Our investigation of DCAA hotline allegations and our DCAA-wide follow- up audit document systemic weaknesses in DCAA’s management environment and structure for assuring audit quality. Last year, our investigation of hotline allegations substantiated auditor concerns made on all 14 audits we reviewed at two locations and 62 forward pricing reports we investigated at a third location. We found that (1) workpapers did not support reported opinions, (2) DCAA supervisors dropped findings and changed audit opinions without adequate audit evidence for their changes, and (3) sufficient audit work was not performed to support audit opinions and conclusions. In addition, we found that contractor officials and the DOD contracting community improperly influenced the audit scope, conclusions, and opinions of some audits—a serious independence issue. This year, our follow-on audit found DCAA-wide audit quality problems similar to those identified in our investigation, including compromise of auditor independence, insufficient audit testing to support conclusions and opinions, and inadequate planning and supervision. For example, of the 69 audits and cost-related assignments we reviewed, 65 exhibited serious GAGAS and other deficiencies that rendered them unreliable for decisions on contract awards and contract management and oversight. Although not as serious, the remaining four audits also had GAGAS compliance problems. Of the 69 audits and cost-related assignments, 37 covered key contractor business systems and related controls, including cost accounting, estimating, and billing systems. Contracting officers rely on the results of these audits for 3 or more years to make decisions on pricing, contract awards, and payments. In addition, while DCAA did not consider 26 of the 32 cost-related assignments we reviewed to be GAGAS audits, DCAA did not perform sufficient testing to support reported conclusions on that work related to contractor billings. DCAA has rescinded 81 audit reports in response to our work and the DOD Inspector General’s (IG) follow-up audit because the audit evidence was outdated, insufficient, or inconsistent with reported conclusions and opinions and reliance on these reports for contracting decisions could pose a problem. About one-third of the rescinded reports relate to unsupported opinions on contractor internal controls and were used as the basis for risk-assessments and planning on subsequent internal control and cost-related audits. Other rescinded reports relate to CAS compliance and contract pricing decisions. Because the conclusions and opinions in the rescinded reports were used to assess risk in planning subsequent audits, they impact the reliability of hundreds of other audits and contracting decisions covering billions of dollars in DOD expenditures. Our hotline investigation found numerous examples where DCAA failed to comply with GAGAS. For example, contractor officials and the DOD contracting community improperly influenced the audit scope, conclusions and opinions, and reporting in three cases we investigated—a serious independence issue. For 14 audits at two DCAA locations, we found that (1) audit documentation did not support the reported opinions, (2) DCAA supervisors dropped findings and changed audit opinions without adequate evidence for their changes, and (3) sufficient audit work was not performed to support audit opinions and conclusions. We also substantiated allegations that forward pricing audit reports at a third DCAA location were issued before supervisors completed their review of the audit documentation because of the 20- to 30-day time frames required to support contract negotiations. Throughout our investigation, auditors at each of the three locations addressed in the hotline allegations told us that the limited number of hours approved for their audits directly affected the sufficiency of audit testing. Deficient audits do not provide assurance that billions of dollars in annual payments to these contactors complied with the FAR, CAS, or contract terms. We also found that DCAA managers took actions against staff at two locations, attempting to intimidate auditors, prevent them from speaking with investigators, and creating a generally abusive work environment. The following discussion highlights some of the examples from our investigation. In planning an estimating system audit of a major aerospace company, DCAA made an up-front agreement with the contractor to limit the scope of work and basis for the audit opinion. The contractor was unable to develop compliant estimates, leading to a draft audit opinion of “inadequate-in-part.” The contractor objected to the draft findings, and DCAA management assigned a new supervisory auditor. DCAA management then threatened the senior auditor with personnel action if he did not delete the findings from the report and change the draft audit opinion to “adequate.” Another audit of the above contractor related to a revised proposal that was submitted after DCAA had reported an “adverse” (inadequate) opinion on the contractor’s 2005 proposal to provide commercial satellite launch capability. At the beginning of the audit, the buying command and contractor officials met with a DCAA regional audit manager to determine how to resolve CAS compliance issues and obtain a favorable audit opinion. Although the contractor failed to provide all cost information requested for the audit, the DCAA regional audit manager (RAM) instructed the auditors that they could not base an “adverse” opinion on the lack of information to audit certain costs. The manager directed the auditors to exclude any reference to CAS noncompliance in the audit documentation and to change the audit opinion to “inadequate-in-part.” Based on the more favorable audit opinion, the buying command negotiated a $967 million contract which has since grown to over $1.6 billion through fiscal year 2009. The Defense Criminal Investigative Service is completing a criminal investigation conducted in response to our findings. The DOD IG performed a follow-up audit and confirmed our findings that DCAA’s audit was impaired because of a lack of independence; the audit working papers did not support the reported opinions in the May 8, 2006, proposal audit report; and the draft audit opinion was changed without sufficient documentation. In addition, the DOD IG concluded that the DCAA RAM failed to exercise objective and impartial judgment on significant issues associated with conducting the audit and reporting on the work—a significant independence impairment—and that the RAM did not protect the interests of the government as required by DCAA policy. The DOD IG also concluded that the contractor’s unabsorbed Program Management and Hardware Support (PM&HS) costs represented losses incurred on other contracts and prior accounting periods, including commercial losses—a CAS noncompliance. The DOD IG recommended that the Air Force buying command withhold the balance of $271 million for unabsorbed PM&HS costs (of which $101 million had already been paid) and that the Air Force cease negotiations with the launch services contractor on a $114 million proposal for unabsorbed costs. DCAA is currently performing CAS compliance audits on the commercial satellite launch contract costs. If DCAA determines that the contractor’s costs did not comply with CAS related to unallowable costs, cost accounting period, and allocation of direct and indirect cost, and the FAR related to losses on other contracts, DCAA findings should provide the basis for recovering amounts already paid. For a billing system audit of a contractor with $168 million in annual billings to the government, the field office manager allowed the original auditor to work on the audit after being assured that the auditors would help the contractor correct billing system deficiencies during the performance of the audit. After the original auditor identified 10 significant billing system deficiencies, the manager removed her from the audit and assigned a second auditor who then dropped 8 of the 10 significant deficiencies and reported one significant deficiency and one suggestion to improve the system. The final opinion was “inadequate- in-part.” However, the DCAA field office retained the contractor’s direct billing privileges—a status conveyed to a contractor based on the strength of its billing system controls whereby invoices are submitted directly to the government paying office without prior review. After we brought this to the attention of DCAA western region officials, the field office rescinded the contractor’s direct billing status. Our follow-up audit found that a management environment and agency culture that focused on facilitating the award of contracts and an ineffective audit quality assurance structure are at the root of the DCAA- wide audit failures that we identified for the 69 audits and cost related assignments that we reviewed. DCAA’s focus on a production-oriented mission led DCAA management to establish policies, procedures, and training that emphasized performing a large quantity of audits to support contracting decisions and gave inadequate attention to performing quality audits. An ineffective quality assurance structure, whereby DCAA gave passing scores to deficient audits compounded this problem. Although the reports for all 37 audits of contractor internal controls that we reviewed stated that the audits were performed in accordance with GAGAS, we found GAGAS compliance issues with all of these audits. The issues or themes are consistent with those identified in our prior investigation. Lack of independence. In seven audits, independence was compromised because auditors provided material nonaudit services to a contractor they later audited; experienced access to records problems that were not fully resolved; and significantly delayed report issuance, which allowed the contractors to resolve cited deficiencies so that they were not included in the audit reports. GAGAS state that auditors should be free from influences that restrict access to records or that improperly modify audit scope. Insufficient testing. Thirty-three of 37 internal control audits did not include sufficient testing of internal controls to support auditor conclusions and opinions. GAGAS for examination-level attestation engagements require that sufficient evidence be obtained to provide a reasonable basis for the conclusion that is expressed in the report. For internal control audits, which are relied on for 2 to 4 years and sometimes longer, the auditors would be expected to test a representative selection of transactions across the year and not transactions for just 1 day, 1 month, or a couple of months. However, we found that for many controls, the procedures performed consisted of documenting the auditors’ understanding of controls, and the auditors did not test the effectiveness of the implementation and operation of controls at all.