Key Takeaways From the Defense Contract Audit Agency's Report to Congress for Fiscal Year 2022

The Defense Contract Audit Agency (DCAA) recently released its Report to Congress on Fiscal Year (FY) 2022 Activities. As with last year's report on FY 2021 activities, which we discussed in a corresponding Advisory, DCAA's latest report details key statistics and trends, as well as DCAA's audit priorities and timelines — including its focus on Business System audits, as Forward Pricing audits trend downward. DCAA also reports on initiatives to leverage technology to augment its reduced staffing levels and maximize its ability to work efficiently with complex datasets.

Statistics and Trends

DCAA's report sets out several statistics that showcase its activities for FY 2022, including that DCAA has examined US$262.3 billion in contract costs, identified more than US$5.7 billion in audit exceptions, and reported a net savings to the government of US$3 billion.¹ While the costs examined remained relatively flat as compared with FY 2021 (at US$259.7 billion), these figures reflect an uptick in exceptions identified in the FY 2021 report (at US$5.3 billion).²

As with prior years, DCAA reported its audit activity across four categories: Forward Pricing; Incurred Cost; Claims and Terminations; and Systems, Cost Accounting Standards (CAS) & Truth in Negotiations (TIN). For each category except Incurred Cost, DCAA reported a decrease in dollars examined, with a notable increase in audit exceptions.³ Conversely, DCAA examined more Incurred Cost dollars in FY 2022, but the audit exceptions identified remained relatively flat.⁴

Most notably, DCAA reported a drop off in net savings to DCAA (from US$3.7 billion in FY 2021 to US$3 billion in FY 2022) as well as the corresponding return on investment (from $5.7 to $1 in FY 2021 to $4.6 to $1 in FY 2022).⁵ The FY 2022 figures reflect the lowest return on investment (ROI) reported by DCAA in some time — dipping below a $5 savings for each dollar invested to conduct the audits, for the first time since FY 2015.⁶

According to DCAA, the drop off in net savings and ROI resulted from a "low number" of Forward Pricing audits requested by contracting officers in FY 2021 — a total of 633⁷ as compared with the seven-year average of 757.⁸ DCAA elaborated that Forward Pricing audits are DCAA's largest driver of questioned costs — this is borne out by the FY 2022 figures, which establish an ROI of $22.05 to $1 for Forward Pricing audits. By contrast, Incurred Cost, Claims and Terminations, and Systems, CAS & TIN audits yielded an ROI of $2.45, $2.26, and $0.45 respectively.⁹ Because the prior year's questioned costs are the largest driver of the current year's net savings and ROI, we may see a reduction in FY 2023 too. DCAA has reported an even lower 486 Forward Pricing audit reports in FY 2022, with US$48.4 billion dollars examined (as compared with US$63 billion in FY 2021).¹⁰

As to sustention rates, DCAA reported similar figures across Forward Pricing, Incurred Cost, and Claims and Terminations as in FY 2021, but approximately half the sustention rate on Systems, CAS & TIN (from 55.3% in FY 2021 to 28.3% in FY 2022), albeit across significantly higher audit exceptions (from US$49.6 million in FY 2021 to US$448.5 million).¹¹

Audit Priorities and Timelines

DCAA also reported on both how it prioritizes audits as well as its timelines for completion across the various audit categories.

DCAA continues to deploy a risk-based approach to Incurred Cost audits — prioritizing those audits involving "significant costs, significant audit findings in the past, or circumstances that reduce the incentive to control costs, such as those inherent in cost-type contracts."¹² In addition to examining US$186.1 billion across 522 audit reports as part of the formal process for high risk Incurred Cost submissions, DCAA also reported examining US$47.6 billion across 2,900 "low risk" submissions.¹³ To this end, DCAA used Independent Public Accountants for 117 audits in FY 2022.¹⁴ Recognizing the one-year turnaround time,¹⁵ DCAA again touted "essentially completing" its Incurred Cost audits on time, citing an average of seven months from receipt of an adequate submission, with certain exceptions.¹⁶

DCAA also reported average turnaround times for the other categories of audit activities. For instance, as to Forward Pricing, DCAA stated its goal is to meet agreed-to dates at least 85% of the time and noted that all reports were issued to meet acquisition timelines.¹⁷

DCAA reported a continued reduction in the auditor workforce in FY 2022 and estimated that "approximately 15 percent of identified workload is not performed due to low staffing levels."¹⁸ Unlike in its FY 2021 report, however, DCAA did not focus its recommended actions or resources to improve the audit process on reduced labor funding. Instead, DCAA acknowledged significant hiring challenges even with additional funding to increase staffing levels, and requested additional funding "for research and development and purchase of technology" that would "allow DCAA to continue exploring efficiency initiatives" — noting "technology based initiatives are more promising than simply increasing the workforce."¹⁹

Outreach and Other Activities

DCAA's report also discusses its industry outreach efforts and growing areas of audit activity.

First, DCAA reported on its efforts to complete 285 Business System audits by FY 2022 — a goal it set in FY 2019.²⁰ Business System audits allow DCAA to verify that a contractor's systems are compliant with applicable Defense Federal Acquisition Regulation Supplement requirements.²¹ Contractors have likely noticed this uptick over the past few years. DCAA reports that by FY 2022, it met its goal — completing over 288 Business System audits for larger defense contractors, with an additional 1,300 for contractors of other sizes.²² DCAA was able to accomplish this task (with a reduced workforce) in part due to the downturn in Forward Pricing audits, which allowed DCAA to focus on self-initiated audits.²³ While Systems, CAS & TIN audits are costly to DCAA relative to quantifiable net savings, DCAA reframes their value as "result[ing] in contractor actions to bring their systems into compliance, thus assuring accuracy of cost data."²⁴

Notably, DCAA also reported that its Business System team — comprised of auditors with expert knowledge in this area, who work with field audit offices — is standing down, with the full responsibility of Business System audits now passed to those field offices.²⁵ It remains to be seen if and how this will impact the course of such audits going forward.

Second, DCAA reported delivering on its expanding role supporting Other Transaction Authority (OTA) agreements. Last year, DCAA tagged these agreements as presenting "more risk factors" because they are not subject to the Federal Acquisition Regulation.²⁶ This year, DCAA reported providing advisory services to contracting officials during negotiations for OTA agreements in an effort to reduce costs to the government. In FY 2022, DCAA examined US$375 million in costs associated with OTA agreements and questioned $981,000.²⁷

Third, DCAA reported on the Operations Business Enterprise and Data Intelligence Division (OBD), established in FY 2022 with "the goal of developing innovative solutions to complex data challenges by leveraging emerging technologies."²⁸ Among its initiatives, the OBD is assessing data pipelines, improvements to system architecture, and AI integration; replacing DCAA's management information system with commercial off-the-shelf software; and is working to link the Contractor Submission Portal, which DCAA implemented in FY 2021, to the Defense Contract Management Agency systems and exploring additional, collaborative data sharing opportunities. DCAA also envisions OBD collaborating with contractors to maximize usability of complex datasets and in turn, enhance the audit process.²⁹

Conclusion

DCAA's Report to Congress on FY 2022 Activities reflects DCAA's evolving mix of audit activity. While DCAA continues to focus on Incurred Cost audits, the downturn in Forward Pricing audits has facilitated the uptick in Business Systems audits, which may challenge DCAA to quantify its net savings and ROI in the coming years. It also remains to be seen whether the increased Business System audits will impact (and specifically, reduce) audit exceptions and sustention rates across the other audit categories downstream.

What remains clear, however, is that there are several opportunities for DCAA to engage with contractors of any size, whether it be before contract award, in furtherance of finalizing rates and contract close out in the event of a termination or claim, or even as part of negotiating an OTA agreement. We look forward to supporting you across all fronts.

© Arnold & Porter Kaye Scholer LLP 2023 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.