed-price contracts. One tool for expediting the closeout of flexibly priced  contracts is a process known as the quick closeout procedure. The quick  closeout procedure can only be applied to certain contracts where the  unsettled contract costs are considered relatively insignificant and can  allow for closing these contracts without an incurred cost audit.
The Senate Armed Services Committee report accompanying the  National Defense Authorization Act for Fiscal Year 2012 directed GAO to  review DCAA’s criteria and procedures for conducting incurred cost audits  and recommend steps DCAA could take to reduce the backlog and to  consider the feasibility and advisability of three options aimed at reducing  the contract closeout backlog. The three options we were asked to  consider were (1) restoring the authority of the head of an agency to close  out a contract that is administratively complete, was entered into 10 or  more years ago, and has an unreconciled balance of less than $100,000;  (2) authorizing the contracting officer, in consultation with DCAA, to waive  the requirement for an incurred cost audit in the case of a low risk, low- cost contract; and (3) authorizing the contracting officer to waive final  payment in a case where the contractor has gone out of business and  cannot be reached. It also asked us to assess the efficacy of a May 2011  change to the Federal Acquisition Regulation (FAR) that was intended, in  part, to increase the use of quick closeout procedures. In response, this  report addresses (1) DCAA’s efforts to reduce the backlog of incurred  cost audits, and (2) the challenges DOD faces in addressing the contract  closeout backlog. Included within the scope of the second objective was a  consideration of the three options outlined in the Committee report as well  as the use of quick closeout procedures.
To assess DCAA’s efforts to reduce the backlog of incurred cost audits,  we reviewed applicable federal regulations and DCAA’s Contract Audit  Manual to identify its criteria and procedures for conducting incurred cost  audits and obtained and reviewed data on DCAA’s incurred cost audit  backlog. We also collected and reviewed documentation on DCAA’s  processes and criteria for conducting incurred cost audits, such as  agency memorandums, guidance, and forms for documenting risk  determinations. We interviewed senior DCAA officials and DCAA auditors  from three field offices that performed a high volume of risk  determinations to obtain a better understanding of the process and  considerations by which they determine the risk associated with a  contractor’s incurred cost proposals. We also interviewed officials at  Defense Procurement and Acquisition Policy (DPAP) and the Defense  Contract Management Agency (DCMA) to get their perspective on  DCAA’s efforts to reduce the backlog of incurred cost audits.
GAO, Internal Control: Standards for Internal Control in the Federal Government,  GAO/AIMD-00-21.3.1 (Washington, D.C.: November, 1999). contracts. We also interviewed officials at DPAP, DCAA, DCMA, the  Defense Finance and Accounting Services (DFAS); Army, Navy, and Air  Force officials at headquarters and the commands, as well as individual  contracting offices. We interviewed one contractor and two contractor  industry associations to obtain their views on the incurred cost audit and  contract closeout backlogs. To address the options outlined in the  Committee report, we reviewed applicable laws, related agency policies  and guidance, and solicited input about the availability and potential  usefulness of the options in our interviews with representatives from  DCAA; DCMA; military department headquarters, commands, and  contracting offices; the military departments’ general counsel; DFAS; and  contractor representatives. Appendix I provides additional details on our  scope and methodology.
We conducted this performance audit from February 2012 to December  2012 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: Closing out contracts involves a number of tasks, such as verifying that  goods or services were provided, making final payment to the contractor,  and deobligating excess funds. A contract is generally eligible to be  closed once all option provisions have expired, the contractor has  completed performance, and the government has accepted the final  delivery of goods or services, or when the government has provided the  contractor a notice of complete contract termination. From this point,  contracts are considered physically complete, and should be closed  within time frames set by the FAR—6 months for firm-fixed-price  contracts and 36 months for flexibly priced contracts. The FAR prohibits  the closing of contract files if the contract is in litigation, under appeal, or  where the contract is being terminated and all termination actions have  not been completed. Contract documents can be stored and retained  after the contracting officer signs and files the contract completion  statement.
Additional time is allowed for the closeout of flexibly priced contracts  because there are additional steps necessary to close out these types of  contracts (see figure 1). Specifically, closing these contracts generally  requires an audit and settlement of the contractor’s final indirect cost  rates. Contracting officers and DCAA need to ensure all costs incurred by  the contractor and charged to the government are allowable, allocable,  and reasonable. Contracting officers also need to establish final indirect  cost rates based on the contractor’s incurred costs, which determine, in  part, the contractor’s final payment on flexibly priced contracts.
Contractors are required by the FAR to submit proposals that include  information on all of their flexibly priced contracts in a fiscal year. Once  submitted, DCAA audits the proposal to determine if the costs incurred  are reasonable, allowable and allocable to government contracts (see  figure 2 for incurred cost audit process). There is not a one-to-one  relationship between an incurred cost audit and an individual contract. In  a single fiscal year, a contractor may incur costs on multiple flexibly  priced contracts, and all of these contracts would be included in the  proposal. The total value of the proposal, called the auditable dollar value  (ADV), is the sum of all the costs on flexibly priced contracts for that  contractor during the fiscal year. Additionally, since the period of  performance on an individual contract may span several fiscal years,  several audits may need to be conducted to provide the information  necessary to close one flexibly priced contract. Further, DCAA may  assess a contractor’s incurred cost proposal as inadequate for a variety of  reasons, for example if the proposal is not certified or contains math  errors, and request that the contractor review, revise, and resubmit its  incurred cost proposal.
The responsibility for closing out a contract resides with the DOD  contracting officer within the military department or other defense agency  that awarded the contract. The contracting officer may, however, delegate  certain administrative responsibilities, including contract closeout, to  DCMA, which provides contract administration services to DOD. DFAS  also plays a role in activities related to contract closeout, such as paying  final vouchers, and, when needed, resolving unreconciled balances on a  contract.
subsections: section_title: Quick Closeout Procedures
paragraphs: To facilitate contract closeout of flexibly priced contracts, federal  regulations authorize the use of quick closeout procedures, by which a  contracting officer can negotiate the settlement of direct and indirect costs  on a specific contract, task order, or delivery order without waiting for the  determination of final indirect cost rates for the contractor’s fiscal year.
To use the quick closeout procedure, several conditions must be met. For  example, the amount of unsettled direct and indirect costs to be allocated  to the contract, task order, or delivery order must be relatively  insignificant—which is defined as costs that do not exceed the lesser of  $1,000,000 or 10 percent of the total contract, task order, or delivery  order amount. The contracting officer also must perform a risk  assessment and determine that the use of the quick closeout procedure is  appropriate and consider such factors as the contractor’s accounting,  estimating, and purchasing systems, and any concerns of cognizant  DCAA auditors. When the quick closeout procedure is used for a contract,  determinations of final indirect costs are considered binding for the  specific contract covered, but the rates used during this process are not  considered binding when establishing the final indirect cost rates for other  contracts.
DCMA has issued a memorandum authorizing its contracting officers to  close specific contracts prior to the establishment of indirect cost rates  regardless of the dollar value of the contract or the percent of unsettled  direct and indirect costs allocable to the contract. This memorandum— known as a class deviation from the FAR because it allows for actions  that are inconsistent with the regulation—was signed by the agency  director in October 2011 and extends through September 2013.  According to DCMA officials, DCMA has had similar deviations in place  since 1999. The policy allows a DCMA contracting officer to waive the  requirement for an incurred cost audit, in consultation with DCAA, when a  compelling reason exists. DCMA guidance indicates that compelling  reasons may include contracts with funds at risk of canceling, contracts  that have been over-age for 6 or more years, and contracts where a  contractor’s historical final indirect cost rates have been fairly consistent  with proposed certified final indirect cost rates.
section_title: Prior Work
paragraphs: Our prior work has highlighted challenges at DCAA as well as some of  DOD’s challenges in closing out contracts, particularly those awarded to  support operations in Iraq and Afghanistan. In 2009, we found problems  with DCAA’s audit quality nationwide, including insufficient testing of  contractors’ support for claimed costs. We recommended that DCAA  develop a risk-based contract audit approach across the agency that  included identification of resource requirements. DCAA officials reported  that as a result of our findings, it now requires more testing and stricter  compliance with government auditing standards, which adds to the  amount of staff time required to complete each audit. In September 2011,  we reported that DOD’s ability to close the contracts it awarded to support  efforts in Iraq was hindered by several factors, including the failure to plan  for or emphasize the need to close these contracts until reconstruction  efforts were well under way.prioritized contract awards over other activities and DOD does not have  visibility into the number of Iraq contracts eligible for closeout. We also  reported that DOD’s efforts to close its large, cost-type contracts was  hindered by staffing shortages at DCAA and unresolved issues with  contractors’ cost accounting practices. We made recommendations to  ensure DOD has sufficient resources to close its Iraq and Afghanistan   We also found that DOD commands  contracts and to better plan for and improve visibility of closeout efforts in  future contingencies. In May 2012, DOD amended the Defense Federal  Acquisition Regulation Supplement to require heads of contracting  activities to monitor and assess on a regular basis the progress of  contingency contract closeout activities and take appropriate steps if a  backlog occurs.
Our prior work has also identified some challenges at DCMA in relation to  establishing indirect cost rates and workload. In November 2011, we  reported that DCMA has been increasing its workforce and rebuilding key  skills sets that had atrophied in recent years, such as cost and pricing  capabilities. According to DCMA, loss of this skill set meant that many of  the agency’s pricing-related contract administration responsibilities, such  as establishing final indirect cost rates, were no longer performed to the  same level of discipline and consistency as in prior years. As a result,  DCMA stated that DOD’s acquisitions were subjected to unacceptable  levels of cost risks. Both DCMA and DCAA have been increasing their  workforce in recent years to address some of the challenges faced by the  agencies.
The challenges faced by DOD in closing out contracts are not recent  phenomena. For example, in 2001, the DOD Inspector General issued a  report that found weaknesses in the closeout process, including  inadequate monitoring of contracts that could be closed, inattention to  closure requirements, erroneous data about contracts available for  closure, lack of coordination, lack of sufficient funding, a shortage of  personnel, and untimely contractor input. reported that DOD made progress by closing about 30,000 contracts from  February 2000 to March 2001, though over 26,000 became over-age  during that same period.
DOD Office of the Inspector General, Closing Overage Contracts Prior to Fielding a New  DOD Contractor Payment System, D-2002-027 (Arlington, Va.: Dec. 19, 2001).
section_title: DCAA Implemented Initiative to Focus on High Risk Incurred Cost Proposals, but Has Not Yet Fully Developed Measures to Evaluate the Initiative’s Results
paragraphs: To address the backlog of incurred cost audits, DCAA implemented a  new, risk-based initiative in 2012 which focuses DCAA’s resources on  incurred cost proposals that have high dollar values or are determined by  auditors to be high risk. In doing so, DCAA will significantly reduce the  number of audits performed on incurred cost proposals that are  determined to be low risk. Under its risk-based initiative, DCAA raised the  threshold by which an incurred cost audit is automatically performed on a  contractor’s incurred cost proposal, revised the criteria used to determine  a proposal low risk, and decreased the percentages of low risk proposals  that will be randomly selected for audit. DCAA plans to track certain data  to help assess progress in eliminating the backlog, but DCAA has not fully  developed measures to determine whether key features of the initiative,  such as revised criteria for determining a proposal is low risk and revised  sampling percentages, should be adjusted in the future. Further, DCAA  estimates it will reach a steady state of audits, which DCAA defines as  two fiscal years of proposals awaiting review, by 2016, but whether DCAA  will achieve its goals will depend on a number of factors, including the  number of proposals determined to be high risk and the completion of  subsequent audits.
subsections: section_title: DCAA’s Initiative Prioritizes High Risk Incurred Cost Proposals for Audit
paragraphs: In 2012, DCAA began implementing a new, risk-based approach that is  expected to shift DCAA’s resources to focus on incurred cost audits  involving high-dollar value and high risk proposals. DCAA officials told us  that in 2011, DCAA recognized that the number of audits that needed to  be conducted exceeded the capacity of DCAA’s staff to do so.  Accordingly, DCAA reported that incurred cost audits were not prioritized  in fiscal year 2011 since they did not provide as many financial benefits  as other audits, such as forward pricing audits, which are used to  determine fair and reasonable rates for the award or modification of a  contract.
In developing the initiative, DCAA performed an analysis of which audits  provided financial benefits by comparing how much money was saved or  recovered by various types of audits (such as incurred cost and forward  pricing audits) to how much money was invested in performing those  audits. As a part of this analysis, DCAA officials found that the agency  spent more in terms of staff resources to conduct incurred cost audits on  proposals valued at less than $1 million than the financial benefits derived  from the audits. DCAA’s analysis also determined that proposals valued  over $1 million have provided more benefits than the cost to conduct  them, with the benefits generally increasing as the value of the proposal  increased.
DCAA’s risk-based initiative includes key changes to its criteria and  procedures that will decrease the number of audits conducted. These  changes include (1) raising the threshold by which proposals  automatically qualify for audit, (2) revising the criteria used to determine a  proposal low risk, (3) lowering the percentage of low risk proposals to be  randomly selected for audit, and (4) eliminating further review of  proposals not selected for audit, and revising its adequacy review  procedures to be more comprehensive. In addition to the changes to  criteria and procedures, DCAA officials noted they plan to increase their  staffing levels from 4,900 employees in 2011 to 5,600 by 2016. DCAA  provided refresher training to its staff, and created 17 dedicated teams to  incurred cost audit work.
DCAA raised the threshold above which an audit is required based on  ADV from $15 million to $250 million, thereby decreasing the number of  proposals automatically qualifying for audit from 5,194 to 659, based on  the backlog as of the end of fiscal year 2011 (see table 1). Proposals  under the $250 million threshold will not be audited unless they are  determined to be high risk or randomly selected for audit.
In conjunction with raising the threshold by which incurred cost proposals  were automatically selected for audit, DCAA revised two of the three  criteria that a contractor’s incurred cost proposal under the $250 million  threshold must meet to be determined low risk (see table 2). For example,  under DCAA’s prior criteria, DCAA must have performed an incurred cost  audit within the past three years; under the new initiative, for proposals  $100 million or under, the time frame for conducting the last incurred audit  was eliminated—the requirement is now that the contractor has had at  least one incurred cost audit. These changes will increase the potential  number of contractor proposals that are eligible for low risk  determinations. The other criterion—audit leads or other significant  risks—did not change. However, DCAA did provide several examples of  the types of risks that should be considered under this criterion, such as  known business system deficiencies or risks identified by the contracting  officer.
Once risk has been determined, those proposals that are determined to  be low risk will be randomly sampled at DCAA’s five regional offices  based on the proposal’s ADV, but now at a lower percentage than before.  Currently, between 1 and 20 percent of low risk proposals are sampled  depending on ADV, whereas under the previous procedure 33 percent of  low risk proposals were sampled (see table 3).
Under DCAA’s risk-based initiative, low risk proposals that are not  selected for audit are not subject to any further review, whereas  previously all proposals not selected for audit were subject to desk  reviews. Desk reviews included an evaluation of the proposal for unusual  items and changes from prior year proposals, among other actions. Now,  when a low risk proposal is not selected for audit, DCAA auditors issue  memorandums to the contracting officers recommending that the  contracting officer use his or her authority to determine the contractor’s  final indirect cost rates, which allows the contracting officer to proceed  with closing the contract. However, in November 2011, DCAA issued  revised guidance to determine whether a contractor’s proposal is  adequate, and DCAA officials explained that the revised adequacy review  provides a more comprehensive determination that includes many areas  previously covered in the desk review process.
A summary of DCAA’s revised incurred cost audit procedures are outlined  in figure 3.
By revising its policies and procedures and dedicating resources to  incurred cost audits, DCAA estimates it will reduce its backlog and reach  a steady state by 2016, which it defines as having two fiscal years of  incurred cost proposals awaiting review. By randomly sampling low risk  proposals, DCAA officials note that the possibility of an audit is still  present, which is a deterrent for contractors to report inaccurate  information. However, DCAA has not yet fully developed measures to  evaluate the initiative’s results and assess whether the changes will  require further adjustments. For example, DCAA is planning to track the  number of risk determinations completed, the numbers of proposals  deemed high and low risk, and the number of audits completed. Further,  DCAA regional offices will be responsible for monitoring risk  determinations on an ongoing basis to ensure that they are completed in  a timely manner and to identify any field audit offices that have a  significantly higher or lower percentage of high risk determinations than  other field audit offices. However, DCAA has not determined how to  assess whether the revised criteria for determining a proposal’s risk level  or the revised sampling percentages are appropriate or should be  adjusted in the future. DCAA stated that they plan to reassess the  initiative in about a year, but did not provide details on what would be  assessed at that time. Internal control standards require the  establishment of clear, consistent objectives and the identification and  analysis of what measures will be used to determine if an agency is  achieving those objectives.
Additionally, it is too early to tell whether DCAA will achieve its goal of  eliminating the backlog by 2016, in part because DCAA does not yet  know how many proposals under $250 million ADV will be determined low  or high risk and its initial estimates have proven inaccurate. DCAA reports  that its auditors have completed risk assessments on 13,522 contractor  proposals that had an ADV of less than $15 million—out of a universe of  approximately 20,000 proposals—as of September 2012. Of 13,522 risk  assessments completed, DCAA determined that 7,815 proposals were  high risk, or about two-and-a-half times more than anticipated. DCAA  determined that the number of high risk proposals is higher than expected  because over 3,500 of those proposals belong to contractors with no  incurred cost audit history. DCAA’s backlog includes multiple proposals  covering several fiscal years for some contractors. DCAA officials stated  the agency plans to audit older proposals first, thus contractors’ proposals  for later years may become eligible for low risk status once an audit has  been conducted for a single fiscal year and an audit history is established.  DCAA’s ability to reach a steady state by 2016 will also depend on  whether DCAA completes its audits within anticipated time frames.  However, DCAA was not able to complete the number of audits it planned  to in 2012. Specifically, DCAA planned to address 4,065 incurred cost  proposals in fiscal year 2012 by, for example, completing an audit or desk  review, but the agency reported that it addressed 2,930 as of the end of  September 2012.
section_title: DOD’s Efforts to Reduce Its Contract Closeout Backlog Is Hindered by Limited Data and Performance Metrics
paragraphs: DCAA’s efforts to reduce its incurred cost backlog will remove one factor  hindering efforts to close out flexibly priced contracts; however, DOD is  also hindered by limited data and performance metrics on contract  closeout efforts. The military departments generally do not have data on  the extent or nature of their contract closeout backlog, while DCMA is  missing key information that would allow it to identify contracts on which it  could take action. Additionally, the military departments generally lack  performance metrics on contract closeout. For example, in November  2012, the Army announced its intent to close 475,000 over-age contracts  by September 2014, but was still in the process of having its commands  identify interim goals and did not yet have a final detailed implementation  plan, while the Navy and Air Force have no department-wide metrics. In  contrast, DCMA has established two agency-wide performance metrics  related to contract closeout with regular reporting to the head of the  agency on progress in meeting goals. Our work identified some efforts at  local contracting offices to focus on contract closeout, but DOD has made  limited use of quick closeout procedures— a tool that can be used to  expedite the closeout of flexibly priced contracts.
subsections: section_title: DOD Has Limited Data on Its Contract Closeout Backlog
paragraphs: Data on the extent and nature of the contract closeout backlog can help  organizations identify or tailor approaches to address the backlog.  However, we found that the military departments had difficulty providing  reliable data on the size of their backlogs and did not have information on  where the contracts were in the closeout process. For example, we  requested data from each of the military departments on the number of  contracts in the backlog, type of contract, and what contracting office was  administering the contract. The military departments took the following  steps to provide the data:
The Army pulled data from its centralized data repository, but there  were large discrepancies between the data provided by headquarters  and data reported at the commands and local contracting offices. For  example, according to the data provided by headquarters, one  contracting office had about 30,000 over-age contracts, yet officials at  the office reported about 3,700 over-age contracts.
The Air Force also pulled data from its centralized data repository for  one command, but the command had to verify the data with its local  contracting offices and acknowledged it needed to make adjustments  based on the input from those offices before providing the data to us.  Air Force officials told us that providing the data for the remaining  commands would require significant effort because they would need  to go through a similar verification process.
Navy officials told us they did not have a centralized data repository,  so the Navy requested data from its local contracting offices.
At the local level, seven out of the nine contracting offices we spoke with  collected some information about their over-age contracts, such as the  total number of contracts in the backlog and the type of contracts, but the  offices generally were unable to provide us with detailed information as to  where the contracts were in the closeout process, such as the number  awaiting a DCAA incurred cost audit.
DCMA collects data through its Mechanization of Contract Administration  Services (MOCAS) system on where its over-age contracts are in the  contract closeout process, but it is missing key information that would  allow it to identify contracts that it could take action on. For example,  DCMA’s data showed that as of July 2012 the agency had approximately  36,000 contracts awaiting closeout, including 28,000 that were awaiting  establishment of final indirect cost rates. However, of these 28,000  contracts, DCMA did not know how many were awaiting a contractor’s  submission of an adequate incurred cost proposal, a DCAA incurred cost  audit, or final negotiation of rates. This information is important because it  identifies who is responsible for moving the contract forward in the  closeout process—for example, DCMA contracting officers may be able  to advance the closeout of contracts awaiting final negotiation of rates.  DCMA officials we spoke with thought that the majority of these contracts  were awaiting DCAA’s audit, and thus would be addressed by DCAA’s  initiative. In addition, DCMA’s MOCAS system was missing data on the   DCMA  reasons why contracts are over-age for about 1,700 contracts.officials told us the agency recently enhanced its efforts to identify and  close contracts within the agency’s control due to an increase in the  number of over-age contracts in fiscal year 2012. DCMA officials reported  that specific categories of contracts are being targeted for closure, such  as firm-fixed-price contracts with no outstanding obligations.
The limited visibility into the characteristics of the contract closeout  backlog, particularly at the military departments, made it challenging for  officials to fully assess the extent to which specific efforts to reduce the  backlog would impact their over-age contracts. For example, we asked  DOD officials their views on restoring the authority of the head of an  agency to close out a contract that is administratively complete, was  entered into 10 or more years ago, and has an unreconciled balance  under $100,000. Many DOD officials we spoke with at various levels  within the military departments and within DCMA stated they did not  believe the option would affect the backlog, as they did not believe their  contracting offices would have many contracts to which this option would  apply. For example, based on DCMA’s over-age contract data, DCMA  officials estimated that as of July 2012, only 85 of the approximately  36,000 contracts in their backlog would meet the criteria of the option.  However, officials at the military departments, commands and local  contracting offices that we asked generally could not provide specific  numbers as to how many contracts this option would impact. Further,  several officials noted that a similar temporary authority was granted in  the mid-2000s that they believed was ineffective, in part because DOD  established a process and administrative requirements that they termed  burdensome. For example, DFAS officials reported that the authority  was only used to close out 14 contracts.
Similarly, when we asked how useful it would be if legislation authorized a  contracting officer to waive final payment in a case where a contractor  has gone out of business and cannot be reached, DOD officials reported  that this situation occurs infrequently. Yet DOD officials at several  locations we reviewed said that they did not have data readily available  on how often they had encountered this situation. Further, some officials  noted that a contracting officer can use the authority in the FAR to  unilaterally close a contract for this purpose.guidebook outlines procedures that contracting officers use to close a  contract where the contractor has gone out of business.
section_title: Military Departments Generally Did Not Have Performance Metrics to Measure Progress in Closing Out Contracts
paragraphs: Performance measures, which compare actual performance against  planned results, can be an important tool in demonstrating leadership  commitment and maintaining adequate internal controls. We found that  the Army recently communicated a goal to its commands for closing over- age contracts, but the Navy and Air Force did not have established  performance metrics for closing out contracts within their organization. In  November 2012, the Office of the Deputy Assistant Secretary of the Army  (Procurement) sent an e-mail to its commands identifying a goal of  closing over 475,000 over-age contracts by September 2014. The office  requested that each command provide information on their over-age  contracts by the end of November 2012, including identifying contracts  that may be suitable to be grouped together and closed at the command  level, such as low dollar contracts, and identifying contracts that fit into  other priority categories, such as certain contracts with expiring funds.  Further, the office directed the commands to establish monthly closeout  goals and describe challenges that may impact the command’s ability to  meet the Army’s September 2014 goal. According to an Army official,  they have drafted an implementation plan for this effort, but the plan has  not yet been approved. Although the Navy did not have department-wide  performance metrics related to contract closeout, one Navy command  established a goal of decreasing the contract closeout backlog from  approximately 23,000 contracts to 13,000 contracts over fiscal year 2012,  and reported it had exceeded that goal before the end of the year. Within  the Air Force, headquarters officials told us in November 2012 that they  plan to begin regular collection of data on contract closeout statistics  starting in January 2013.
In contrast, DCMA had established two agency-wide performance  measures related to contract closeout for contracts where they have been  delegated contract administration responsibilities. For example, one of  DCMA’s closeout measures looks at the total number of over-age  contracts in the agency, with a target of reducing the total number of over- age contracts by 10 percent during a fiscal year. The measures are  reviewed at a number of levels within DCMA, including a briefing to the  DCMA Director approximately twice a year, and monthly reviews at each  of the contract management offices. When the targets for each measure  are not met, DCMA officials conduct a root cause analysis to identify the  reasons why, as well as to identify potential methods for addressing the  issues.
While many DOD officials acknowledged that contract closeout is not a  priority compared to other mission critical activities, we found some  contracting offices were taking actions locally to address their contract  closeout backlogs. For example, one Army contracting office made its  contract closeout process more centralized, added two new staff, and  tracked the number of contracts they closed. Officials at this office  reported that they closed over 14,000 of a reported 20,000 low dollar firm- fixed-price contracts in its backlog over the past year. Further, we found  four contracting offices established a contract closeout team whose work  is focused on contract closeout activities. Officials from three of these  offices noted that their office prioritizes closing out contracts when funds  are close to canceling to preserve funds for other uses.
Further, DOD has established a contract with the AbilityOne program for  contract closeout support services to help address some of the contract  closeout backlog. According to DOD officials, this contract is limited to  closing firm-fixed-price contracts across the department, whether over- age or not. AbilityOne representatives reported that the contractor has  already provided contract closeout support services for over 50,000  contracts across DOD. DOD stated that using AbilityOne allows  contracting officers to focus on other duties and mission-critical work such  as awarding contracts; however, some DOD officials noted limitations,  including the administrative burden on the contracting officer to locate all  appropriate documentation to forward to the AbilityOne contractor, and  ensuring AbilityOne staff have the proper clearance and access for the  contractors. While AbilityOne’s efforts are currently limited to firm-fixed- price contracts, senior DOD officials told us they are looking into the  feasibility of contracting with AbilityOne for contract closeout services on  flexibly priced contracts.
section_title: DOD Organizations Made Limited Use of Quick Closeout Procedures
paragraphs: Our work found that DCMA and the contracting offices we reviewed made  only limited use of quick closeout procedures. For example, even though  DCMA has a policy, based on a FAR deviation, that allows for broader  use of quick closeout procedures than what is allowed under the FAR,  and DCMA’s guidance recommends that contracting officers use quick  closeout where applicable, the two DCMA contract management offices  we reviewed made little or no use of quick closeout procedures.at DCMA headquarters and one contract management office said they  were unsure why quick closeout is not used more often. Officials at the  other DCMA contract management office we spoke with told us one  reason they had not made more use of DCMA’s policy related to quick   Officials  closeout procedures is that DCMA did not define what can be considered  a compelling reason to waive an audit until December 2011. Further,  once they started to assess eligibility, this office encountered challenges  in identifying contractors that they considered to be eligible for the quick  closeout procedure. Specifically, the office initially identified 1,489  contracts with 32 contractors that may be eligible for quick closeout  procedures. However, after further analysis, officials reported that 463  contracts with 7 contractors were deemed potentially eligible. Contractors  were excluded from eligibility due to issues such as contractor billing  problems, DCAA concerns about the contractor, or contractor delays in  submitting an incurred cost proposal.
Similarly, none of the nine military department contracting offices reported  using quick closeout procedures currently, although three reported  minimal use in the past. For example, one contracting office estimated  using quick closeout procedures for about 40 to 50 contracts in fiscal  years 2010 and 2011. Officials at two other contracting offices reporting  use of quick closeout on a handful of contracts in the past, but are not  making use of it now. With regard to the efficacy of the May 2011 change  to the FAR that was intended, in part, to increase the use of quick  closeout, officials at the two contracting offices that previously used quick  closeout procedures reported that the May 2011 change reduced the  number of eligible contracts by including direct costs in the eligibility  criteria. Officials from one of these contracting offices explained that the  previous language allowed the contracting officer to waive the dollar  threshold based on a risk determination. Since the current language  removed the waiver, officials explained that the contracting officer is no  longer able to make a business decision for contracts above the dollar  threshold to determine an acceptable level of risk.
DCMA and contracting officials we interviewed also noted that other  challenges to the use of quick closeout procedures included a lack of  audit history by which to determine what a contractor’s rates should be.  DOD officials told us there was sometimes a reluctance to use quick  closeout procedures because they are uncertain of the risk they are  taking on and concerned that their decisions may be questioned later by  others.
During our interviews with DOD officials, we asked about the advisability  and feasibility of authorizing a contracting officer, in consultation with  DCAA, to waive the requirement for an audit in the case of a low risk, low  cost contract to assist in closing out contracts—one of the options we  were asked to consider in our review. Officials throughout DOD—at  DCMA, military commands, military department contracting offices, and  others—told us they believed this option was similar to quick closeout  procedures, a tool already available to them.
section_title: Conclusions
paragraphs: DOD has fallen far behind in closing out its contracts, in part due to the  large backlog of incurred cost audits that must be performed by DCAA.  DCAA has recognized that completing the volume of these audits, as well  as other high-priority audits, using its traditional approach exceeds the  capacity of its resources. In response, DCAA launched a risk-based  approach to focus its resources on audits that are considered to be high  risk or high dollar value. Such an approach appears prudent and shows  promise, but its success will depend upon reducing the audit backlog in a  way that protects the taxpayers’ interests. DCAA, however, has not  developed a plan with measures to assess progress toward achieving  these goals. DCAA must ensure that the key changes to its criteria and  procedures—such as increasing thresholds for audit, revising its risk  determination criteria, and decreasing sampling percentages for low risk  proposals—adequately direct resources to audits that will provide the  greatest benefit to the taxpayer. Without a plan that includes appropriate  measures, DCAA will not be well-positioned to assess whether the  initiative is achieving its goals.
Reducing the incurred cost audit backlog should enable more flexibly  priced contracts to be closed out, but the extent to which it will do so is  uncertain. As there is not a one-to-one relationship between an incurred  cost audit and a specific contract, and there are additional steps that need  to be taken to close a contract, there is likely to be a lag in closing out  contracts even if DCAA is successful in its efforts. Within the military  departments, limited data on the extent of the backlog or the reasons why  contracts are in the backlog hinders their ability to develop targeted  approaches, with goals and performance metrics, to address over-age  contracts. The Army is just starting to collect the information necessary to  determine if it can realistically meet its goal of closing over-age contracts  and has not issued an implementation plan. The Navy and the Air Force,  while facing similar data issues, have no department-wide performance  metrics. Even DCMA, which does have performance measures in place  as well as some information on where the contract is in the closeout  process, has incomplete information on who has responsibility for moving  the contract forward in the closeout process. One technique—the use of  quick closeout procedures—has been available for a number of years, but  we found little evidence that any organization has made significant effort  to use it, either before or after the May 2011 change in federal  regulations. Until DOD prioritizes closing contracts in a timely fashion and  underscores the need to do so by improving the availability of accurate  data and establishing performance measures, it will not see a significant  reduction in its contract closeout backlog.
section_title: Recommendations for Executive Action
paragraphs: To improve DCAA’s ability to assess whether its incurred cost backlog  initiative is achieving the objectives of reducing the incurred cost audit  backlog while continuing to protect the taxpayer’s interests, we  recommend that the Director, DCAA, develop a plan that includes time  frames and measures to assess progress towards achieving its  objectives, and as appropriate, to identify how it will assess whether the  changes in DCAA’s procedures and criteria are appropriate or require  further revisions.
To increase visibility and enhance management attention on closing out  contracts within their departments, we recommend that the Secretaries of  the Navy and Air Force, respectively, develop baseline data and  performance measures for closing out contracts, including consideration  of the use of quick closeout procedures, as appropriate.
To facilitate the closeout of contracts within the Army, we recommend the  Secretary of the Army ensure that the Army’s contract closeout  implementation plan includes baseline data and performance measures,  and includes consideration of the use of quick closeout procedures, as  appropriate.
To enable DCMA to better identify contracts that may be closed out, we  recommend that the Director, DCMA, take steps to ensure the data in  DCMA’s contract information system on who has responsibility for moving  the contract forward in the closeout process is complete.
section_title: Agency Comments and Our Evaluation
paragraphs: DOD provided written comments on a draft of this report. DOD concurred  with the four recommendations and identified a number of ongoing and  planned actions to address them. For example, DCAA stated that by  March 2013 it will develop a more detailed plan to monitor and assess its  progress towards achieving the objectives of its initiative. DCAA stated  that this plan will include time frames and measures to determine whether  its current criteria and procedures will require future modification. Further,  DCAA identified several factors that this plan will include, such as an  analysis of high risk determinations and audit results to determine if some  criteria are better indicators of risk than others and an analysis of DCAA’s  return on investment to determine if revisions to the sampling variables  are needed.
Each of the military departments identified actions that they would take to  increase visibility and management attention on closing out contracts  within their departments. For example, the Navy plans to collect data and  internal policies and procedures on closing out contracts, including the  use of quick closeout procedures, from its contracting activities as an  initial step developing Navy-wide baseline data and performance  measures for closing out contracts. The Air Force stated that it plans to  place additional emphasis on aging contracts at a joint forum focused on  high priority issues between DCMA, DCAA, and the departments. The  Army concurred with our recommendation and reiterated its goal of  eliminating approximately 475,000 over-age contracts by the end of fiscal  year 2014, but did not provide additional details on how baseline data,  performance measures, or consideration of the use of quick closeout  procedures would be integrated into its detailed implementation plan. We  believe that doing so would facilitate the Army’s efforts and enable it to  assess progress.
In response to our recommendation to better identify contracts that may  be closed out, DCMA plans to begin requiring the use of a code within its  MOCAS system that will clearly identify who is responsible for the next  step in the closeout process, and to ensure the code is properly entered  into the system. DOD’s comments are reprinted in appendix II.
We are sending copies of this report to the Secretary of Defense; the  Secretaries of the Army, Navy, and Air Force; the Director, Defense  Contract Audit Agency; the Director, Defense Contract Management  Agency; appropriate congressional committees; and other interested  parties. This report will also be available at no charge on GAO’s website  at http://www.gao.gov.
If you or your staff have any questions concerning this report, please  contact me at (202) 512-4841 or by e-mail at dinapolit@gao.gov. Contact  points for our Offices of Congressional Relations and Public Affairs may  be found on the last page of this report. Key contributors to this report are  listed in appendix III.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: The Senate Armed Services Committee report accompanying the  National Defense Authorization Act for Fiscal Year 2012 directed us to  review the Defense Contract Audit Agency’s (DCAA) criteria and  procedures for conducting incurred cost audits and recommend steps  DCAA could take to reduce the backlog, and to consider the feasibility  and advisability of three options aimed at reducing the contract closeout  backlog. The three options we were asked to consider were (1) restoring  the authority of the head of an agency to close out a contract that is  administratively complete, was entered into 10 or more years ago, and  has an unreconciled balance of less than $100,000; (2) authorizing the  contracting officer, in consultation with DCAA, to waive the requirement  for an incurred cost audit in the case of a low risk, low-cost contract; and  (3) authorizing the contracting officer to waive final payment in a case  where the contractor has gone out of business and cannot be reached. It  also asked us to assess the efficacy of a May 2011 change to the Federal  Acquisition Regulation (FAR) that was intended, in part, to increase the  use of quick closeout procedures. In response, this report addresses (1)  DCAA’s efforts to reduce the backlog of incurred cost audits, and (2) the  challenges the Department of Defense (DOD) faces in addressing the  contract closeout backlog. Included within the scope of the second  objective was a consideration of the three options outlined in the  Committee report as well as the use of quick closeout procedures.
To conduct our work for each objective, we reviewed relevant sections of  the FAR, including FAR Subpart 4.804, Closeout of Contract Files and  FAR Subpart 42.1, Contract Audit Services, and the Defense Federal  Acquisition Regulation Supplement (DFARS), including DFARS Subpart  242, Contract Administration and Audit Services. We also reviewed DOD  policies, such as the Office of the Under Secretary of Defense for  Acquisition, Technology, and Logistics memorandum on Increasing  Contracting Opportunities with the AbilityOne Program. We also reviewed  prior GAO and DOD Inspector General reports pertaining to challenges at  DCAA and the Defense Contract Management Agency (DCMA), and  contract closeout at DOD, including contract closeout in a contingency  environment. And finally, we reviewed GAO’s Standards for Internal  Controls in the Federal Government.
To assess DCAA’s efforts to reduce the backlog of incurred cost audits,  we reviewed applicable sections of federal regulations and DCAA’s  Contract Audit Manual to identify criteria and procedures for selecting and  conducting incurred cost audits. We obtained and reviewed data from  DCAA’s management information system on the agency’s incurred cost  audit backlog. To assess the reliability of DCAA’s data on its incurred cost  audit backlog, we reviewed related documentation, interviewed  knowledgeable agency officials, looked for obvious inconsistencies in the  data, and verified the accuracy of the data when necessary. From these  efforts, we believe the information obtained is sufficiently reliable for this  report. We also reviewed documentation on DCAA’s incurred cost audit  initiative, such as DCAA guidance on its revised criteria and procedures  for risk assessment, agency memorandums related to the timing and  implementation of the new sampling procedures, new forms for  documenting risk determinations, and data on which proposals were  selected for audit. We reviewed analyses and projections DCAA used to  establish its goal of becoming current on incurred cost audits by 2016.  We interviewed senior DCAA officials responsible for the incurred cost  audit initiative, and DCAA auditors from three field offices to obtain a  better understanding of the process and considerations for determining  risk for the contractor’s incurred cost proposals. We selected the three  DCAA field offices that had completed the largest number of risk  assessments under the new incurred cost audit initiative as of September  2012. We also interviewed officials at Defense Procurement and  Acquisition Policy (DPAP) and DCMA to get their perspective on DCAA’s  incurred cost audit initiative.
To identify the challenges DOD faces in addressing the contract closeout  backlog and to assess the efficacy of the May 2011 change to the FAR  pertaining to quick closeout procedures, we reviewed applicable sections  of the FAR, including FAR Subpart 42.3, Contract Administration Office  Functions and FAR Section 42.708, Quick Closeout Procedures, and  DFARS Subpart 242.3, Contract Administration Office Functions. We also  reviewed Air Force, Navy, Army, and DCMA guidance, as well as DCMA  policy on contract closeout and quick closeout procedures, such as the  agency’s March 2012 closeout instructions and DCMA’s deviation to the  quick closeout procedures. We obtained available data from the Army,  Navy, and Air Force, five commands and nine contracting offices within  the military departments. We selected the commands and contracting  offices based on factors such as the total reported volume of over-age  contracts and interviews with senior DOD officials (see table 4). We  determined that the data reported by the military departments was  sufficient for our purposes of selecting which commands and contracting  offices to review, but did not take steps to assess the reliability of the data  collected from the local contracting offices.
We collected and analyzed available data and documentation on over- age contracts from DCMA headquarters and the two DCMA contract  management offices with the largest volume of over-age contracts— located in Manassas, Virginia and Baltimore, Maryland. To assess the  reliability of DCMA’s data, we reviewed related documentation,  interviewed knowledgeable agency officials, looked for obvious  inconsistencies in the data, and verified the accuracy of the data when  necessary. We also compared the data received from DCMA  headquarters to the data that we received from Manassas and Baltimore.  From these efforts, we believe the information we obtained is sufficiently  reliable for this report. We also interviewed officials from DCMA  headquarters and the two contract management offices. Further, we  interviewed and collected documentation from officials at DPAP, DCAA,  and the Defense Finance and Accounting Services; and from Army, Navy,  and Air Force officials at the headquarters and command level, as well as  individual contracting offices. We interviewed two contractor industry  associations as well as a DOD contractor to obtain their views on the  incurred cost audit and contract closeout backlogs.
To address the options outlined in the Committee report, we reviewed  applicable laws, such as the National Defense Authorization Acts of  Fiscal Years 2004, 2005, and 2007, which had authorities similar to one  we were asked to review, and related agency policies and guidance, such  as DCMA’s contract closeout guidebook. We also solicited input about the  availability and potential usefulness of the options in our interviews with  DCAA, DCMA, military departments’ headquarters, commands, and local  contracting offices, military departments’ general counsel, DFAS, and  contractor representatives.
We conducted this performance audit from February 2012 to December  2012 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
section_title: Appendix II: Comments from the Department of Defense
section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above Tatiana Winger, Assistant  Director; Arkelga Braxton, Virginia Chanley, Nicole Dery, John Krump,  Janet McKelvey, Anh Nguyen, Robert Swierczek, and Omar Torres made  key contributions to this report.