[House Hearing, 115 Congress]
[From the U.S. Government Publishing Office]






 
                         [H.A.S.C. No. 115-35]

            EVALUATING THE DEFENSE CONTRACT AUDITING PROCESS

                               __________

                                HEARING

                               BEFORE THE

              SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS

                                 OF THE

                      COMMITTEE ON ARMED SERVICES

                        HOUSE OF REPRESENTATIVES

                     ONE HUNDRED FIFTEENTH CONGRESS

                             FIRST SESSION

                               __________

                              HEARING HELD

                             APRIL 6, 2017




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              SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS

                  VICKY HARTZLER, Missouri, Chairwoman

K. MICHAEL CONAWAY, Texas            SETH MOULTON, Massachusetts
MATT GAETZ, Florida                  TOM O'HALLERAN, Arizona
JIM BANKS, Indiana                   THOMAS R. SUOZZI, New York
LIZ CHENEY, Wyoming                  (Vacancy)
AUSTIN SCOTT, Georgia
              Matthew Sullivan, Professional Staff Member
                       Barron YoungSmith, Counsel
                         Anna Waterfield, Clerk
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                            C O N T E N T S

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                                                                   Page

              STATEMENTS PRESENTED BY MEMBERS OF CONGRESS

Hartzler, Hon. Vicky, a Representative from Missouri, Chairwoman, 
  Subcommittee on Oversight and Investigations...................     1
Moulton, Hon. Seth, a Representative from Massachusetts, Ranking 
  Member, Subcommittee on Oversight and Investigations...........     2

                               WITNESSES

Bales, Anita F., Director, Defense Contract Audit Agency, Under 
  Secretary of Defense (Comptroller).............................     3
Berteau, Hon. David, President and Chief Executive Officer, 
  Professional Services Council..................................    15
Panetta, John, National Secretary, Financial Executives 
  International..................................................    17
Thomas, James, Assistant Vice President of Policy, National 
  Defense Industrial Association.................................    19

                                APPENDIX

Prepared Statements:

    Bales, Anita F...............................................    33
    Berteau, Hon. David..........................................    52
    Hartzler, Hon. Vicky.........................................    29
    Moulton, Hon. Seth...........................................    31
    Panetta, John................................................    68
    Thomas, James................................................    87

Documents Submitted for the Record:

    [There were no Documents submitted.]

Witness Responses to Questions Asked During the Hearing:

    Mrs. Hartzler................................................   101

Questions Submitted by Members Post Hearing:

    Mrs. Hartzler................................................   105
    
    
    
    
    
    
            EVALUATING THE DEFENSE CONTRACT AUDITING PROCESS

                              ----------                              

                  House of Representatives,
                       Committee on Armed Services,
              Subcommittee on Oversight and Investigations,
                           Washington, DC, Thursday, April 6, 2017.
    The subcommittee met, pursuant to call, at 9:00 a.m., in 
room 2212, Rayburn House Office Building, Hon. Vicky Hartzler 
(chairwoman of the subcommittee) presiding.

OPENING STATEMENT OF HON. VICKY HARTZLER, A REPRESENTATIVE FROM 
      MISSOURI, CHAIRWOMAN, SUBCOMMITTEE ON OVERSIGHT AND 
                         INVESTIGATIONS

    Mrs. Hartzler. Good morning. This hearing will come to 
order. I welcome our subcommittee members and witnesses 
testifying before us today.
    Over the last 15 years, the Department of Defense [DOD] has 
become increasingly reliant on the use of government 
contractors. When used properly, this public and private 
partnership can both improve our national security and at the 
same time preserve limited government resources. But this work 
requires competent and timely oversight.
    To that end, financial audits of defense contracts can play 
a vital role in ensuring that expenditures paid by the 
government for goods and services are fair and reasonable. It 
also ensures that taxpayers are getting the best bang for their 
buck.
    Within the Department of Defense, the Defense Contract 
Audit Agency, or DCAA, is charged with this critical mission. 
Today's hearing seeks to learn more about where the auditing 
process is working and identify any shortcomings with current 
accounting efforts. I am always looking for productive ways to 
improve government performance. I look forward to hearing from 
our witnesses about their feedback on the current auditing 
system.
    At the outset, I have several overarching questions about 
how the audit process is working within DCAA. In particular, 
for years DCAA has had a significant backlog of incurred cost 
audits. These audits are meant to identify instances where the 
government might have overpaid. However, as I understand it, it 
has been taking on average more than 2 years from the time DCAA 
receives the information necessary to conduct an incurred cost 
audit to the date the audit report is issued.
    These delays can create problems for government contract 
managers. Their efforts to recover improper costs are slowed. 
It also means managers do not have important financial 
information available soon after an expenditure takes place 
when the information is most important. From a business 
perspective, this delay can also create economic burdens. I 
look forward to hearing from our panel of industry experts on 
how these delays impact the private sector.
    I also have questions about how efficiently DCAA is 
performing these incurred cost audits. Although they account 
for the most significant portion of total costs audited each 
year, these audits only account for a relatively small amount 
of reported savings. I want to understand how much these audits 
are costing American taxpayers compared to the return from that 
cost.
    On a related note, I am interested to hear from our 
witnesses about how DCAA audit practices compare to what is 
commercially acceptable in the private sector. Perhaps there 
are lessons to be learned outside of government that could 
improve defense contract audit performance.
    The bottom line is simple: We all want a fair, efficient, 
and timely auditing process that works for all interested 
parties. I look forward to everyone's views this morning in 
addressing this important topic.
    But before I introduce the witnesses, I turn to Mr. 
Moulton, the Oversight and Investigations Subcommittee ranking 
member, for any opening remarks that he would like to make.
    [The prepared statement of Mrs. Hartzler can be found in 
the Appendix on page 29.]

     STATEMENT OF HON. SETH MOULTON, A REPRESENTATIVE FROM 
 MASSACHUSETTS, RANKING MEMBER, SUBCOMMITTEE ON OVERSIGHT AND 
                         INVESTIGATIONS

    Mr. Moulton. Thank you, Madam Chairwoman.
    The topic of our hearing today should be important to 
anyone concerned about accountability, efficiency, and 
transparency in our multibillion-dollar defense sector.
    The Defense Contract Audit Agency is the government 
organization charged with auditing the $287 billion in defense 
contracts that the Pentagon and other agencies make with 
private businesses every year. That makes it one of the main 
organizations whose job it is to ensure that the taxpayers' 
defense dollars are well spent and not stolen, wasted, or 
otherwise abused. DCAA also helps the government negotiate more 
competitive prices from the private sector.
    These roles, in which DCAA holds a public trust, are 
important to keep in mind as we discuss the pace of DCAA's 
auditing process. According to their annual report, DCAA 
currently has a backlog of incurred cost audits that it needs 
to reduce to ensure defense contracts are not unnecessarily 
delayed. But as we try to reduce this backlog, we should also 
be wary of exactly what proposals are made to do so and 
anything that could undermine the public trust.
    One thing under consideration is proposals to privatize the 
functions of DCAA and hand this important work over to private 
auditors. I am a strong believer in public-private 
partnerships, and I have personally advocated for them in many 
sectors, including transportation projects in which I have 
worked.
    In this case, however, I caution that early estimates 
suggest privatization could cost the taxpayers about 30 percent 
more, and we would also be positioning a small number of 
auditing companies to oversee defense contractors with whom 
there would likely be conflicts of interest. Obviously, the 
history of Enron and the financial crisis suggest we have to be 
very careful in this situation.
    We should also keep in mind the origin and state of DCAA's 
backlog as we develop defense reform policies. DCAA first 
developed a backlog when the number of defense contracts and 
expenditures ballooned during the wars in Iraq and Afghanistan.
    DCAA has certainly made mistakes. In 2010, it recognized 
this problem, hired 400 additional workers, and adopted new 
strategies to begin reducing the backlog. Those efforts have, 
in fact, succeeded so far. And as you can see from the graph of 
the backlog presented in the testimony, it has been shrinking 
by about 4,000 contracts per year to the point where about 
4,677 are left in the queue. When the pace has slowed more 
recently, it has been due to sequestration and now President 
Trump's hiring freeze.
    This evidence suggests that we can make a lot of progress 
on this backlog by properly resourcing DCAA's mission, 
mitigating the impact of sequestration and hiring freezes, and 
ensuring DCAA has enough capacity to cope with an unexpected 
increase in defense spending.
    I look forward to the testimony this morning to 
understanding better how we can make reforms and improve the 
process and, ultimately, preserve the important mission that 
DCAA does for our taxpayers and for our defense.
    Madam Chair.
    [The prepared statement of Mr. Moulton can be found in the 
Appendix on page 31.]
    Mrs. Hartzler. Thank you, Mr. Moulton.
    Today, we are going to have two panels. First, we will get 
to visit with and hear from the director of the DCAA, and then 
our second panel will be from the private sector. And we look 
forward to both those testimony.
    And we do have votes a little after 10, and so hopefully, 
we can get both panels in and get this hearing wrapped up.
    But I really am pleased to recognize Ms. Bales, Ms. Anita 
Bales, director of the Defense Contract Audit Agency. And 
members have already been provided with her biography.
    So thank you for being here, Ms. Bales, and we will welcome 
your opening statement.

 STATEMENT OF ANITA F. BALES, DIRECTOR, DEFENSE CONTRACT AUDIT 
        AGENCY, UNDER SECRETARY OF DEFENSE (COMPTROLLER)

    Ms. Bales. Thank you. Chairwoman Hartzler, Representative 
Moulton, and members of the subcommittee, thank you for the 
opportunity to appear before you today.
    You have my written statement. And now in my opening, I 
would like to highlight points related to our processes for 
incurred cost audits and for bringing in independent public 
accounting firms to conduct incurred cost audits.
    The incurred cost audits have received a lot of attention 
by several organizations concerned about us getting the backlog 
down. I would like to recap that the backlog resulted from 
significant increases in defense spending post-9/11 while DCAA 
staffing remained stagnant.
    To address the backlog, the agency came up with a 
comprehensive approach. Despite the staffing challenges, we 
have reduced the backlog 75 percent over the past 5 years. We 
expected to be current by the end of fiscal year 2018, but need 
to assess the impact of the current hiring freeze.
    Let me expand on two of those initiatives. First, the use 
of multiyear audits has reduced our audit time by 40 percent 
over single-year auditing. Because of the efficiency obtained 
through multiyear audits, we would see this as a methodology we 
would like to continue after we resolve the backlog.
    Second, implementing low-risk sampling allowed us to reduce 
the number of audits we conduct. Based on risk and materiality, 
we only audit a small percentage of low-risk submissions. Using 
our low-risk procedures over the past 5 years, we closed over 
14,000 incurred cost years without an audit.
    I believe part of the desire to use IPAs [independent 
public accounting firms] is a belief they are more efficient 
based on people's experience with their financial statement 
audits.
    That brings me to our first concern: Contracting audit is 
different from financial statement auditing. A financial 
statement auditor attests that the financial statements fairly 
present the financial position of the company in accordance 
with Generally Accepted Accounting Principles, or GAAP. For 
contract auditing, GAAP standards are only part of the 
equation. DCAA auditors also have to evaluate the costs are in 
accordance with statutory cost accounting standards and the 
Federal Acquisition Regulations.
    The risk the financial auditor faces is a material 
misstatement in the company's financial statements. The risk 
the contract auditor faces is the payment of improper cost. The 
materiality associated with those risks is different.
    Let me illustrate the risk and materiality aspect through 
my experience doing financial statement audits. I worked on an 
audit of a balance sheet, and applying materiality levels we 
determined that if a line item wasn't at least $100 million, it 
was not material and we wouldn't audit it.
    However, if we had been concerned about making payments, 
money actually going out the door that shouldn't, no company or 
government entity would say, it is only $90 million, so that is 
okay. So that is the difference in the risk, in the materiality 
levels.
    In addition, many expenses that are acceptable under GAAP 
are unallowable under CAS [Cost Accounting Standards] and FAR 
[Federal Acquisition Regulation]. The contract auditor has to 
take additional steps to prevent that risk of improper payment.
    Another challenge IPAs may face that would be difficult to 
overcome is the efficiencies that DCAA can bring to bear 
through having the knowledge gained by doing other types of 
audits for contractors and for having access to all the 
contractors and subcontractors.
    First, our work on each type of our audits, be it incurred 
costs, forward price, business systems, all of the different 
audits that are in our portfolio, inform our risk assessment on 
all other audits, allowing us to do less work, bringing 
efficiencies in that will be lost if we don't do the incurred 
cost audits.
    Second, subcontracts are a large part of most audits. 
Incorporating results of separate subcontractor audits into the 
prime contractor report is very efficient for us, because as 
one agency, we can share results and collaborate across our 
offices. If an IPA were to perform the prime contract incurred 
costs, the government would have to create new processes to 
facilitate the subcontractor audits among the IPAs.
    Finally, 65 percent of all incurred cost audits involve 
auditor-determined annual indirect rates for incurred cost 
submissions. FAR distinguishes this function as inherently 
governmental.
    In the coming year, I would like to continue to work with 
the committee to better understand its objectives and how to 
best achieve those. I will also ask that you give me the time 
to work with industry and the acquisition community on these 
acquisition reform ideas to include evaluating the appropriate 
use of IPAs and doing a cost-benefit analysis of performing 
single-year audits versus multiyear audits.
    We have seen clear benefits. Multiyear audits reduce our 
audit time by 40 percent, and industry has responded favorably 
to the potential of reducing their resources as well. I want to 
better understand any detrimental effects of a 2-year 
inventory, and I will work with stakeholders to determine the 
costs and benefits of auditing one year at a time. However, at 
this point, I suggest that a 40 percent increase in efficiency 
makes a compelling case for gathering more information before 
discontinuing the multiyear process.
    I commit to you that if a data-driven cost-benefit analysis 
demonstrates that single-year audits are more beneficial than 
multiyear audits, we will do single-year audits.
    I would like to thank the committee for allowing me to 
share my thoughts. If investments are going to be made in 
additional resources, I would like the opportunity to restore 
and stabilize DCAA's staffing levels. I would like the 
opportunity to finish what we are so close to achieving.
    I look forward to your questions, and if there are any 
additional questions after the industry panel, I would welcome 
the opportunity to answer those. Thank you.
    [The prepared statement of Ms. Bales can be found in the 
Appendix on page 33.]
    Mrs. Hartzler. You bet.
    Thank you very much, Ms. Bales. That was very interesting, 
especially your comments about the multiyear auditing, and that 
is encouraging, something to look into.
    You mentioned materiality, and I wanted to hone in on that 
again. So what is the standard of materiality DCAA auditors use 
when conducting? Is it $100 million? You used that example.
    Ms. Bales. No. That example I used was when I worked for 
the Army, I did financial statement audits. And due to the 
magnitude of the assets and liabilities on the Army's balance 
sheet at that time--and that information is dated--$100 million 
was the materiality level we used. And so if there was an asset 
on the balance sheet that was less than $100 million, it could 
be entirely wrong and not materially misstate the financial 
statements. So that is why we would not choose that line as one 
to audit.
    But within DCAA, we don't do a standard percentage, because 
it depends on the risk level of the different cost elements 
that we would look at. We may have a cost element that we have 
experience with over the years and have not identified any 
discrepancies or questioned costs. We would look at that--we 
would make the decision whether we even want to look at that 
cost segment first, because we do a two-step risk evaluation.
    First, which audits do we do. And that gets into, like, our 
low-risk sampling, because we have determined that certain 
companies and their incurred costs are low risk. We don't audit 
every one. We put them into a sample, and we only do a sample 
of the low risk. We believe doing the sampling is important, 
because it provides a deterrent effect. If there was the 
possibility that you would never be audited, what would creep 
into the incurred costs.
    So that is the first step, is deciding which audits to do. 
And then when we start an audit, we start looking at the risk 
that involves the different cost segments, be it labor, 
material, subcontract costs, other direct, and determine where 
the risk is and decide which elements to audit and to the 
degree that we audit those.
    Certain costs are more sensitive, so we would have a lower 
materiality level on those than we would ones that would flow 
down and end up not having as large an impact on the overall 
cost.
    Mrs. Hartzler. Okay. Very good.
    So talk about your backlog. You mentioned that a little 
bit. And so as I understand it, in fiscal year 2011 the total 
value of the backlog inventory was $414 billion and in fiscal 
year 2016 the total value and the backlog inventory is $409 
billion. So why has the incurred cost backlog not been reduced 
more in terms of the actual value of the audits that are 
pending?
    Ms. Bales. The dollar value will continue to go up as we 
get additional incurred costs in every year. Every year we get 
about 5,000 additional incurred cost submissions, and the 
dollar value that comes in relates to the dollar value that is 
being contracted out over the past few years, because we will 
get an incurred cost audit that will have the dollars for that 
fiscal year for all contracts for that company. So part of the 
increase is also due to how much is out on contract.
    The dollar value we have probably reduced--we started 
reducing the dollar value--I think you have a chart in the--if 
not in my testimony, in the report to Congress--that shows 
that, initially, we brought the numbers of incurred cost 
submissions down more quickly than we brought down the dollars.
    And part of that goes to the multiyear auditing. We started 
with our multiyear auditing on the smaller contractors. So we 
were able to bring down the numbers of submissions faster than 
we were able to bring down the dollars. But we have now moved 
into doing multiyear audits, sometimes upwards of 4 years at 
our larger contracts, and you now see the backlog of dollars 
coming down faster.
    Mrs. Hartzler. Okay. Is it true that DCAA has issued 
approximately 14,000 low-risk memos to reduce the backlog?
    Ms. Bales. Yes, that is true. That is the ones I referred 
to that we have closed without audit. We do a low-risk memo to 
close those out.
    Mrs. Hartzler. Sure. So how many audits were actually 
completed during that time?
    Ms. Bales. That number is--I apologize for not having 
that----
    Ms. Hartzler. Sure. That is fine.
    Ms. Bales. I think that number is around 4,000. But let 
me--I will confirm that and get back to you.
    [The information referred to can be found in the Appendix 
on page 101.]
    Mrs. Hartzler. Okay. So you completed 4,000 and then just 
wrote off 14,000, and that is the way to reduce the amount of 
backlog quick.
    Ms. Bales. Right. But that, it goes back into the risk 
assessment of doing that. And, you know, that is one of the 
things that we hear a lot, is, well, you audit everything and 
you don't consider risk. So as we went into the low-risk 
sampling, we did take a look at those submissions. And every 
submission we get in, we do an evaluation of the submission to 
help determine if it should be low risk or not.
    Mrs. Hartzler. Okay.
    Ms. Bales. So we see what is in there. We also do other 
audits to say, you know, we have looked at vouchers that have 
come in, we do interim vouchers, which is kind of like a mini 
incurred cost. So if we don't have issues that are coming in on 
those vouchers, that is another reason we can determine those 
low risk. So if we haven't done an audit, it is not that we 
haven't done anything in evaluating that contractor's cost.
    Mrs. Hartzler. Very good. Thank you.
    I have got more questions, but I will go to other members.
    Ranking Member Moulton.
    Mr. Moulton. Thank you, Madam Chairwoman.
    So as I mentioned in my opening statement, I think that as 
we all look at opportunities for Defense Department reform, one 
of the things that we are taking a serious look at is the role 
that the private sector plays and can play in the future in 
functions like this and functions, frankly, across the 
Department of Defense. There are a lot of places where the 
private sector is better equipped to do things than the 
military or the defense civilians, and we have done a lot of 
contracting out in recent years. But I just want to dive into 
that a little bit with you to better understand exactly what 
that would look like here.
    One of the issues that has been brought up in, sort of, an 
early look at this is the potential for conflicts of interest. 
So can you just explain a little bit more what that means, what 
kinds of private auditors would be available to do this work, 
and why there might be this heightened risk?
    Ms. Bales. Well, one of the issues that an auditor that--a 
company that would come in and potentially do the incurred cost 
audits, they could not audit any company that they do any other 
work for, because they would then be making a determination on 
their own costs, because their own costs would be part of what 
is in that contractor claim.
    There is also the issue, potentially, of proprietary data. 
One of the things that our contractors are very concerned about 
is who sees their proprietary data. And I think this would be a 
question that industry would have to ask is--have to answer is 
how comfortable are they with sharing their proprietary data 
with folks that may be auditing their competitors. And, 
obviously, we audit the competitors, but our purpose is very 
much into the government interest.
    Mr. Moulton. Right. Sure. But there are a lot of--there are 
thousands of companies. There are plenty of auditors out there. 
Why is the issue that they be, you know, potentially auditing 
their competitors in this situation, whereas that is not the 
case in another typical industry?
    Ms. Bales. And I think that gets down to the level of 
proprietary data. One of the things that we find with our 
contractors is they are very trusting and know that we take 
care of very sensitive data in terms of their price 
relationships and cost relationships and what they charge 
different customers. We had a situation with one contractor 
where they were comfortable giving us the information, but it 
was very controlled, and we had to make a judgment on that. 
They didn't really even want to share that information with the 
contracting officer.
    So I think that is the difference between sharing 
contract--auditors that might do their financial statement 
audits, which is very public information, versus doing audits 
that are in the contract arena, which has that very sensitive 
proprietary data.
    Mr. Moulton. Well, what are the private companies that 
could do this kind of contract auditing?
    Ms. Bales. I would assume that the folks that are going to 
come in and look at this would be, you know, all of your--the 
public accounting firms. I think you will have to look at the 
different sizes that would--you know, some of the smaller ones 
would not be able to probably absorb an audit that relates to 
the really large contractors. I don't know in terms of the 
large contractors if they would really be able to come in and 
do this type of work or if it would conflict them out on other 
audits that they do.
    Mr. Moulton. Okay. But the important thing to understand is 
that, at least in your estimation, the big public accounting 
firms would have the capability to do this?
    Ms. Bales. They would.
    Mr. Moulton. Okay. Even though it is different than the 
typical financial statement accounting?
    Ms. Bales. Right.
    Mr. Moulton. Okay. That is very helpful.
    When we are talking about the backlog, there is, obviously, 
some concern across DOD with the hiring freeze and the impact 
that that has been having on the work. Could you talk about 
whether that is an issue and how you are working around it at 
this point?
    Ms. Bales. It is absolutely an issue for us, because we 
came into fiscal year 2017 lower on our end strength than we 
needed to complete the work years that we had planned for this 
year. And we were under a hiring freeze in fiscal year 2016 as 
a result of the 2016 NDAA [National Defense Authorization Act] 
that didn't allow us to do work for nondefense agencies, so 
that lowered the reimbursable dollars that we have in that fund 
about 10 percent of our workforce.
    So we had to go into a hiring freeze to accommodate that 
reduction in funding in 2016. So we entered 2017 very low. And 
we wanted to hire back that loss from 2016 as well as our 
normal attrition. We were planning on hiring about 100 people a 
month, and we started doing that in the first quarter. It got 
turned on a little slower. And right now we aren't in a hiring 
freeze--we are in a hiring freeze--so we haven't been able to 
hire that in January, February, March, and still not hiring to 
date.
    So we are really getting behind the power curve on our 
ability to execute the work years that we need to this year. 
And the later we hire in the year--at this point, there is 
probably no way that we can hire enough to complete the number 
of work years that we need to this year.
    Mr. Moulton. Okay. Great. Thank you very much. Thank you 
for being here.
    Madam Chairwoman.
    Mrs. Hartzler. Thank you.
    Mr. Scott from Georgia.
    Mr. Scott. Thank you. Thank you, Madam Chair.
    Ma'am, you will have to forgive me. I did not receive the 
testimony until 9:30 last night.
    Ms. Bales. I apologize.
    Mr. Scott. When was the testimony due?
    Ms. Bales. It was due 48 hours before. And quite honestly, 
as it went through the approval process, it got kicked back to 
us.
    Mr. Scott. And the approval process, that is through OPM 
[Office of Personnel Management]?
    Ms. Bales. It is through our Pentagon and then over to OMB 
[Office of Management and Budget].
    Mr. Scott. I am sorry. OMB is what I meant.
    Ms. Bales. Yes.
    Mr. Scott. Madam Chair, I hope we will start taking note of 
when we actually receive testimony.
    Mrs. Hartzler. Yes, absolutely.
    Mr. Scott. It makes it very difficult to do a good job when 
you don't have the testimony prior to the meetings.
    Ms. Bales. Sir, we were pushing as hard as we could.
    Mr. Scott. I understand, ma'am. But there is a breakdown of 
management there that has to be fixed for us to do proper 
oversight. I don't blame it--and understand this, I don't blame 
you for it. It seems to be habit in most of our agencies today.
    Second, I will tell you, I think you are exactly right. If 
you have a threshold of $100 million, I think you are going to 
have an awful lot of stuff stop between $85 and $95 million. So 
I hope you will continue to audit it.
    One thing I would also encourage that we never do is 
something in the auditing that has been done in health care, 
which is what is called RAC [Recovery Audit Contractor] audits, 
where auditors are actually paid a commission instead of a fee.
    My question for you, though, is how do you measure success? 
What are the most important metrics, in your opinion, to 
evaluate your agency's performance?
    Ms. Bales. So one of the things we obviously do is report 
our return on investment. I think that is important for our 
investors or taxpayers through Congress to know what they are 
getting for the dollars they spend on us. And currently, in 
fiscal year 2016, our return on investment was 5.7 to 1. And I 
will say those are actual realized benefits and dollars that 
don't go out on contract or money that we get back in through 
our incurred cost audits.
    One of the things that we learned back in 2007, 2008, is 
you have to have a balanced set of metrics, because if you only 
measure, like, production, then you forget about quality. Or if 
you only measure return on investment, you may start doing 
things that drive unintended behavior, and we don't want to do 
that.
    I know one of the rumors or myths out on the street is that 
our auditors get appraised for finding dollars. None of our 
auditors in any of their performance standards say, you get X 
amount of dollar savings and you are going to get an 
``exceed,'' you are going to get an award, you are going to get 
anything like that. What we measure our auditors on is that 
they do quality audits that meet the standards and that find 
what is appropriate.
    One of the things that we do is we measure the amount of 
exceptions that we find on an audit, which is how many dollars 
do we question. But then we also balance that with how much do 
we sustain, because we don't want our auditors just questioning 
cost because it looks good to question. You have to have that 
balance of how much do we sustain.
    So that is what we look for, is measuring--getting balanced 
measures. Part of it is dollar return. That is what, you know, 
obviously, we look at, is making sure we do fair and reasonable 
prices, and that is very easily measured in dollars.
    We also look at our timing. So, obviously, the incurred 
cost backlog is not a good story as we look at our timing 
metric, but as we look at our forward pricing and we look at--
we have brought down our elapsed time on that, we have brought 
down our elapsed time on most of our audits, and we also look 
for forward pricing, meeting what we promised the customer.
    Mr. Scott. Can I ask you, obviously, you are auditing 
things that happen on our bases and equipment that we purchase.
    Ms. Bales. Right.
    Mr. Scott. Are your auditors actually on-site at the base 
permanently or do they simply go in as requested?
    Ms. Bales. So our auditors, they go into the contractor 
facilities and do the audit versus doing the audits on base. So 
we have residencies at many of the large contractors, and then 
with our smaller contractors we have branch offices where they 
go out and go to the contractor facilities. Because while the 
expenditures for what we audit are used on base, what we audit 
is the contractor.
    Mr. Scott. Thank you for your testimony, ma'am. I am out of 
time. But I do wonder if maybe it would be better to audit at 
the base level, would be a question if we have time I will come 
back to. But I yield the remainder of the time that I am out 
of.
    Mrs. Hartzler. Well, thank you, Mr. Scott.
    Mr. Suozzi.
    Mr. Suozzi. Director, thank you so much for your time 
today. Would you say your main job is to try and root out 
waste, fraud, and abuse in the Department of Defense?
    Ms. Bales. I would say it is to make sure that--absolutely. 
I mean, that is, I think, a job of any Federal employee, is to 
make sure we don't have fraud, waste, and abuse in our 
expenditures. And the way we do that is making sure that we are 
getting fair and reasonable prices for the goods that we--the 
Department expends with our contractors.
    Mr. Suozzi. So how many employees do you have in your 
department now?
    Ms. Bales. We are currently around 4,500. It fluctuates.
    Mr. Suozzi. And in your view, what would be the ideal 
number of people to have in that department?
    Ms. Bales. We have estimated, as we went through this, that 
if we could settle in around 5,000, that we would be able to do 
our portfolio of audits. One of the things that we did to 
reduce the incurred cost backlog was to go in and ask for more 
resources and put that in the budget. And we were able to get 
to about in between 5,000 and 5,100 a couple of times in 
between the sequestration and the hiring freezes. And if we 
could do that, we think we will be able to accomplish our 
incurred cost backlog and then accomplish incurred costs on a 
regular basis, as well as doing the other audit.
    Mr. Suozzi. You say you would like to see a 10 percent 
increase in your current employee level?
    Ms. Bales. Yes. And that is what we have on hand. 
Currently, we have a higher budget than what we have on hand, 
as we said, because of the hiring freeze, so----
    Mr. Suozzi. So the incurred cost backlog, you say it is 
based upon the submissions. How do you get a submission in the 
first place? How does something get in the queue in your list 
of what is on the incurred cost backlog in the first place? 
What makes that list?
    Ms. Bales. So every contractor that has flexibly priced 
contracts are required to submit an annual incurred cost 
submission 6 months after the end of their fiscal year. For us, 
that means we get most of ours in at 30 June, because most of 
the contractors, about 75 percent of them, have calendar year 
end as----
    Mr. Suozzi. So 100 percent of those are subject to audit?
    Ms. Bales. If they have flexibly priced, yes. And they are 
subject to audit. And then we go in, again, as the low-risk 
process. Not all of them will get audited. We do the sampling.
    Mr. Suozzi. But 100 percent of those type of contracts 
become on the list of incurred cost backlog?
    Ms. Bales. Yes. Yes, sir.
    Mr. Suozzi. And is that a reasonable way of doing that, of 
looking at 100 percent of them? Is that a statute? Or is that a 
requirement?
    Ms. Bales. It is a requirement.
    Mr. Suozzi. As a statute or is something you do, your 
department determined?
    Ms. Bales. No. It is statutorily required that if you have 
fixed--flexibly priced contracts that you submit an incurred 
cost submission.
    Mr. Suozzi. Is that a good way of doing it, that all of 
them make the list?
    Ms. Bales. I think yes, because as I go back to the 
deterrent effect, that if you have flexibly priced contracts 
and you can report--record costs, we are going to say we are 
going to reimburse you for all your costs, if no one is looking 
at what your costs are or there is not the chance that the cost 
that you submit will be looked at, there is that opportunity to 
put a lot of costs on. And it is one of those things. It is 
like we help folks be honest.
    Mr. Suozzi. Okay. You think it makes sense that 100 percent 
are on the list?
    Ms. Bales. Yes.
    Mr. Suozzi. That is all I want to know, your expert 
opinion.
    Do you issue an annual report of any kind that we could 
read----
    Ms. Bales. Yes.
    Mr. Suozzi [continuing]. That says, hey, these are really 
good examples of things we should be trying to go after, these 
are good examples of waste, fraud, and abuse that we should be 
trying to attack?
    Ms. Bales. We annually issue our report to Congress, and we 
also have--our audits in the DOD IG's [Department of Defense 
Inspector General's] report that would show examples of audits 
where we have found that.
    Mr. Suozzi. And when you say you issue it to Congress, who 
gets that?
    Ms. Bales. All of the--the HASC [House Committee on Armed 
Services], the SASC [Senate Committee on Armed Services], the 
HAC [House Committee on Appropriations], and the SAC [Senate 
Committee on Appropriations].
    Mr. Suozzi. Okay. Let me see, the HASC, the HAC----
    Ms. Bales. I figured this was one place I could use those 
acronyms.
    Mr. Suozzi. Okay. Well, I think, you know, as a practical 
matter, it would be good for us to hear ideas from you as to 
places you think that we can try and eliminate waste, fraud, 
and abuse in the Department of Defense, because I think in 
these difficult times when we are looking at increasing budget 
and scarce resources, we would all like to hear in very 
practical, straightforward terms: This is a good place to look.
    Ms. Bales. Okay.
    Mr. Suozzi. Thank you very much.
    Mrs. Hartzler. Thank you, Mr. Suozzi.
    So I had just a couple more questions here. So last year's 
NDAA required the DCAA to accept certain audit findings of 
indirect costs from commercial auditors. So has DCAA 
implemented this policy?
    Ms. Bales. We have not yet. I think we have--the timeframe 
is, like, June that we have to start doing that. And I think 
part of that is determining how we are going to do that.
    One of the things in terms of our professional standards is 
we can't just accept work from another auditor or auditing 
company without doing certain things to know that we can rely 
on their work.
    And, in addition we have been talking somewhat about the 
intent of that, and we are working through which of those do we 
accept. Because, quite frankly, the way that is worded--and we 
have put in a legislative proposal to clarify--is because it 
says cost type not even flexibly priced, as we talk about the 
intent, was it the intent that even our largest contractors 
would not be audited. Because some of those, as a percentage of 
revenue, even our--like, three of our top five defense 
contractors would not have incurred cost audits done by DCAA.
    And we think that that, with the fact that we are sitting 
there at those facilities doing all of the other audits, that 
that would be more efficient that if we were to be able to go 
in and do those.
    Mrs. Hartzler. So you have put in a legislative request to 
get more clarification on that?
    Ms. Bales. Right. Well, our legislative proposal hat is 
requesting that we don't do that. And, really, as we see the 
legislative proposals and having the discussions for 2018, 
making sure that what we are asking to have in 2018 or 
proposing in 2018 doesn't conflict with that. But our proposal 
has come in to say if we could eliminate that.
    Mrs. Hartzler. Okay. So if private auditing companies took 
on a certain percentage of incurred cost audits how would DCAA 
audit teams be redeployed? And could staff currently allocated 
to performing incurred cost audits be tasked to work on other 
audit types?
    Ms. Bales. Absolutely. And that is our plan in terms of as 
we--you know, the increase in workforce that we had, one of our 
goals and plans in how to get rid of the incurred cost was to 
dedicate those to doing incurred cost audits to eliminate the 
backlog. And then, as we got current, we would move those to 
audits that we aren't doing now that we need to be doing, more 
cost accounting standard disclosure audits, TINA [Truth in 
Negotiations] Act audits, those types of things, because we 
aren't doing all of the audits in other areas that we should.
    One of the questions that had come up is, well, if you had 
hired more people earlier, could you have got the backlog down 
more quickly? We could have, but then it would be, do I want to 
staff up and have that temporary workforce or do I want to look 
at what we would need for a steady state?
    In addition, it is how many contract and how many auditors 
can the contractor support at one time. Because we have had 
pushback even now as we go in to do the backlog is we can't 
support any more audit from the contractors.
    Mrs. Hartzler. Very good.
    Mr. Moulton, do you have any more questions?
    Mr. Moulton. Thank you, Madam Chairwoman.
    Just a couple things, and really points for clarification, 
because I have some numbers in front of me that I just don't 
fully understand.
    The first question is just about the average time it takes 
for an incurred cost audit to be completed, because I see one 
number of 838 days, in some instances we have 124 days. Can you 
just speak briefly to that discrepancy?
    Ms. Bales. So the 885 days shows how long they have been in 
inventory. It is not actually how long it takes to complete the 
audit once started. The 134-day average is once we have an 
entrance, let the contractor know we are starting to do that 
audit, how long it takes us to do and issue the report.
    The 885, as I said, especially, since we have a backlog, is 
high, because that is when we first received the proposal, the 
incurred cost submission.
    Mr. Moulton. Great. That is very helpful.
    And then we have heard this estimate that privatizing this 
business would cost the taxpayer about 30 percent more. Can you 
explain where that comes from and why--what you have to justify 
that estimate, Director?
    Ms. Bales. Sure. So we looked at that. We did a very simple 
comparison of saying that--compare our hourly rate compared to 
the GSA [General Services Administration] schedules for 
companies that would be probable contenders in here. So looking 
at that, we did a conservative estimate. Our rate includes our, 
you know, all levels of our auditors, including up to our 
senior management, and we compared that to a senior auditor 
rate, which doesn't include the senior partners and everything. 
So that is how we came up with an estimate on that.
    But I think that is one of the things when I said that it 
would give us some time to evaluate that, I think a business 
case on whether, you know, will it be cheaper, will it not, I 
think would be appropriate to do.
    Mr. Moulton. That was some of my experience serving in 
Iraq, is that a lot of times having private contractors made 
short-term costs go down but long-term costs go up, and that 
underlies some of my concerns.
    Ms. Bales. Sir, like I said, we don't have a business case 
analysis. I do have some anecdotal stories, but they are 
anecdotes. We had some of our nondefense customers wanted to 
come back to us. We had one that, because we were in backlog 
and weren't getting the work done, went to an IPA to have their 
work done.
    Then, in fiscal year 2016, they wanted to come back to us, 
but because of the other language they couldn't. But they 
wanted to come back to us. One of the reasons was because the 
contractor doubled their price in the second year.
    So those, I think, are some of the concerns, that if we 
could do and have the opportunity to do a good business case 
analysis could be evaluated.
    Mr. Moulton. Okay. Thank you, Director.
    And then just one other quick question. Mr. Scott brought 
up this issue with the testimony. Can you just describe in a 
little bit more detail what the holdup is with OMB? That is 
where it got held up? Is that right?
    Ms. Bales. They passed it back for some language.
    Mr. Moulton. Are these political considerations, or what 
was going on?
    Ms. Bales. They thought we were--because we talked about 
potential legislative--acquisition reform legislation--and 
because we--they had not been aware of legislation, they were 
concerned that we had not went through them on legislation 
reform and proposals. So that could have been I said the word 
``legislation'' instead of that we are here to talk about ideas 
for potential reform.
    Mr. Moulton. Okay. Well, I would hope in the future that we 
would be able to----
    Ms. Bales. So I think that is what got us hung up.
    Mr. Moulton. We would certainly value your feedback on 
legislative proposals. After all, we are legislators, and we 
are here to hear your views and opinions. And so, hopefully, 
that will be not an issue in the future.
    Director, thank you very much.
    Madam Chairwoman, I yield back.
    Mrs. Hartzler. You bet.
    Well, thank you, Ms. Bales. We appreciate you being here 
today. And so this will conclude the first panel. We appreciate 
that very much.
    And I ask the second panel now to come to the witness 
table.
    Thank you, gentlemen, for being here. We appreciate it very 
much.
    We have Mr. David Berteau from Professional Services 
Council here, Mr. John Panetta from Financial Executives 
International, and Mr. James Thomas from the National Defense 
Industrial Association.
    And the members have been provided with your biographies.
    So, Mr. Berteau, we will start with you.

STATEMENT OF HON. DAVID BERTEAU, PRESIDENT AND CHIEF EXECUTIVE 
             OFFICER, PROFESSIONAL SERVICES COUNCIL

    Mr. Berteau. Thank you very much, Chairwoman Hartzler and 
Ranking Member Moulton and other members of the subcommittee 
who might come in while we are talking here. We really 
appreciate the opportunity to testify this morning on behalf of 
the 400 members of the Professional Services Council. These are 
all government contractors who fall into the category of both 
being audited and some of them being potential third-party 
independent providers for services being discussed here this 
morning.
    Your invitation letter asked us to discuss evaluating the 
defense contract auditing process. And as part of that 
discussion, my written statement includes a number of specific 
recommendations as well as some criteria that we think are 
useful to you. And I would ask that my full written statement 
be incorporated into the record this morning. I would just 
highlight a couple of things.
    Mrs. Hartzler. So ordered.
    Mr. Berteau. For efficiency and effectiveness, we certainly 
endorse the idea that the government needs good, timely 
auditing and proper accounting practices. They have actually 
got pretty good guidelines out there to do it.
    I have brought with me this morning the last printed 
version of the DCAA contract audit manual. This roughly 4,000 
pages gives very good guidance on how to do contract auditing. 
It also, I think, illustrates the complexity of the process and 
part of the reason why it might take a while. So I just bring 
those along so you can get a sense.
    These issues, though, have been with us for a long time. It 
is not just a result of increased defense spending in the 
aughts. And the questions are, clearly: How do we protect the 
government's interests in a timely and cost-effective manner? 
How do we do this without excessive burden on the system, both 
the contractors and the program offices that manage those 
contractors and the contracting officers? How do we focus on 
getting the best and most useful results? And how do we use 
contract auditing to support better contracting and better 
program management? Because auditing is not an end in itself. 
It is a means to support the execution of government missions 
and the achievement of government objectives.
    The private sector has these same issues, those same 
questions. And they have made great progress over the years in 
applying innovative processes and automated tools. And there 
are some examples that I would be happy to go into during the 
questions.
    Simply adding more people doesn't really change the dynamic 
of the problem. When you have got a backlog of 2\1/2\ years, 
even if you cut the time in half, it is still taking more than 
a year to audit a year's worth of costs. And at some point you 
can't dig your way out of that hole. So that, I think, is an 
important element to keep in mind.
    Many of the functions performed by DCAA that we have talked 
about this morning should, in fact, only be performed by 
government employees. But auditing activities themselves as 
compared to the use of the results of those audits are not an 
inherently governmental function.
    In fact, one of the things that we have seen over the last 
couple of years is a dramatic increase in the use by civilian 
Federal agencies of independent third-party contractors. You 
may be aware there is actually a schedule from the General 
Services Administration, a contract schedule, which has 
prequalified auditors on there, and at the time an agency wants 
to issue a potential task for bid by those prequalified 
auditors, they can be screened so you eliminate anybody who has 
a potential conflict of interest for the particular task to be 
contracted.
    So it addresses some of the questions that came up here 
earlier today of how do you resolve those conflict of interest 
questions, how do you make sure you only deal with actually 
qualified entities who can do cost auditing and who have a 
demonstrated track record.
    And, in fact, if you look at the agency costs for these 
audits, the costs they were paying to DCAA to do the audit 
before and the costs they are paying to the independent third-
party auditors to do that now, you will see not a 30 percent 
increase, but in many cases a dramatic reduction in those 
costs.
    And I would submit that it would behoove the committee to 
get some data on that, and we will be happy to try to provide 
some of that as well, what we have from the public record, but 
the agencies themselves have substantially more data.
    So how would third-party auditors help? They might reduce 
the cost. They might reduce the backlog. They would certainly 
help address the question that Ms. Bales raised of, I want to 
increase, but I don't want to increase the permanent staff, I 
want to be able to meet my surge requirements and then come 
back down to a steady state. This is exactly where you use 
contractors, is to increase that surge capacity and then draw 
it back down.
    I really wanted to associate myself with Mr. Moulton's 
comments about what you saw in Iraq in terms of sometimes the 
short-term costs went down but the long-term costs went up.
    I had the privilege in 2007 of being a member of the 
Gansler Commission that looked at contracting in Iraq and 
Afghanistan, and then later had the opportunity in DOD to be 
overseeing the policy associated with that.
    And some of that was actually not the fault of anybody in 
theater, but of policies and procedures back here. The Army, 
for instance, releasing funds one week at a time so you can 
never actually buy the thing, you could only rent it for a 
week, with the cost built in at the end to haul it out of the 
country, right?
    That is not a good way to--that only matters if you think 
you are only going to be there for another week. We won't go 
there this morning.
    So in the end here, DCAA, I think, has a critical role to 
play. The numbers say they need some help, and they have 
admitted that, that is what they have asked for here. The 
question is, what is the best way to give them that help? And I 
would submit that there is an enormous opportunity, and it 
would be useful for them to test that opportunity in reality, 
not just do a business case assessment but actually try it out 
and see what the results are.
    And rather than recommend to the committee that you repeal 
the language that you put in the fiscal year 2017 NDAA, 
actually test it out, and let's look at the results. And I 
think we will have a very fair comparison under those 
circumstances. And I would submit to you that would be a good 
way to go forward.
    So I am over my time here, so I will shut up.
    [The prepared statement of Mr. Berteau can be found in the 
Appendix on page 52.]
    Mrs. Hartzler. Well, what you said was very, very helpful. 
I appreciate that very much.
    Mr. Panetta.

   STATEMENT OF JOHN PANETTA, NATIONAL SECRETARY, FINANCIAL 
                    EXECUTIVES INTERNATIONAL

    Mr. Panetta. Good morning, Chairwoman Hartzler, Ranking 
Member Moulton, and committee members. I am John Panetta, the 
senior director of government accounting at Raytheon in 
Waltham, Massachusetts. I am here today on behalf of and 
representing the Financial Executives International Committee 
on Government Business.
    Defense contract auditing has been a matter of discussion 
in both the private sector and the government for several 
years. The timeliness of audits, and in particular final 
incurred cost rate audits, are at the center of the 
conversation.
    Let me start by talking about how we got here. The current 
state is due to a series of events starting in 2008 when 
reports surfaced critical of DCAA audit practices. DCAA's 
reaction was to stress audit quality and independence above all 
other considerations.
    Quality standards over a period of years were in a state of 
flux. New, untrained auditors were added without sufficient 
supervision and audit schedules were not considered.
    From 2006 to 2015, DCAA's staff grew by approximately 20 
percent. Incurred cost audits that were issued over that period 
were generally incredibly long and packed with immaterial 
items. This resulted in the number of audits being issued per 
DCAA employee declining by approximately 90 percent.
    In 2012, the Federal Acquisition Regulation Council, at 
DCAA's urging, expanded the requirements for certified incurred 
cost proposals in the regulations by adding 30 items for the 
submission of final indirect rates. Many of these items are not 
relative to final indirect rates.
    DCAA used this FAR change to retroactively reject many 
previously accepted contractor proposals. This action further 
delayed the settlement of final rates as contractors needlessly 
created complicated informational schedules for DCAA that we 
view as having little, if any, value.
    Recently, some progress has been made. DCAA has put a dent 
in the audit backlog through the use of multiyear audit 
techniques. Contractor resources have been strained supporting 
these multiyear audits, and that is not sustainable over the 
long run. We are not where we need to be. More needs to be 
done.
    The backlog of audits is merely a symptom of underlying 
issues. Working off the backlog by applying resources will not 
prevent the condition from returning after the spotlight has 
moved on to other priorities.
    In today's environment, risk management is a buzz word, and 
risk avoidance is the practice. Adopting an outlook of risk 
avoidance drives behavior. Perfection becomes the standard, and 
perfection is an expensive commodity.
    There is no question, perfection is something that we 
should all strive to achieve. However, if the cost to implement 
a perfect system exceeds the risks that are being addressed, we 
are collectively wasting resources that could better be applied 
in other areas.
    The CGB [Financial Executives International's Committee on 
Government Business] believes that getting back to basics, 
implementing efficient audit management practices, and changing 
how success is measured with respect to oversight will go a 
long way in addressing the root cause of the issues we are 
addressing.
    Emphasizing audit practices such as establishing 
materiality thresholds, relying on the work of others, meeting 
schedules, and using documentation standards that are accepted 
by other audit groups, will all speed up the process without 
shifting significant risks to the government.
    For example, a company that has received a passing grade 
from a CPA [certified public accountant] firm with respect to 
the requirements of the Sarbanes-Oxley Act has already run a 
gauntlet of audits. Why should DCAA retest underlying systems 
and transactions that have already been validated for financial 
reporting purposes?
    The current measure of success at DCAA is the amount at 
annual findings. That is akin to paying a CPA firm upon the 
receipt of a clean opinion. That works against the requirements 
for independence, and CPAs would certainly grab the attention 
of the SEC [Securities and Exchange Commission] for that.
    This measure creates churn in the acquisition process. 
There are a number of examples where DCAA's implementation of 
the FAR to generate those findings resulted in legal disputes 
overturning their positions. This, again, wastes both the 
government and contractor resources. Success should be measured 
by the completion of a timely, quality audit that promotes and 
provides reasonable assurance of an effective acquisition 
process.
    These actions, together with the introduction of 
independence CPA firms to conduct audits at DOD, as they do at 
other executive departments, will result in the fundamental 
change that is required for the acquisition process to function 
as envisioned in the guiding principles of the FAR.
    Thank you very much. I would be happy to answer any 
questions that you have.
    [The prepared statement of Mr. Panetta can be found in the 
Appendix on page 68.]
    Mrs. Hartzler. Very good. Only 12 seconds over 5 minutes. 
That is pretty amazing.
    I have a lot of questions. I want to come back to you on a 
lot of good stuff there.
    Mr. James Thomas, let's go to you, though, first.

STATEMENT OF JAMES THOMAS, ASSISTANT VICE PRESIDENT OF POLICY, 
            NATIONAL DEFENSE INDUSTRIAL ASSOCIATION

    Mr. Thomas. Thank you. Chairwoman Hartzler, Ranking Member 
Moulton, and members of the subcommittee, thank you for the 
opportunity to appear before you this morning. I am here on 
behalf of the National Defense Industrial Association, the 
Nation's oldest and largest defense industry association, 
comprised nearly of 1,600 corporate and 80,000 individual 
members.
    My testimony this morning will focus on the main theme and 
associated recommendations within my written statement, the 
change in DCAA's mission from its original purpose, and the 
effect of that change on industry and the operations of the 
defense acquisition system.
    Industry recognizes that the audit responsibilities of DCAA 
play an essential role within DOD's acquisition oversight 
activities throughout the contracting life cycle. DCAA was 
stood up in 1965 to serve as an advisory function for 
contracting officer decision making, but has evolved to serve 
solely as an enforcer of their own process requirements, 
lacking a nexus with the contracting officer decision-making 
process.
    Industry is concerned that DCAA has lost focus of their 
purpose within the defense acquisition system over the past 
decade and has become much more closely tied with the inspector 
general function than needed or desired to fulfill their 
oversight role.
    DCAA is not a profit center, but their reports to Congress 
highlight that the measure of mission success is that their 
audit activities provide a large return on investment by 
identifying a large number of adverse audit findings rather 
than on executing their primary advisory functions.
    We also question whether the agency can inherently be truly 
independent and objective in their audit responsibilities while 
continuing to emphasize success based upon questioned costs and 
return on investment.
    Auditing is process based, not outcome based. DCAA asserts 
that their return on investment to the taxpayer in fiscal year 
2015 was $4.80 per dollar spent. Unfortunately, that value 
computation does not accurately measure all costs to the 
acquisition system and contractors. These costs include but are 
not limited to delays in contract closeouts for the government, 
legal disputes, and records retention for industry.
    Another cost driver for industry occurs through the 
misunderstanding of the concept of materiality as expressed in 
the work product and inconsistent judgment of DCAA auditors. As 
it pertains to business system, contractors incur high costs to 
achieve perfection and internal controls to avoid any 
allegations of deficiencies rather than achieve controls that 
provide reasonable assurance.
    Striving for perfection is admirable; however, the costs 
incurred by industry to seek perfection of systems and controls 
in order to avoid allegations of deficiencies when a reasonable 
assurance standard would serve the agency mission objectives 
and not result in increased costs to the government runs 
contrary to the emphasis on risk management contained in the 
FAR.
    This level of process perfection driven by a reluctance to 
employ judgment about materiality undermines the timeliness of 
business systems in post-award audits. Instead, DCAA should 
measure its success in quality audits that meet the 
expectations of contracting officers in a timely manner, which 
aligns more appropriately with DCAA's original purpose.
    Contracting officers need audit reports with timely and 
actionable findings to help them make decisions. A review of 
aggregate data provided in the five publicly available reports 
to Congress from fiscal year 2011 to 2015 and the DOD 
inspectors general semiannual report shows decreasing 
productivity in the number of audits completed per auditor and 
that less than one-third of the questioned costs are sustained 
for fiscal year 2014 and 2015.
    Moving forward, the following recommendations should be 
considered.
    First, reevaluate the DCAA mission, organization, and 
management and responsibilities and functions provided in DOD 
directive 5105.36. This could be achieved by establishing a 
working group of government and industry acquisition and 
auditing professionals to align mission objectives with the 
statutory audit record requirements.
    Second, establish timely deadlines for the completion of 
incurred cost audits. The optimal timeline would be 90 days 
from submission of incurred cost proposals, which aligns more 
closely with SEC requirements for a company's annual filing. 
These filings incorporate an accounting firm's audit opinion 
regarding these statements.
    Third, embrace the use of third-party auditors for incurred 
costs in business system audits. This is likely the only 
solution to eliminate the incurred cost audit backlog and 
should continue thereafter. However, it is not a complete 
solution. The efficacy of Sections 820 and 893 in reducing the 
backlog will be limited if DCAA still requests working papers 
and backup materials on work performed by public accounting 
firms, which we believe is not necessary or appropriate.
    Fourth, publish an annual report card with assessment of 
DCAA's services from DOD entities responsible for procurement 
and contract administration. This feedback would be highly 
beneficial in understanding how well DCAA is performing in its 
customer service role. We are not aware of any existing 
attempts to do this.
    And lastly, Congress should strongly consider the 
recommendations of the congressionally established 809 panel. 
The Section 809 panel will be examining the defense contract 
audit process as part of its larger review. Although their 
final report is not due for another 18 months, it should 
provide insight into the proper role and responsibilities of 
DCAA and other oversight actors through a broader systemic 
perspective.
    Thank you for the opportunity to appear before you this 
morning, and I am happy to answer any questions you may have.
    [The prepared statement of Mr. Thomas can be found in the 
Appendix on page 87.]
    Mrs. Hartzler. Thank you very much. Some good information 
here.
    I would like to ask all of you, I guess start with you, Mr. 
Panetta, because you mentioned multiyear audits in your 
testimony. And DCAA has indicated to us, and she just 
testified, that even after the backlog is eliminated, the 
agency would like to see more multiyear auditing done as the 
standard practice.
    So how does that practice compare to private sector norms? 
And what do you think of that practice for both audits in the 
backlog and for new ones going forward?
    Mr. Panetta. Well, thank you, Madam Chairwoman.
    In comparing that to private sector norms, in the private 
sector audits are done on a concurrent basis. And we don't see 
multiyear audits. DCAA audits are retrospective. And what we 
see when we look, say, at our financial statement audits, the 
auditors are auditing the year as we are going along such that 
when the year is complete, a couple months after the year is 
closed, we issue our financial statements and they issue their 
opinion.
    So we don't really see multiyear audits. We see concurrent 
audits. And I see a problem with doing multiyear audits from a 
DCAA perspective, and it is because it is very difficult for 
contractors.
    We like to staff at a level of activity. And, normally, 
audit activity will go along at a certain level. When you go to 
multiyear audits, you are going to have peaks and valleys and 
spikes. And to support that activity, it strains the 
organization, because you either have to be overstaffed for 
part of the year or you have to bring in excess resources 
otherwise that aren't familiar.
    So we would rather see a regular cadence of an annual audit 
that is done quickly and concurrently.
    Mrs. Hartzler. Obviously, votes are occurring, but I would 
like to visit with you more about the concurrent. How would 
that change if the DCAA would do concurrent rather than after? 
What changes would there be?
    Mr. Panetta. Years ago they used to do concurrent auditing 
as a practice. They would roll it out. And what would happen 
is, as the year would go along, they would test particular 
accounts that were as costs were incurred, and contractors 
would, say, make adjustments as they found things, such that 
when the year was over, the audit work was complete, the 
findings were known, and the contractors could actually make 
the adjustments before we made the submission.
    I mean, that to me would be nirvana, in that when you make 
your submission 6 months after the year, it has already been 
audited in terms of the underlying information and adjustments 
have been made and you are done. I mean, that would be a great 
goal to try to achieve.
    Mrs. Hartzler. Yes, Mr. Berteau.
    Mr. Berteau. Madam Chairwoman, if I could add one thing to 
that. The value of multiyear is only there if you have a 
substantial backlog that goes back a number of years. We have 
some examples of third-party independent auditors for civilian 
agencies that are current through fiscal year 2015 and soon 
current through fiscal year 2016. And so there is no need for a 
multiyear audit if you are up-to-date. And I think that should 
be the objective that we want to achieve. Even if we can't go 
nirvana, we can at least get partway to currency.
    Mrs. Hartzler. Yeah. That is good.
    I will go ahead and shift to Mr. Moulton.
    Mr. Moulton. Thank you, Madam Chairwoman.
    So just to hone in on that for a second. The director just 
testified that she would be completely open to moving to 
single-year audits if a cost-benefit analysis showed that they 
would be more effective. I mean, do you agree with that 
assessment?
    Mr. Berteau. I think a level playing field assessment, 
particularly if you tested it with real world experience and 
try it out, would produce the kind of results that she would be 
comfortable with and we would be comfortable with.
    Mr. Moulton. And, Mr. Panetta, would you agree with that as 
well?
    Mr. Panetta. A single-year audit would certainly make more 
sense to me.
    Mr. Moulton. Well, that is not what I asked. I asked if you 
would be open to having a cost-benefit analysis determine 
whether a single-year audit or a multiyear audit is more 
effective.
    Mr. Panetta. Well, certainly. More information and 
understanding is always something good. So data-driven 
decisions always work out best.
    Mr. Moulton. Okay.
    And, Mr. Thomas, what is your opinion on this?
    Mr. Thomas. I agree with the other two members. Having a 
multiyear process is really not ideal for a standard practice. 
Certainly, it is a benefit to address a backlog. Most of our 
members agree that that is okay for that purpose. But as a 
standard practice, having concurrent and timely audits is more 
ideal.
    In answer to your question just now about having a business 
case analysis, I don't think that would hurt at all. But I 
think if there was an analysis done, it has to take into 
account all the costs associated with having all the 
liabilities on the books, the time and the costs associated 
with that, not just the efficiency of being able for the 
department to move through those audits.
    Mr. Moulton. Thank you.
    And, Mr. Thomas, in your testimony you cited the fact that 
DCAA talks about the ROI [return on investment] for taxpayers, 
the dollars that it recovers. And I think the issue about risk 
avoidance versus risk mitigation is well taken, and this is 
something that we have heard from other folks as well. But it 
just seems to me that if the agency is recovering a significant 
amount of money here, then obviously there is a purpose to 
having these audits. I mean, there is clearly some waste, 
fraud, and abuse going on.
    Do you disagree with that?
    Mr. Thomas. I don't disagree entirely. I think, though, we 
have to draw a distinction between waste, fraud, and abuse and 
finding certain unallowable costs or things that can be easily 
addressed. Most companies want to comply. They want to be able 
to be audit ready and have these done in a timely, efficient 
manner.
    And when you look at the purpose of the DCAA, it is really 
for an advisory role to the contracting officer to make a final 
determination of price reasonableness and understand that risk 
assurance. That is really separate from the role of an IG 
[inspector general]. Certainly, you can identify where they 
blend together. Obviously, you are identifying issues within an 
audit.
    But the purpose really shouldn't be to identify that. That 
is why you have a separate entity. It really should be to work 
with the contractor through the audit process, identify those 
issues, make the appropriate changes, and move on so that the 
contracting officer can make a determination in a reasonable 
amount of time.
    Mr. Moulton. So we have to wrap up, but just real quickly 
so I understand here, you agree that, clearly, there is a role 
for auditing in the Department of Defense? I mean, we have the 
Secretary of Defense now saying we should audit the entire 
Department, which is something I think we on the committee all 
agree with. And yet you say the mission--there has sort of been 
some mission creep here or whatever.
    Look, I don't accept the premise that just because the 
mission in 1965 is different than the mission today that 
therefore it is wrong. I mean, the mission of the Marine Corps 
that I joined is not the same today as it was in 1775. So that 
can evolve.
    But if there is this issue with auditing, we have 
acknowledged at length the backlog, and you think that this 
should be more taken up by the inspector general, then I must 
assume that there are not enough resources with the IG to do 
this. Would that be your conclusion as well?
    Mr. Thomas. Not necessarily. I don't know that the two 
roles are the same in audit. And first, I do agree, absolutely, 
that it is an essential part of the government, particularly 
DCAA, to be able to audit as part of the internal control 
process of the acquisition system. So there is no question, 
particularly from our members.
    But I believe that the inspector general has a different 
purpose in identifying abuse, whereas the auditor's financial--
going through the audit to find risk assessment with the rate 
sustainment is very different, and that is really, again, just 
more of an advisory function for the contracting officer.
    Mr. Moulton. Well, there is a certain way to look at it, 
which might be oversimplistic, which is that there is a 
difference between outright fraud and abuse versus just getting 
the best price so we don't have the sort of infamous $30,000 
toilet. But, nonetheless, taxpayers want both, and I think 
taxpayers probably deserve both. Is that right?
    Mr. Thomas. Absolutely.
    Mr. Moulton. Okay. Thank you, Madam Chairwoman. I yield 
back.
    Mrs. Hartzler. Well, we have had a very good discussion 
with a lot of information here today, and we want to continue 
this discussion. And we will look further into your testimony 
and these ideas moving forward.
    But we really appreciate your insights. Thank you for being 
here today.
    And this hearing is now adjourned.
    [Whereupon, at 10:15 a.m., the subcommittee was adjourned.]

      
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                            A P P E N D I X

                             April 6, 2017

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              PREPARED STATEMENTS SUBMITTED FOR THE RECORD

                             April 6, 2017

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              WITNESS RESPONSES TO QUESTIONS ASKED DURING

                              THE HEARING

                             April 6, 2017

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            RESPONSE TO QUESTION SUBMITTED BY MRS. HARTZLER

    Ms. Bales. DCAA has issued over 34,000 audit reports between FY 
2011-2016. However, the number of audit reports issued is only part of 
our workload. Incurred cost audits continue to be a top priority for 
DCAA and we have increased the number of audits covering multiyear 
incurred cost submissions although a multiyear audit only counts as one 
report. We believe multiyear audits help increase audit coverage and 
reduce our audit time over single-year audits. Furthermore, we perform 
other work that results in memorandums that are fed into other audits 
but does not count as a report issued. For example, we perform annual 
real-time labor verifications (also known as floor checks) and 
interview a sample of contractor employees to ensure they are correctly 
charging their time to the appropriate cost objectives. The results of 
these verifications are summarized in a memorandum rather than an audit 
report, and later incorporated into a future incurred cost report. We 
do notify contracting officials on a real-time basis if we find 
internal control issues and we notify the appropriate investigative 
agency if we identify evidence of mischarging.   [See page 7.]

?

      
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              QUESTIONS SUBMITTED BY MEMBERS POST HEARING

                             April 6, 2017

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                  QUESTIONS SUBMITTED BY MRS. HARTZLER

    Mrs. Hartzler. In reference to DCAA's response to HASC (March 31, 
2017) question #4 (``Return on Investment'') from FY 16 to FY 12, 
provide the mathematical justification (nominator/denominator) for each 
ROI reported. Please ensure the answer provides the amount of money, 
and percent of budget, DCAA allocated to incurred cost audits, forward 
pricing audits, and other audits in comparison to the respective net 
savings of each audit type.
    Ms. Bales. DCAA does not calculate its ROI in the nature requested 
as DCAA does not collect the cost for each type of audit. DCAA 
calculates ROI as the ratio of savings to total Agency funding each 
year. Net savings are supported through a Contracting Officer's 
documented actions based on DCAA's recommendations. As a result, in the 
table below, we show a ROI breakdown by audit type for FY 2016 to FY 
2012 by taking reported savings based on when we receive the 
contracting officer's negotiation memorandum over the total operating 
costs for the fiscal year we reported the savings.


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    .epsMrs. Hartzler. What specific findings from forward pricing 
reviews are typically driving net savings? For forward pricing audits, 
how does DCAA define when a cost is ``sustained'' and when a cost 
generates a ``net savings''?
    Ms. Bales. In responding to this question, we looked at some of the 
audit reports issued in FY 2016 with large amounts of questioned costs 
where negotiations have taken place and we have visibility into the net 
savings. The majority of questioned costs related to labor and material 
costs proposed. We have provided a summary of some of the common 
findings related to labor and material below:
    For labor, significant questioned costs have resulted from the 
following:
      The contractor overstated their labor hours when compared 
to historical hours and taking into account improvement curves and 
trends;
      The contractor proposed hours to account for a 
contingency with no basis to support the costs proposed;
      The application of the indirect rates to the questioned 
labor costs.
    For material, significant questioned costs have resulted from the 
following:
      The inaccuracy of the prime/higher-tier contractor cost 
or price analyses resulted in overstated costs on a subcontract;
      The contractor did not update their proposal with current 
purchase orders, quotes, and/or agreements with vendors resulting in 
overstated costs;
      The contractor did not incorporate cost reduction 
initiatives in their estimates;
      The contractor overstated quantities when compared to 
historical actual quantities taking into account improvement curves and 
trends;
      The contractor did not include quantity discounts;
      Exchange rates were overstated;
      Escalation rates were overstated;
      The contractor did not account for lower prices that were 
available.
    DCAA considers a questioned cost ``sustained'' when there is a 
negotiated cost reduction in the contract price directly attributable 
to audit exceptions and recognizes ``net savings'' as the amount of 
cost and profit the Government saves through sustention of our 
recommended audit exceptions. Because many factors affect the timing of 
contract negotiations, we report audit exceptions in the year the 
report is issued as a performance measure and document sustention and 
net savings in the year the contract is negotiated.
    Mrs. Hartzler. In Ms. Bales' oral testimony on April 6, 2017, she 
indicated that DCAA had not implemented Section 820 of the NDAA FY 
2017, in part, because DCAA ``can't just accept work from another 
auditor or auditing company without doing certain things to know that 
we can rely on their work.'' Explain in greater detail why DCAA has not 
implemented Section 820 with respect to the mandate requiring 
acceptance of commercial audit findings of indirect costs.
    Ms. Bales. The amendments made by Section 820 are not effective 
until October 1, 2018. In the interim, DCAA is taking the following 
actions.
    DCAA has met with HASC and SASC staff members to discuss some of 
unintended consequences of Section 820 that do not appear to align with 
Congress' intent. The results of these discussions are informing DCAA 
as they begin working the proposed rule with Defense Procurement and 
Acquisition Policy (DPAP). For example, while this provision was 
intended to remove barriers to non-traditional small businesses, this 
provision will apply to some of the largest Defense contractors 
resulting in them not being subject to government audits of their 
indirect costs. For example, some of the top defense contractors (e.g., 
Raytheon Missile Systems, Lockheed Martin Aeronautics, Boeing Military 
Aircraft) performing contracts on major defense programs (e.g., F-35, 
Chinook, AMRAAM) would be permitted under this provision to have their 
indirect costs audited by a private sector auditor.
    DCAA plans to work with the Government Accountability Office (GAO) 
on the provision that requires DCAA to accept, without performing 
additional audits, the audit findings prepared by a private sector 
auditor. The law, as written, would have DCAA violate the auditing 
standards as published by the GAO. DCAA is not allowed to accept the 
work of another auditor without performing procedures for determining 
reliance. (Generally Accepted Government Auditing Standards (GAGAS) 
Section 2.09.) DCAA is committed to working with industry and 
Government stakeholders on the appropriate use of private auditors; 
however; they plan to seek the advice of the GAO to ensure they do not 
violate their professional standards.
    DCAA is currently working with DPAP on developing a proposed rule 
for Section 893, Contractor Business System, which also includes the 
use of private auditors. DCAA intends to the use the knowledge gained 
in implementing this rule in developing the proposed rule for 
implementing Section 820.
    Lastly, DCAA has been asked to comment on draft FY 2018 legislation 
prepared by the HASC. The proposed language will directly impact the 
Section 820 language. DCAA plans to have additional discussions with 
the HASC and SASC staff members on the effects of the draft legislation 
on Section 820. These discussions will help inform DCAA as they begin 
working with DPAP on a proposed rule.

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