DCAA Audits: Allegations That Certain Audits at Three Locations  
Did Not Meet Professional Standards Were Substantiated		 
(22-JUL-08, GAO-08-857).					 
                                                                 
The Defense Contract Audit Agency (DCAA) under the Department of 
Defense (DOD) Comptroller plays a critical role in contractor	 
oversight by providing auditing, accounting, and financial	 
advisory services in connection with DOD and other federal agency
contracts and subcontracts. DCAA has elected to follow generally 
accepted government auditing standards (GAGAS). These standards  
provide guidelines to help government auditors maintain 	 
competence, integrity, objectivity, and independence in their	 
work. GAO investigated hotline complaints it received related to 
alleged failures to comply with GAGAS on 14 DCAA audits.	 
Specifically, it was alleged that (1) working papers did not	 
support reported opinions, (2) supervisors dropped findings and  
changed audit opinions without adequate evidence, and (3)	 
sufficient work was not performed to support audit conclusions	 
and opinions. GAO also investigated issues related to the quality
of certain forward pricing reports. GAO investigators interviewed
over 50 individuals, reviewed the working papers and related	 
documents for 14 audits issued from 2003 through 2007 by two DCAA
field offices, and reviewed documentation on audit issues at a	 
third DCAA office. GAO did not reperform the audits to validate  
the completeness and accuracy of DCAA's findings. DCAA did not	 
agree with the "totality" of GAO's findings, but it did 	 
acknowledge shortcomings with some audits and agreed to take	 
corrective action.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-08-857 					        
    ACCNO:   A83032						        
  TITLE:     DCAA Audits: Allegations That Certain Audits at Three    
Locations Did Not Meet Professional Standards Were Substantiated 
     DATE:   07/22/2008 
  SUBJECT:   Audit oversight					 
	     Audit reports					 
	     Auditing procedures				 
	     Auditing standards 				 
	     Contract administration				 
	     Contract oversight 				 
	     Contractor payments				 
	     Corporate audits					 
	     Data collection					 
	     Defense audits					 
	     Department of Defense contractors			 
	     Documentation					 
	     Internal auditors					 
	     Internal audits					 
	     Internal controls					 
	     Investigations into federal agencies		 
	     Noncompliance					 
	     Reporting requirements				 
	     Requirements definition				 
	     Standards						 
	     Corrective action					 
	     GAO High Risk Series				 

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GAO-08-857

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Report to Congressional Addressees: 

United States Government Accountability Office: 
GAO: 

July 2008: 

DCAA Audits: 

Allegations That Certain Audits at Three Locations Did Not Meet 
Professional Standards Were Substantiated: 

GAO-08-857: 

GAO Highlights: 

Highlights of GAO-08-857, a report to congressional addressees. 

Why GAO Did This Study: 

The Defense Contract Audit Agency (DCAA) under the Department of 
Defense (DOD) Comptroller plays a critical role in contractor oversight 
by providing auditing, accounting, and financial advisory services in 
connection with DOD and other federal agency contracts and 
subcontracts. DCAA has elected to follow generally accepted government 
auditing standards (GAGAS). These standards provide guidelines to help 
government auditors maintain competence, integrity, objectivity, and 
independence in their work. 

GAO investigated hotline complaints it received related to alleged 
failures to comply with GAGAS on 14 DCAA audits. Specifically, it was 
alleged that (1) working papers did not support reported opinions, (2) 
supervisors dropped findings and changed audit opinions without 
adequate evidence, and (3) sufficient work was not performed to support 
audit conclusions and opinions. GAO also investigated issues related to 
the quality of certain forward pricing reports. 

GAO investigators interviewed over 50 individuals, reviewed the working 
papers and related documents for 14 audits issued from 2003 through 
2007 by two DCAA field offices, and reviewed documentation on audit 
issues at a third DCAA office. GAO did not reperform the audits to 
validate the completeness and accuracy of DCAAï¿½s findings. DCAA did not 
agree with the ï¿½totalityï¿½ of GAOï¿½s findings, but it did acknowledge 
shortcomings with some audits and agreed to take corrective action. 

What GAO Found: 

GAO substantiated the allegations. Although DCAA policy states that its 
audits are performed according to GAGAS, GAO found numerous examples 
where DCAA failed to comply with GAGAS. For example, contractor 
officials and the DOD contracting community improperly influenced the 
audit scope, conclusions, and opinions of three auditsï¿½a serious 
independence issue. At two DCAA locations, GAO found evidence that (1) 
working papers did not support reported opinions, (2) DCAA supervisors 
dropped findings and changed audit opinions without adequate evidence 
for their changes, and (3) sufficient audit work was not performed to 
support audit opinions and conclusions. GAO also substantiated 
allegations of inadequate supervision of certain audits at a third DCAA 
location. The table below contains selected details about three cases 
GAO investigated. 

Table: Selected Details of Audits GAO Investigated: 

DOD contractor: Major aerospace company (DCAA location 1); Audit type: 
Estimating system; 
Significant case study issues: 
* DCAA made an up-front agreement with the contractor to limit the 
scope of work and basis for audit opinion.
* Contractor was unable to develop compliant estimates, leading to a 
draft opinion of ï¿½inadequate in part.ï¿½
* Contractor objected to draft findings, and DCAA management assigned a 
new supervisory auditor.
* Management threatened the senior auditor with personnel action if he 
did not delete findings from the report and change the draft audit 
opinion to ï¿½adequate.ï¿½ 

DOD contractor: Company produces and supports military and satellite 
systems (DCAA location 2); Audit type: Billing system; 
Significant case study issues: 
* Draft audit report identified six significant deficiencies, one of 
which led the contactor to overbill the government by $246,000 and 
another which may have led to $3.5 million in overbillings. 
* First supervisory auditor and auditor were replaced by other auditors 
who dropped the findings and changed the draft audit opinion from 
ï¿½inadequate,ï¿½ to ï¿½adequate.ï¿½ 
* Sufficient testing was not performed to support an opinion that 
controls were adequate. 
* DOD Inspector General recommended that DCAA rescind the final audit 
report. Over a year later, at the end of GAOï¿½s investigation, DCAA 
rescinded the final report. 

DOD contractor: Major weapons system contractor (DCAA location 3); 
Audit type: Forward pricing; Significant case study issues: 
* Two supervisors responsible for 62 forward pricing audits of over 
$6.4 billion in government contract negotiations did not review working 
papers before report issuance. 
* Inexperienced trainee auditors were assigned to 18 of the 62 audits 
without proper supervision. 
* An internal DCAA audit quality review found 28 systemic deficiencies 
in 9 of 11 selected forward pricing audits. 
* The DCAA field office lost control of final working papers because 
trainee auditors did not always properly enter them in the electronic 
workpaper system. 

Source: GAO. 

[End of table] 

Throughout GAOï¿½s investigation, auditors at each of the three DCAA 
locations told us that the limited number of hours approved for their 
audits directly affected the sufficiency of audit testing. Moreover, 
during GAOï¿½s investigation, DCAA managers took actions against staff at 
two locations, attempting to intimidate auditors, prevent them from 
speaking with investigators, and creating a generally abusive work 
environment. 

To view the full product, including the scope and methodology, click on 
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-857]. For more 
information, contact Gregory D. Kutz at (202) 512-6722 or 
[email protected]. 

[End of section] 

Contents: 

Letter: 

Summary of Investigation: 

Background: 

Questioned DCAA Audits Did Not Comply with GAGAS: 

DCAA Management Actions Intimidated Auditors, Impaired Some Audits, and 
Created a Generally Abusive Environment: 

Corrective Action Briefing and Agency Response: 

Conclusions: 

Appendix I: Comments from the Department of Defense: 

Appendix II: Additional Investigative Case Study Results: 

Appendix III: GAO Contacts and Staff Acknowledgments: 

Tables: 

Table 1: GAGAS Compliance Problems Associated with Hotline Case 
Investigations: 

Table 2: Summary of DCAA Case Studies GAO Investigated: 

Table 3: Additional Case Studies of DCAA Audits at Location 2: 

Figures: 

Figure 1: Relationship between Contract Phases, Contract Events, and 
DCAA Audit Activities: 

Figure 2: DCAA Internal Control and CAS Compliance Audit Opinions, 
Criteria, and Resultant Actions: 

Abbreviations: 

ASBCA: Armed Services Board of Contract Appeals: 

BOE: basis of estimates: 

CAM: Contract Audit Manual: 

CAP: corrective action plan: 

CAS: Cost Accounting Standards: 

DCAA: Defense Contract Audit Agency: 

DCIS: Defense Criminal Investigative Service: 

DCMA: Defense Contract Management Agency: 

DFARS: Defense Federal Acquisition Regulation Supplement: 

DOD: Department of Defense: 

DOD IG: DOD Office of Inspector General: 

ELC: expendable launch capacity: 

ELS: expendable launch services: 

FAO: field audit office: 

FAR: Federal Acquisition Regulation: 

FOB: free-on-board: 

G&A: general and administrative: 

GAGAS: generally accepted government auditing standards: 

GPS: global positioning system: 

IPT: integrated product team: 

RAM: regional audit manager: 

SMC: Space and Missile Systems Center: 

[End of section] 

United States Government Accountability Office:
Washington, DC 20548: 

July 22, 2008: 

The Honorable Joseph I. Lieberman: 
Chairman: 
The Honorable Susan M. Collins: 
Ranking Member: 
Committee on Homeland Security and Governmental Affairs: 
United States Senate: 

The Honorable Henry A. Waxman: 
Chairman: 
Committee on Oversight and Government Reform: 
House of Representatives: 

Department of Defense (DOD) contract management has been included on 
our high-risk list since 1992, meaning that the government continues to 
be vulnerable to fraud, waste, abuse, and mismanagement in this area. 
In our most recent High-Risk Series: An Update,[Footnote 1] we reported 
that DOD is not able to assure that it is using sound business 
practices to acquire the goods and services required to meet the needs 
of U.S. warfighters. Additionally, we reported that DOD has not always 
made sound use of various techniques to acquire goods and services, nor 
has it had a comprehensive plan to ensure that its workforce has the 
right skills and capabilities. Downsizing of contract oversight staff 
in the 1990s coupled with hundreds of billions of dollars in increased 
contract spending since 2000 has exacerbated the risks associated with 
DOD contract management. 

The Defense Contract Audit Agency (DCAA), a defense agency supervised 
by the Office of the Under Secretary of Defense (Comptroller), plays a 
critical role in DOD contractor oversight by providing auditing, 
accounting, and financial advisory services in connection with the 
negotiation, administration, and settlement of contracts and 
subcontracts. DCAA also performs audit services for other federal 
agencies, as requested, on a fee-for-service basis. Although DCAA 
provides a range of services to contracting officers and other DOD 
officials, DCAA's primary function is contract audit services. The DCAA 
Contract Audit Manual (CAM)[Footnote 2] prescribes the standards, 
policies, and techniques to be followed by DCAA personnel in carrying 
out contract audits. DCAA contract audits are intended to be a key 
control to help assure that prices paid by the government for needed 
goods and services are fair and reasonable and that contractors are 
charging the government in accordance with applicable laws, regulations 
(e.g., Federal Acquisition Regulation (FAR) and Defense Federal 
Acquisition Regulation Supplement (DFARS), standards (e.g., Cost 
Accounting Standards (CAS)), and contract terms. DCAA also audits 
contractor-proposed estimates used to support contract negotiations and 
costs charged to the government. To determine the amount of testing on 
these proposal and cost-related audits, DCAA audits contractor controls 
in accounting, billing, estimating, and other key systems, and issues 
opinions on the adequacy of those control systems. For example, DCAA 
auditors may audit a contractor billing system to determine whether the 
contractor has adequate internal controls in place to assure that the 
government is being charged appropriately for the goods and services 
received. The results of billing system audits support decisions to 
approve contractors for direct-billing privileges, whereby the 
government pays contractors without prior review of invoices. 

In performing its audits, DCAA states that it follows generally 
accepted government auditing standards (GAGAS).[Footnote 3] These 
standards provide guidelines to help government auditors maintain 
competence, integrity, objectivity, and independence in their work and 
require that they obtain sufficient evidence to support audit 
conclusions and opinions. GAGAS apply to financial and performance 
audits and attestation engagements. Although DCAA refers to the 
assignments covered by our investigation as audits, most of them were 
performed as examination-level attestation engagements.[Footnote 4] 
GAGAS covering examination-level engagements require that auditors 
perform sufficient testing to express an opinion on whether the subject 
matter, such as internal control, conforms with applicable criteria in 
all material respects.[Footnote 5] GAGAS also require that an 
experienced auditor who is unfamiliar with the audit should be able to 
review the evidence in the audit documentation and come to the same 
conclusion as the original auditor.[Footnote 6] According to GAGAS, 
supervisors should review and approve audit documentation before audit 
reports are issued.[Footnote 7] 

We investigated FraudNet hotline complaints and additional allegations 
and auditor concerns we received during our investigation related to 
alleged failures to comply with GAGAS on 14 DCAA audits at two DCAA 
locations in California. Specifically, DCAA auditors alleged that (1) 
the working papers did not support the reported opinions; (2) on 
certain audits, their supervisors personally changed (or directed 
others to change) draft audit conclusions without adequate audit 
evidence to support the changes; and (3) work performed on other audits 
was not sufficient to support the final audit opinions. Auditors noted 
that as a result of these practices, DCAA supervisors were issuing 
reports in which the audit documentation was not sufficient or it 
contradicted the final opinions or conclusions of the reports. During 
our investigation, we received additional allegations that raised 
concerns regarding the quality of forward pricing audit reports issued 
by a third DCAA field office in California. We investigated the 
allegations and concerns we received as 13 separate cases[Footnote 8] 
to determine whether they could be substantiated. 

In our case investigations, we conducted over 100 interviews of over 50 
individuals and reviewed applicable CAM and relevant FAR, DFARS, and 
CAS requirements. We also obtained and reviewed the working papers 
related to the audits. We interviewed current and former DCAA auditors, 
supervisors, and managers who worked on the audits and interviewed DOD 
and other federal agency contracting officers. In assessing DCAA 
audits, we used GAGAS as our criteria. We learned that the DOD Office 
of Inspector General (DOD IG) was investigating the 10 audits noted in 
the original allegations we received. We therefore coordinated our work 
closely with DOD IG auditors and Defense Criminal Investigative Service 
(DCIS) investigators.[Footnote 9] DOD IG's Office of Audit Policy and 
Oversight, which has oversight responsibility for DCAA, issued a 
memorandum to DCIS on its findings on January 24, 2007. We reviewed 
this memorandum and DCAA's response. 

DCAA audit reports covered by our investigation were issued from 2003 
through 2007. We did not reperform the audits to independently validate 
the completeness or accuracy of the findings contained in DCAA working 
papers. Where it was relevant to our investigation, we relied on the 
electronic date and name stamps on audit files to indicate when files 
were accessed and who accessed them. During our investigation, we noted 
a pattern of frequent management actions that served to intimidate the 
auditors and create an abusive environment at locations 1 and 2. As a 
result, some auditors were hesitant to speak to us. We performed our 
investigation from June 2006 through July 2008 in compliance with the 
standards for investigations prescribed by the President's Council for 
Integrity and Efficiency. 

Summary of Investigation: 

We substantiated the allegations and auditor concerns made on each of 
the 13 cases we investigated, involving 14 audits and forward pricing 
audit issues related to seven contractors. In the 12 cases at locations 
1 and 2, we substantiated the allegations and auditor concerns that (1) 
workpapers did not support reported opinions, (2) DCAA supervisors 
dropped findings and changed audit opinions without adequate audit 
evidence for their changes, and (3) sufficient audit work was not 
performed to support audit opinions and conclusions. In addition, we 
also found that contractor officials and the DOD contracting community 
improperly influenced the audit scope, conclusions, and opinions of 
some audits--a serious independence issue. We also substantiated 
allegations of problems with the audit environment and inadequate 
supervision of certain forward pricing audits at location 3. Moreover, 
during our investigation, DCAA managers took actions against their 
staff at two locations, attempting to intimidate auditors, discouraging 
them from speaking with our investigators, and creating a generally 
abusive work environment. DCAA states that its audits are performed 
according to GAGAS. However, in substantiating the allegations, we 
found numerous failures to comply with GAGAS. The working papers did 
not adequately support the final conclusion and opinion for any of the 
14 audits we investigated. In many cases, supervisors changed audit 
opinions to indicate contractor controls or compliance with CAS was 
adequate when workpaper evidence indicated that significant 
deficiencies existed. We also found that in some cases, DCAA auditors 
did not perform sufficient work to support draft audit conclusions and 
their supervisors did not instruct or allow them to perform additional 
work before issuing final reports that concluded contractor controls or 
compliance with CAS were adequate. Two supervisors were responsible for 
the 12 audits we investigated at location 2, and 11 of these audits 
involved insufficient work to support the reported opinions. The 
following examples illustrate problems we found with audits at two DCAA 
locations: 

* In conducting a 2002 audit related to a contractor estimating system, 
DCAA auditors reviewed draft basis of estimates (BOE) prepared by the 
contractor and advised the contractor on how to correct significant 
deficiencies. BOEs are the means for providing government contract 
officials with information critical to making contract pricing 
decisions. This process resulted from an up-front agreement between the 
DCAA Resident Auditor and the contractor--one of the top five 
government contractors based on contract dollar value--that limited the 
scope of work and established the basis for the audit opinion. 
According to the agreement, the contractor knew which BOEs would be 
selected for audit and the audit opinion would be based on the final, 
corrected BOEs after several DCAA reviews. Even with this BOE review 
effort, the auditors found that the contractor still could not produce 
compliant BOEs and labeled the estimating system "inadequate in part." 
We found that enough evidence had been collected by the original 
supervisory auditor and senior auditor to support this opinion. 
However, after the contractor objected to draft findings and 
conclusions presented at the audit exit conference, the DCAA Resident 
Auditor replaced the original supervisory auditor assigned to this 
audit and threatened the senior auditor with personnel action if he did 
not change the summary workpaper and draft audit opinion. The second 
supervisory auditor issued the final report with an "adequate" opinion 
without documenting adequate support for the changes. This audit did 
not meet GAGAS for auditor objectivity and independence because of the 
up-front agreement, and it did not meet standards related to adequate 
support for audit opinions. 

* The draft report for a 2005 billing system audit identified six 
significant deficiencies, one of which allowed the contractor to 
overbill the government by $246,000 and another that may have led to 
$3.5 million in overbillings. DCAA managers replaced the supervisory 
auditor and auditor, and the new staff worked together to modify 
working papers and change the draft audit opinion from "inadequate," to 
"inadequate in part," and, finally, to "adequate." Sufficient testing 
was not documented to support this opinion. DOD IG concluded that DCAA 
should rescind the final report for this audit, but DCAA did not do so. 
As noted previously, billing system audits are conducted to assess 
contractor controls for assuring that charges to the government are 
appropriate and compliant and to support decisions on whether to 
approve contractors for direct billing. As a result of the 2005 audit, 
DCAA authorized this contractor for direct billing of its invoices 
without prior government review thereby providing quicker payments and 
improved cash flow to the contractor. On June 20, 2008, when we briefed 
DOD on the results of our investigation, DCAA advised us that a DCAA 
Western Region review of this audit in 2008 concluded that the $3.5 
million finding was based on a flawed audit procedure. As a result, it 
rescinded the audit report on May 22, 2008. However, DCAA officials 
said that they did not remove the contractor's direct-billing 
privileges because other audits did not identify billing problems. 

* The draft report for a 2005 CAS 403[Footnote 10] compliance audit 
requested by a Department of Energy administrative contracting officer 
(ACO) identified four deficiencies related to corporate cost 
allocations to government business segments. However, a DCAA 
supervisory auditor directed a member of her staff to write a "clean 
opinion" report in 1 day using "boilerplate" language and without 
reviewing the existing set of working papers developed by the original 
auditor. The supervisory auditor appropriately dropped two significant 
deficiencies from the draft report, but did not adequately document the 
changes in the workpapers. In addition, the supervisory auditor 
improperly referred two other significant deficiencies to another DCAA 
office that does not have audit jurisdiction, and therefore did not 
audit the contractor's corporate costs or CAS 403 compliance. The final 
opinion was later contradicted by a September 21, 2007, DCAA report 
that determined that this contractor was in fact not in compliance with 
CAS 403 during the period of this audit. 

We also substantiated allegations that there were problems with the 
audit environment at a third DCAA location--a resident office 
responsible for audits of another of the five largest government 
contractors. For example, the two supervisors, who approved and signed 
62 of the 113 audit reports performed at the Resident Office location, 
[Footnote 11] said that trainees were assigned to complex forward 
pricing audits as their first assignments even though they had no 
institutional knowledge about the type of materials at risk of 
overcharges, how to look at related sources of information for cost 
comparisons, or how to complete the analysis of complex cost data 
required by FAR. The supervisors, who did not always have the benefit 
of experienced auditors to assist them in supervising the trainees, 
admitted that they generally did not review workpapers in final form 
until after reports were issued. Moreover, because the trainee auditors 
did not have an adequate understanding of DCAA's electronic workpaper 
filing system, they did not always enter completed workpapers in the 
system, resulting in a loss of control over official workpapers. In 
addition, one of the two supervisory auditors told us that contracting 
officers would sometimes tell auditors to issue proposal audit reports 
in as few as 20 days with whatever information the auditor had at that 
time and not to cite a scope limitation in the audit reports so that 
they could begin contract negotiations. If the available information 
was insufficient, GAGAS[Footnote 12] would have required the auditors 
to report a scope limitation. Where scope limitations existed, but were 
not reported, the contracting officers could have negotiated contracts 
with insufficient information. Moreover, a 2006 DCAA Region quality 
review reported 28 systemic deficiencies on 9 of 11 forward pricing 
audits reviewed, including a lack of supervisory review of the audits. 
The problems at this location call into question the reliability of the 
62 forward pricing audit reports issued by the two supervisors 
responsible for forward pricing audits at the Resident Office location 
from fiscal years 2004 through 2006, connected with over $6.4 billion 
in government contract negotiations. 

Throughout our investigation, auditors at each of the three DCAA 
locations told us that the limited number of hours approved for their 
audits and the number of audits required to be completed directly 
affected the sufficiency of audit testing. Noncompliance with GAGAS in 
the cases we investigated has had an unknown financial effect on the 
government. However, substandard audits do not provide assurance that 
billions of dollars in annual payments made to these contractors 
complied with FAR, CAS, or contract terms. 

During the DOD IG and GAO investigations, we identified a pattern of 
frequent management actions that served to intimidate the auditors and 
create an abusive environment at two of the three locations covered in 
our investigation. In this environment, some auditors were hesitant to 
speak to us even on a confidential basis. For example, supervisory 
auditors and the branch manager at one DCAA location we visited 
pressured auditors, including trainees who were in probationary status, 
to disclose to them what they told our investigators. Some probationary 
trainees told us this questioning made them feel pressured or 
uncomfortable. Further, we learned of verbal admonishments, 
reassignments, and threats of disciplinary action against auditors who 
raised questions about management guidance to omit their audit findings 
and change draft opinions or who spoke with or contacted our 
investigators, DOD investigators, or DOD contracting officials. We 
briefed cognizant DCAA Region and headquarters officials on the results 
of our investigation in February 2008 and reviewed additional 
documentation they provided. We briefed DOD officials on the results of 
our investigation on June 20 and 25, 2008. 

On July 3, 2008, DCAA provided a written response to our corrective 
action briefing that stated that the 13 cases related to the three 
field audit offices (FAO) whose audits we investigated represent a very 
small portion of the audit work performed by these FAOs. DCAA stated 
that the three FAOs are currently operating at a satisfactory level of 
compliance with GAGAS. DCAA's response also stated that it did not 
agree with the "totality" of our overall conclusions. However, DCAA 
acknowledged that shortcomings existed in the working paper evidence 
and documentation to support the final audit conclusions in several of 
the assignments we investigated. DCAA's response noted that the 
rationale for dropping many of the significant deficiencies from audit 
reports was not adequately supported or documented and stated that DCAA 
has no evidence that the supervisors "willfully" removed findings from 
the audit reports. DCAA also acknowledged that in some cases, 
additional work should have been performed to support the final audit 
opinion. Finally, DCAA's response stated that DCAA found no evidence to 
support our conclusions that DCAA managers took actions against their 
staff at two locations, attempting to intimidate auditors, preventing 
them from speaking with investigators, and creating a generally abusive 
work environment because we had not provided them specific evidence. 
DCAA stated that we did not advise them of this problem during our 
investigation. We advised DCAA headquarters of our conclusions on 
management issues in February 2008. However, because of the fear of 
retaliation expressed by several individuals during our confidential 
interviews, we did not provide DCAA the names of individuals or 
specific incidents. DCAA indicated that it has begun actions to assess 
the existence of management abuse. We maintain our position on the 
results of our investigation of the 13 cases as well as the DCAA 
management issues at locations 1 and 2. A more detailed discussion of 
DCAA's response is presented in the Corrective Action Briefing section 
of this report. We also reflected DCAA actions, as appropriate, in the 
individual case summary discussions. DCAA's written response is 
reprinted in appendix I. 

We plan to issue a separate report at the request of the Senate 
Committee on Homeland Security and Governmental Affairs concerning our 
broader audit of DCAA's overall organizational environment and quality 
control system and our review of selected audits performed by selected 
offices within DCAA's five regions. Our report will include 
recommendations for strengthening the overall contract audit 
environment and ensuring compliance with GAGAS. 

Background: 

DCAA, reporting to the Office of the Under Secretary of Defense 
(Comptroller), consists of a headquarters office at Fort Belvoir, 
Virginia, and six major organizational components--a field detachment 
office, which handles audits of classified contracting activity, and 
five regional offices within the United States. The regional offices 
manage FAOs, which are identified as branch offices, resident offices, 
or suboffices. Resident offices are located at larger contractor 
facilities in order to facilitate DCAA audit work. In addition, 
regional office directors can establish suboffices as extensions of 
FAOs to provide contract audit services more economically. A suboffice 
depends on its parent FAO for release of audit reports and other 
administrative support. In total, there are more than 300 FAOs and 
suboffices throughout the United States and overseas. 

DCAA plays a critical role in DOD contractor oversight by providing 
auditing, accounting, and financial advisory services in connection 
with the negotiation (i.e., procurement), administration, and 
settlement of contracts and subcontracts. DCAA also performs audit 
services for other federal agencies, as requested, on a fee-for-service 
basis. Although DCAA provides a range of services to contracting 
officers and other DOD officials, DCAA's primary function is contract 
audit services. Figure 1 provides a summary of audit activities by 
contract phase and event and notes the types of audit activities 
covered in our investigation. 

Figure 1: Relationship between Contract Phases, Contract Events, and 
DCAA Audit Activities: 

[See PDF for image] 

This figure is an illustration of the relationship between contract 
phases, contract events, and DCAA audit activities, as follows: 

Contract phase: Negotiation phase; 
Contract events: Proposal; Contract negotiations; Contract award; 
Audit activities: 
* Full proposal[A]; 
* Rate review[A]; 
* Financial capability; 
* Pre-award accounting survey; 
* Initial disclosure statement review; 
* Other[A]. 

Contract phase: Administrative phase; 
Contract events: Contract performance; 
Audit activities: 
* Provisional billing rates; 
* Progress payments (fixed price and fixed price incentive fee 
contracts only); 
* Earned value management system (if required); 
* Other requested special audits; 
* Annual incurred cost reviews (flexibly priced contracts only); 
* Audits of contractor internal control systems[A]; 
* Cost accounting standard (CAS) compliance[A]; 
* Paid voucher reviews; 
* Overpayment review. 

Contract phase: Close out/termination phase; 
Contract events: Contract physically complete; Contract closed; 
Audit activities: 
* Final price submissions (fixed price incentive fee contracts); 
* Contract audit closing statemente (cost type and time and materials 
contracts); 
* Termination. 

[A] Audits covered by GAO's investigation. 

Source: GAO analysis of DCAA information. 

[End of figure] 

According to DCAA data, in 1989, DCAA had almost 6,000 auditors on its 
staff. During fiscal year 2007, as a result of gradual downsizing, DCAA 
had about 3,500 auditors. According to the DCAA Director, DCAA's 3,500 
auditors annually perform about 40,000 audits of approximately 10,000 
contractors. In terms of organizational structure, teams of DCAA 
auditors typically report to supervisory auditors. Among many other 
duties, supervisory auditors are in charge of staffing audits and 
helping auditors manage the scope of their audits in compliance with 
DCAA policies and procedures. DCAA supervisory auditors review and 
approve audit plans and risk assessments, allocate audit hours at the 
beginning of an audit, and perform supervisory review and approval of 
summary workpapers and underlying workpapers, as appropriate, at the 
end of an audit. Supervisory auditors report to branch managers or 
resident auditors, who oversee the operations of their offices and 
manage the progress of all audits assigned to them. Branch managers and 
resident auditors also work with regional management staff, such as 
quality assurance managers, regional audit managers who oversee the 
work of multiple DCAA offices, and region directors. 

In accordance with GAGAS, the results of DCAA audits are issued in 
report form. For example, DCAA audits internal controls in key 
contractor accounting and management systems that have a significant 
effect on government contract costs. DCAA reports on those audits 
describe whether any significant deficiencies[Footnote 13] were found 
in contractor internal controls and, if necessary, include 
recommendations to correct the deficiencies. DCAA may issue one of 
three opinions on a contractor's internal control system: "adequate," 
when no internal control deficiencies are found; "inadequate," when 
internal control deficiencies are so significant that the entire system 
is unreliable; or "inadequate in part," when deficiencies are found 
that affect parts of the system. There are no materiality criteria for 
determining whether significant deficiencies would result in a system 
being labeled inadequate in part versus inadequate. However, DCAA's 
CAM[Footnote 14] states that "A deficiency is significant when the 
auditor believes that additional audit procedures are needed in related 
audits to protect the Government's interest because the contractor's 
internal controls are unlikely to accomplish specific control 
objectives." Contractors are required to take action to correct 
significant deficiencies. DCAA reports may also include suggestions for 
improvement where identified weaknesses are not considered significant 
deficiencies but still merit action by the contractor. Contractors are 
encouraged, though not required, to address suggestions for 
improvement, and suggestions for improvement do not affect the audit 
opinion. According to the policy in effect at the time DCAA issued its 
reports on all but one of the audits we investigated, if an audit 
report expressed an "adequate" opinion, supervisory auditors could 
issue the report under their own signature, if the branch manager or 
resident auditor delegated this authority to them. However, if an audit 
report expressed any opinion other than "adequate," a DCAA branch 
manager or resident auditor was required to sign the report.[Footnote 
15] In instances where the auditor determines that a contractor has an 
"inadequate in part" or "inadequate" internal control system, DCAA is 
required to perform a follow-up audit within 6 months to determine 
whether the contractor has fully implemented corrective actions. 

DCAA audit opinions provide support for granting contractors 
authorization to directly bill a federal agency and receive payment 
without prior review of invoices by the government. DCAA is the agent 
of the contracting officer for purposes of granting contractors direct- 
bill authorization.[Footnote 16] If DCAA determines, based on its audit 
work, that a contractor should not be granted direct-bill authority, 
DCAA must review the contractor's invoices prior to payment.[Footnote 
17] DCAA's CAM states that to the extent appropriate, voucher (invoice) 
reviews based on judgmental sampling will be performed by clerical 
staff and requires the reviews to be completed within 5 business 
days.[Footnote 18] DCAA forwards approved invoices to the federal 
agency payment office, and it returns invoices with errors or 
unallowable costs to the contractor for correction. Moreover, the 
results of DCAA internal control audits affect auditor decisions on the 
scope of work performed on future internal control audits and other 
DCAA cost-related audits. This is because the nature, extent, and 
timing of audit work are based on risk associated with significant 
deficiencies. For example, if controls for a particular system are 
deemed adequate, the level of testing on future audits will be 
decreased based on the assurance provided by adequate controls. 
Conversely, if a contractor's system is determined to be "inadequate" 
or "inadequate in part," the assessment of risk and the testing 
required would be increased because the controls do not provide 
reasonable assurance that data generated by the contractor's system are 
reliable. 

Figure 2 summarizes the different DCAA audit opinions, the criteria for 
judging them, and the resultant actions for audits of contractor 
internal control systems and CAS compliance. 

Figure 2: DCAA Internal Control and CAS Compliance Audit Opinions, 
Criteria, and Resultant Actions: 

[See PDF for image] 

This figure is an illustration of DCAA internal control and CAS 
compliance audit opinions, criteria, and resultant actions, as follows: 

Risk: Low; 
DCAA Opinion: Adequate; 
Criteria: No significant deficiencies; 
Resultant actions: 
* Report could be signed by supervisory auditor[A]; 
* Contractor can potentially directly bill the government; 
* Scope of future and concurrent audits of contractor may be narrowed. 

Risk: Moderate; 
DCAA Opinion: Inadequate in part; 
Criteria: One or more significant deficiencies that affect parts of the 
system; 
Resultant actions: 
* Field office manager or higher must sign report; 
* Contractor required to make improvements; 
* Follow-up testing within 6 months; 
* Expanded audit scopes on future and concurrent audits; 
* Contractor may not be authorized to directly bill (billing system 
audits only). 

Risk: High; 
DCAA Opinion: Inadequate; 
Criteria: One or more significant deficiencies that render the entire 
system unreliable; 
Resultant actions: 
* Field office manager or higher must sign report; 
* Contractor required to make improvements; 
* Follow-up testing within 6 months; 
* Expanded audit scopes on future and concurrent audits; 
* Contractor may not be authorized to directly bill (billing system 
audits only). 

Source: GAO analysis of DCAA policy. 

[A] On December 3, 2007, the DCAA Western Region changed its policy to 
require branch manager or resident auditor signature on all internal 
control audit reports. DCAA adopted this policy change agencywide on 
February 13, 2008. 

[End of figure] 

Because DCAA audit opinions determine whether a contractor can directly 
bill the government and drive the nature and extent of testing on 
subsequent audits, it is essential that audit opinions be supported by 
sufficient testing. 

Questioned DCAA Audits Did Not Comply with GAGAS: 

We substantiated the allegations regarding the 13 cases at the three 
locations we investigated. Specifically, at two locations, we 
substantiated the allegations that DCAA supervisors dropped findings 
and changed audit opinions without adequate audit evidence for their 
changes. In some cases, supervisors changed opinions in final audit 
reports without changing the underlying workpapers, resulting in 
opinions that contradicted the workpapers. We also found that even 
though some auditors believed that they had not performed sufficient 
work to support draft audit conclusions, their supervisors did not 
instruct or allow them to perform additional work before issuing final 
audit reports. At a third DCAA location, we substantiated allegations 
that there were problems with the audit environment. These problems 
included supervisors (1) assigning inexperienced trainees to forward 
pricing audits (i.e., more complex audits related to proposals for 
contract modifications) without proper supervision and (2) issuing 
forward pricing audit reports before audit work was completed. In 
addition, one DCAA supervisor noted problems with inadequate training 
of new auditors on the electronic audit documentation system that 
resulted in losing control over versions of the working papers as they 
were imported and exported from the system for review and revision. The 
problems at this location call into question the reliability of at 
least 62 forward pricing audit reports issued by the two supervisors 
responsible for forward pricing audits at this office from fiscal years 
2004 through 2006, connected with over $6.4 billion in government 
contract negotiations. 

The DCAA audit reports we investigated all stated that they were 
performed in accordance with GAGAS. These standards are intended for 
use by government auditors to ensure that they maintain competence, 
integrity, objectivity, and independence in planning, conducting, and 
reporting their work and that auditors obtain sufficient evidence to 
support findings and conclusions. GAGAS pertain to auditors' 
professional qualifications and the quality of their work, the 
performance of fieldwork, and the characteristics of meaningful 
reporting. Adherence to GAGAS can help provide credibility of the 
information in audit reports so that it can be relied upon by users and 
decision makers. Among many key GAGAS requirements are the following: 

* The audit organization and the individual auditor should be free both 
in fact and appearance from personal, external, and organizational 
impairments to independence.[Footnote 19] 

* Auditors should plan audit work, perform sufficient testing, and 
obtain sufficient evidence to express an opinion on the subject matter. 
[Footnote 20] 

* In making professional judgments, auditors should exercise reasonable 
care and diligence and observe the principle of serving the public 
interest and maintaining the highest degree of integrity, objectivity, 
and independence.[Footnote 21] 

* Documentation related to planning, conducting, and reporting on the 
engagement should contain sufficient information to enable an 
experienced auditor with no previous connection to the engagement to 
determine that the evidence supports the auditor's significant 
judgments and conclusions.[Footnote 22] 

* Audit staff should collectively possess technical knowledge, skills, 
and experience necessary to be competent for the type of work being 
performed and should be properly supervised.[Footnote 23] 

Despite DCAA's statements that its reports are performed according to 
GAGAS, we found numerous failures to comply with GAGAS on the 13 cases 
we investigated. These problems are briefly summarized in table 1. 

Table 1: GAGAS Compliance Problems Associated with Hotline Case 
Investigations: 

Case: 1; 
Impairment to auditor independence: [Check]; 
Working papers did not support reported opinions: [Check]; 
Draft audit opinions changed without sufficient documentation: [Check]; 
Auditor did not perform sufficient work to support conclusions: 
[Empty]; 
Significant problems: The DCAA resident office and contractor made an 
up-front agreement on audit scope, which had the effect of 
predetermining an "adequate" audit opinion. 

Case: 2; 
Impairment to auditor independence: [Check]; 
Working papers did not support reported opinions: [Check]; 
Draft audit opinions changed without sufficient documentation: [Check]; 
Auditor did not perform sufficient work to support conclusions: 
[Empty]; 
Significant problems: Based on pressure from contractor and buying 
command to resolve CAS compliance issues and issue a favorable opinion, 
a DCAA region official directed the auditors not to include CAS 
compliance problems in the audit workpapers. 

Case: 3; 
Impairment to auditor independence: [Empty]; 
Working papers did not support reported opinions: [Check]; 
Draft audit opinions changed without sufficient documentation: [Check]; 
Auditor did not perform sufficient work to support conclusions: 
[Check]; 
Significant problems: Branch manager and supervisory auditor terminated 
audit work and issued opinions without sufficient documentation based 
on their view that defective pricing did not exist on the related 
contracts. 

Case: 4; 
Impairment to auditor independence: [Empty]; 
Working papers did not support reported opinions: [Check]; 
Draft audit opinions changed without sufficient documentation: [Check]; 
Auditor did not perform sufficient work to support conclusions: 
[Check]; 
Significant problems: Supervisory auditor dropped preliminary findings 
of deficiencies based on a flawed audit procedure instead of requiring 
auditors to perform sufficient testing to conclude on the adequacy of 
billing system controls. 

Case: 5; Impairment to auditor independence: [Empty]; 
Working papers did not support reported opinions: [Check]; 
Draft audit opinions changed without sufficient documentation: [Check]; 
Auditor did not perform sufficient work to support conclusions: 
[Check]; 
Significant problems: Auditor was excluded from exit conference, 
findings were dropped without adequate support, and supervisor made 
contradictory statements on her review of the audit. 

Case: 6; 
Impairment to auditor independence: [Empty]; 
Working papers did not support reported opinions: [Check]; 
Draft audit opinions changed without sufficient documentation: [Check]; 
Auditor did not perform sufficient work to support conclusions: 
[Check]; 
Significant problems: Dropped findings on corporate accounting were 
referred to another FAO, which does not review corporate costs. 
Supervisor prepared and approved key working papers herself, without 
required supervisory review. 

Case: 7; Impairment to auditor independence: [Empty]; 
Working papers did not support reported opinions: [Check]; 
Draft audit opinions changed without sufficient documentation: [Check]; 
Auditor did not perform sufficient work to support conclusions: 
[Check]; 
Significant problems: Supervisor directed another auditor to write a 
clean opinion report without reviewing the working papers. Supervisor 
then changed the working papers without support and referred two 
dropped findings to another FAO, which does not review corporate 
overhead allocations. 

Case: 8; 
Impairment to auditor independence: [Check]; 
Working papers did not support reported opinions: [Check]; 
Draft audit opinions changed without sufficient documentation: [Empty]; 
Auditor did not perform sufficient work to support conclusions: 
[Check]; 
Significant problems: Inexperienced trainees assigned to complex 
forward pricing audits without proper supervision. Reports issued with 
unqualified opinions before supervisory review was completed due to 
pressure from contracting officers. 

Case: 9; 
Impairment to auditor independence: [Empty]; 
Working papers did not support reported opinions: [Check]; 
Draft audit opinions changed without sufficient documentation: [Empty]; 
Auditor did not perform sufficient work to support conclusions: 
[Check]; 
Significant problems: Significant deficiency and FAR noncompliance 
related to the lack of contractor job descriptions for executives not 
reported. 

Case: 10; 
Impairment to auditor independence: [Empty]; 
Working papers did not support reported opinions: [Check]; 
Draft audit opinions changed without sufficient documentation: [Empty]; 
Auditor did not perform sufficient work to support conclusions: 
[Check]; 
Significant problems: Significant deficiency related to subcontract 
management not reported. 

Case: 11; 
Impairment to auditor independence: [Empty]; 
Working papers did not support reported opinions: [Check]; 
Draft audit opinions changed without sufficient documentation: [Check]; 
Auditor did not perform sufficient work to support conclusions: 
[Empty]; 
Significant problems: Second auditor and supervisor dropped 6 of 10 
significant deficiencies without adequate documentation to show that 
identified weaknesses were resolved. 

Case: 12; 
Impairment to auditor independence: [Empty]; 
Working papers did not support reported opinions: [Check]; 
Draft audit opinions changed without sufficient documentation: [Check]; 
Auditor did not perform sufficient work to support conclusions: 
[Check]; 
Significant problems: Supervisor identified problems with test 
methodology but dropped findings instead of requiring tests to be 
reperformed. 

Case: 13; 
Impairment to auditor independence: [Empty]; 
Working papers did not support reported opinions: [Check]; 
Draft audit opinions changed without sufficient documentation: [Empty]; 
Auditor did not perform sufficient work to support conclusions: 
[Check]; 
Significant problems: Second auditor and supervisor deleted most audit 
steps and performed limited follow-up work that did not support the 
reported opinion of overall compliance with CAS. 

Source: GAO analysis. 

[End of table] 

Our investigation found that contractor officials and the DOD 
contracting community improperly influenced the audit scope, 
conclusions, and opinions of some audits--a serious independence issue 
(Cases 1, 2, and 8). In addition, we found problems with the adequacy 
of workpaper support for opinions in all 13 cases we investigated. 
Specifically, our investigation determined that working papers for 14 
audits[Footnote 24] at two DCAA locations (Cases 1 through 7 and 9 
through 13) did not adequately support the final audit report opinions. 
The two supervisors responsible for 12 audits we investigated at 
location 2 did not ensure that sufficient work was performed to support 
audit conclusions and opinions for 11 of these audits. Further, all but 
two of the 12 audit reports were issued in the last 2 weeks of the 
fiscal year to meet performance metrics. The two remaining audits were 
issued by the end of the first quarter of the following fiscal year-- 
also a performance metric. Finally, absent final supervisory review of 
forward pricing working papers prior to report issuance, there is no 
assurance that audit opinions in Case 8 were supported by sufficient 
audit evidence, as required by GAGAS.[Footnote 25] In 9 of our 13 
cases, a supervisory auditor or manager either changed or directed 
changes to be made to an auditor's draft audit conclusions without 
adequate audit evidence to support the changes. In Case 6, the 
supervisory auditor prepared and reviewed her own working papers, which 
is also a GAGAS noncompliance. Moreover, in 9 of our 13 cases, the 
auditors did not perform sufficient work to support their draft 
conclusions, and the supervisory auditors failed to note that the work 
was insufficient or direct or authorize the auditors to perform 
additional audit procedures before issuing the final reports. On 10 
audits, the original supervisor or auditor was reassigned and the new 
supervisor or auditor dropped findings and changed conclusions and 
opinions without adequate supporting documentation. 

Throughout our investigation, auditors at each of the three DCAA 
locations told us that the limited number of hours approved for their 
audits directly affected the sufficiency of audit testing. At the third 
DCAA location we investigated, two former supervisory auditors told us 
that the volume of requests for the audits, short time frames demanded 
by customers for issuing reports to support contract negotiations 
(e.g., 20 to 30 days), and limited audit resources affected their 
ability to comply with GAGAS. Our review of DCAA performance data 
showed that DCAA measures audit efficiency and productivity as a factor 
of contract dollars audited divided by audit hours. In addition, 
because customer-requested assignments--such as forward pricing audits 
requested by contracting officers--which are referred to as demand work 
by DCAA, take priority, other work, such as internal control and CAS 
compliance audits, are often performed late in the year. Auditors told 
us that there is significant management pressure to complete these 
nondemand audits by the end of the fiscal year to meet FAO performance 
plans. To test this, we analyzed internal control audit reports issued 
in fiscal years 2005 and 2006 at the location associated with nine of 
the nondemand audits in our initial hotline complaint. We found that 92 
percent (2005) and 83 percent (2006) of these reports were issued in 
the last 2 weeks of the fiscal year. These percentages are 
significantly higher than those for most other DCAA offices. DCAA 
Western Region officials also recognized that this office issued an 
unusually high number of reports at fiscal year-end. 

Noncompliance with GAGAS in the cases we investigated has had an 
unknown financial effect on the government. Because DCAA auditors' 
limited work identified potential significant deficiencies in 
contractor systems and accounting practices that were not analyzed in 
sufficient detail to support reportable findings and recommendations 
for corrective action, reliance on data and information generated by 
the audited systems could put users and decision makers at risk. 
Because the DOD IG was concerned with the effect of certain 
noncompliance issues, in its January 24, 2007, memorandum of 
investigation, it concluded that the final reports associated with 
Cases 4, 5, and 9 should be rescinded. In making its determinations, 
the DOD IG stated that "the reports were not supported by the working 
papers, are still being used, and could have a negative effect on 
current actions involving the contractor." We agree with the DOD IG's 
position and advised DCAA of our same concern with the final report 
related to Case 13. The DCAA Western Region Director disagreed with the 
DOD IG's and our determinations. As a result, the systems and processes 
audited may have been relied on since the 2005 audits. After our 
briefings on the results of our investigation, DCAA's Western Region 
rescinded the reports associated with Cases 4 and 5. In addition, new 
audits were performed on Cases 7, 9, and 12 that identified numerous 
significant deficiencies and included "inadequate in part" opinions. 
The following table summarizes key details related to 8 of the 13 cases 
we investigated, which are explained in detail in the body of our 
report. We included 5 of the 10 cases we investigated at location 1 in 
the body of our report. The additional 5 cases are summarized in 
appendix II. 

Table 2: Summary of DCAA Case Studies GAO Investigated: 

Case: 1; 
Type of audit: Estimating system survey follow-on (2002); 
Contractor: Contractor A; DCAA Location: Location 1[A]; 
Case details: 
* Purpose of audit was to review the corrective action plan (CAP) 
developed by Contractor A in response to prior findings of inadequate 
BOEs related to labor hours; 
* In the face of pressure from DOD's contracting community to approve 
Contractor A's estimating system, we found evidence that there was an 
up-front agreement between DCAA and Contractor A to limit the scope of 
work and basis for the audit opinion (a significant impairment of 
auditor independence); 
* Auditors found significant deficiencies with the CAP implementation 
plan, that is, the contractor could not develop compliant BOEs without 
DCAA's assistance at the initial, intermediate, and final stage of 
estimates; 
* Original supervisory auditor was reassigned; the resident auditor and 
new supervisory auditor directed the draft opinion be changed from 
"inadequate in part" to "adequate" after the contractor objected to 
DCAA draft findings and opinion; 
* The working papers did not contain audit evidence to support the 
change in opinion; 
* Field office management threatened the senior auditor with personnel 
action if he did not change the draft audit opinion to "adequate". 

Case: 2; 
Type of audit: Proposal audit (2006); 
Contractor: Contractor A; 
DCAA Location: Location 1; 
Case details: 
* Audit related to a revised proposal submitted after DCAA reported an 
adverse (inadequate) opinion on Contractor A's 2005 proposal; 
* At beginning of the audit, buying command and Contractor A officials 
met with a DCAA regional audit manager to determine how to resolve CAS 
compliance issues and obtain a favorable audit opinion; 
* Contractor A did not provide all cost information requested for 
audit; 
* Contrary to DCAA CAM guidance, the regional audit manager instructed 
auditors that they could not base an "adverse" (inadequate) audit 
opinion on the lack of information to audit certain costs; 
* On the basis of an "inadequate in part" opinion reported in May 2006, 
the buying command negotiated a $967 million contract, which has grown 
to $1.2 billion. 

Case: 3; 
Type of audit: Three defective pricing audits (2004); 
Contractor: Contractor B; 
DCAA Location: Location 2[B]; 
Case details: 
* Branch manager and supervisory auditor predetermined that there was 
no defective pricing; however, the auditor concluded that Contractor 
B's practice potentially constituted defective pricing and obtained 
technical guidance that specific contracts would need to be analyzed to 
make a determination. The branch manager disagreed; 
* Supervisory auditor and branch manager subsequently issued three 
reports stating that Contractor B's practice at three divisions did not 
constitute defective pricing; 
* Insufficient work was performed on these audits to come to any 
conclusion about defective pricing, and as a result, the final opinions 
on all three audit reports are not supported; 
* Absent DCAA audit support for defective pricing, the contracting 
officer pursued a CAS 405 noncompliance at three contractor divisions 
and recovered $71,000; 
* At the end of our work, a settlement on a separate DCIS defective 
pricing case was being negotiated. 

Case: 4; 
Type of audit: Billing system; (2005); 
Contractor: Contractor C; 
DCAA Location: Location 2; 
Case details: 
* Draft audit report identified six significant deficiencies, one of 
which led Contractor C to overbill the government by $246,000 and 
another which potentially led to $3.5 million in overbillings, but 
audit work was incomplete. The contractor had refunded the $246,000; 
* The original auditor concluded that the $3.5 million was for 
subcontractor costs improperly billed to the government. The supervisor 
deleted the finding based on a flawed audit procedure, but did not 
require additional testing; 
* First supervisory auditor and auditor were replaced after draft audit 
report was completed; 
* New auditor and supervisory auditor worked together to modify working 
papers and change the draft audit opinion from "inadequate," to 
"inadequate in part," and, finally, to "adequate"; 
* Sufficient testing was not performed to determine if the contractor 
had systemic weaknesses or to support an opinion that contractor 
billing system controls were adequate; 
* On the basis of the "adequate" opinion, the FAO approved the 
contractor for direct billing; 
* DOD IG recommended that DCAA rescind the final report for this audit, 
but DCAA did not do so; 
* Following the briefing on our investigation, the DCAA Western Region 
rescinded the audit report on May 22, 2008. 

Case: 5; 
Type of audit: Estimating system (2005); 
Contractor: Contractor C; 
DCAA Location: Location 2; 
Case details: 
* Auditor identified five deficiencies and concluded the contractor's 
system was "inadequate in part"; 
* Auditor did not perform sufficient work to support some findings, but 
supervisory auditor did not direct the auditor to gather additional 
evidence; 
* After consulting with the branch manager, the supervisory auditor 
modified documents and eliminated significant deficiencies, changing 
the draft audit opinion from "inadequate in part" to "adequate"; 
* Working papers did not properly document the reason for the change in 
opinion and therefore do not support the final opinion; 
* DOD IG recommended that DCAA rescind the final report for this audit, 
but DCAA did not do so; 
* On June 27, 2008, the DCAA Western Region informed us that it was 
rescinding this audit report. 

Case: 6; 
Type of audit: Accounting system (2005); 
Contractor: Contractor D; 
DCAA Location: Location 2; 
Case details: 
* Auditor believed audit evidence related to a 24 percent error rate in 
a small sample of cost pools supported an "inadequate in part" opinion 
and suggested testing be expanded, but supervisory auditor disagreed; 
* Auditor and supervisory auditor documented their disagreement in the 
working papers; 
* Supervisory auditor subsequently modified documents to change the 
draft audit opinion from "inadequate in part" to "adequate" before 
issuing the final report; 
* Certain final working papers were prepared and approved by the 
supervisory auditor; 
* Branch manager and supervisory auditor determined that findings of 
corporate accounting problems should be referred to another FAO for 
future audit. However, the other FAO does not audit corporate costs; 
* Working papers do not support the final opinion. 

Case: 7; 
Type of audit: Compliance, CAS 403 (2005); 
Contractor: Contractor D; 
DCAA Location: Location 2; 
Case details: 
* Auditor identified four potential instances of noncompliance with CAS 
403; 
* Auditor was transferred to a different team before supervisory review 
of her working papers. Three months later, the supervisory auditor 
requested that another auditor write a "clean (adequate) opinion" 
report; 
* Second auditor used "boilerplate" (i.e., standardized) language to 
write the final report and never reviewed the working papers; 
* The supervisor correctly deleted two findings and referred two 
findings of corporate-level noncompliance to another FAO for future 
audit. The other FAO does not audit corporate-level costs; 
* Working papers do not support the final "clean opinion," which was 
later contradicted by a September 21, 2007, DCAA report that determined 
that Contractor D was in fact not in compliance with CAS 403 during the 
period of this audit. 

Case: 8; 
Type of audit: Forward pricing (2004 through 2006); 
Contractor: Contractor E; 
DCAA Location: Location 3[C]; 
Case details: 
* Two Location 3 supervisors signed 62 of 113 forward pricing audits 
performed by the resident office related to Contractor E from 2004 
through 2006; 
* Supervisors responsible for the 62 forward pricing audits admitted to 
us that they did not always have time to review working papers before 
report issuance; 
* According to the DCAA Region, inexperienced trainee auditors were 
assigned to 18 of the 62 audits. However, the region did not provide 
assignment documentation for the 62 audits; 
* An internal DCAA Region audit quality review found audits where the 
audit working papers did not support the final audit report, working 
paper files were lost, and working paper files were not archived in the 
DCAA-required time period; 
* The 62 forward pricing audits were connected with over $6.4 billion 
in government contract negotiations. 

Source: GAO analysis. 

[A] Location 1 is a DCAA resident office located at facilities run by 
one of the five largest DOD contractors (Contractor A). The audit in 
Case 1 was performed at a suboffice location and the audit in Case 2 
was performed at the resident office. 

[B] Location 2 is a DCAA branch office. 

[C] Location 3 is a DCAA resident office located at facilities run by 
another of the five largest DOD contractors (Contractor E). 

[End of table] 

The following discussion summarizes our investigations of the above 
eight cases, including the allegations we received, and the details of 
the audits for seven cases at two DCAA locations; for Case 2, similar 
significant audit issues we identified in current GAO work; and for 
Case 8, the issues associated with the forward pricing audit 
environment at a third location; and the results of our investigation 
of each case. 

Case 1: 2002 Follow-on Survey of Contractor A's Estimating System: 

We investigated allegations that DCAA managers at a suboffice under 
location 1 engaged in an up-front agreement with Contractor A to 
provide an "adequate" audit opinion on a corrective action plan (CAP) 
developed by the contractor to correct weaknesses in its estimating 
system that DCAA had identified in two previous audits. According to 
the allegations, consonant with this up-front agreement, the working 
papers for this audit do not support the opinion because the DCAA 
resident auditor at location 1 directed the auditor to remove findings 
from the draft report. Contractor A is a major aerospace company that 
is among the five largest defense contractors in the United States. In 
calendar year 2006, Contractor A reported over $61 billion in revenue. 
The resident office we investigated is located on the site of a wholly 
owned subsidiary of Contractor A; this subsidiary produces cost 
estimates for several major Air Force weapon systems. 

Details of the Audit (Case 1): 

In audit reports issued in September 2000 and September 2001, DCAA 
documented inadequacies in the estimating system Contractor A used to 
produce BOEs on labor hours related to support and maintenance of the 
major weapon systems manufactured at this California location. BOEs are 
critical because they define the purpose of contract estimates, the 
estimate scope, the basis for pricing, and other important factors that 
government contract managers must consider in making decisions on 
pricing contract work. As a result of these reports, the Defense 
Contract Management Agency (DCMA) downgraded Contractor A's estimating 
system rating from green (satisfactory) to yellow (marginal). As 
required by DCAA policy,[Footnote 26] whenever at least one inadequacy 
is disclosed in an audit, the contractor must develop a CAP to address 
the deficiencies. Because of continuing problems with labor-hour 
estimates noted in the 2000 and 2001 DCAA reports, DOD established an 
integrated product team (IPT) to address the inadequacies. The IPT, 
which included DCMA contracting officials, Air Force acquisition 
officials, Contractor A management representatives, and DCAA auditors, 
was a key component of the contractor's CAP. 

According to working papers we reviewed, at the time the audit of 
Contractor A's CAP was initiated in March 2002, there was an up-front 
agreement between the DCAA resident auditor and Contractor A officials 
that limited the audit scope and noted that the yet-to-be-performed CAP 
audit opinion would be based on final approved BOEs for labor hours in 
selected forward pricing proposals. This agreement had the effect of 
predetermining an "adequate" audit opinion. For example, under the 
agreement, Contractor A would provide BOEs to be audited for all 
proposals issued during March through June 2002. Thus, Contractor A 
knew in advance which proposals would be audited. Further, under the 
agreement, DCAA auditors would review Contractor A's BOE proposals at 
three phases and advise the contractor of needed corrections. According 
to the agreement, which was documented in a "letter of understanding" 
between DCAA and Contractor A, DCAA would only report on its audit 
results after reworking the BOE proposals and reaching agreement on 
them. This represented a significant deviation from DCAA audit 
procedures. According to the auditors, DCAA normally allows a 
contractor to produce several final proposals through its estimating 
system before randomly selecting and reviewing proposals. Our 
interviews of DOD contracting officials and an Air Force buying command 
official revealed that there was pressure from the contracting 
community to approve Contractor A's estimating system. 

In October 2002, DCAA auditors prepared a draft audit opinion of 
"inadequate in part." They found that Contractor A failed to adequately 
implement the CAP and that the contractor could not produce compliant 
BOEs even after they had been reviewed twice by DCAA auditors. In 
addition, they identified a risk of $11 million in unsupported labor 
charges on the specific BOEs Contractor A had selected for them to 
review. Auditors explained that the effect of the unsupported labor 
charges could extend beyond the specific BOEs they reviewed and could 
affect all BOEs prepared over the next 3 to 4 years, until the next 
estimating system internal control audit is performed, if the problems 
were not corrected. A DCAA working paper showed that during an exit 
conference with Contractor A on September 13, 2002, the director of the 
contractor's estimating system stated that if the report was issued 
with an "inadequate in part" opinion he would "escalate" the issue "to 
the highest level possible" in the government and within his own 
company. He contended that the DCAA audit attempted to hold Contractor 
A to standards that were guidelines rather than requirements in the 
contractor's estimating system manual. However, our analysis of DCAA 
working papers showed that the contractor's estimating system manual 
was not FAR compliant,[Footnote 27] which led to the disagreement. 

In mid-January 2003, the resident auditor at this location reviewed the 
working papers for the CAP audit and, as documented in the working 
papers, demanded in several e-mail messages that the senior auditor 
make modifications that would support an "adequate" opinion. The senior 
auditor acquiesced and added a statement in certain key working papers, 
including the working paper summarizing the exit conference with 
Contractor A, stating that DCAA's understanding of the contractor's 
estimating system manual was "clarified." The statement concluded that 
the draft report findings were based on guidelines rather than 
requirements. The statement closed by noting, "In addition, the 
contractor has corrected the originally cited deficiency discussed in 
DCAA's prior audits due to the government's participation in the BOE 
IPT." On February 10, 2003, the new supervisory auditor issued a report 
stating that contractor's estimating system was adequate. 

Results of Investigation (Case 1): 

Our investigation substantiated the allegations. We determined that 
this audit did not comply with GAGAS because (1) the working papers did 
not support an "adequate" opinion, (2) the resident auditor directed 
the auditor to remove findings from the draft report without adequate 
supporting documentation, and (3) draft conclusions in the working 
papers were changed without adequate support. Moreover, the up-front 
agreement, which limited the scope of the audit and provided the basis 
for an "adequate" opinion, impaired the objectivity of the audit and 
posed a serious independence issue.[Footnote 28] Our review of the 
audit workpapers showed that the DCAA auditors determined that the 
contractor's estimating system guidance was not FAR compliant; thus, 
the resident auditor's directions to add language to certain key 
working papers stating that Contractor A "clarified" its estimating 
system procedures misrepresented the condition of the contractor's 
estimating system and related controls. We found that the majority of 
the working papers were not revised to reflect an "adequate" opinion, 
and that enough evidence had been collected by the original supervisory 
auditor and senior auditor to support an "inadequate in part" opinion. 
For instance, the auditors identified a risk of $11 million dollars in 
unsupported labor charges on the final BOEs. Further, the auditors told 
us that the risk to the government would be much greater than the $11 
million because once Contractor A's estimating system controls were 
deemed adequate, future proposals would receive less audit scrutiny. 

According to the senior auditor whom we interviewed, he initially 
refused to make changes, but later did so after being pressured by the 
resident auditor who did not want this report to be inconsistent with 
recent proposal audit opinions. An Air Force procurement official who 
had worked closely with the auditors on reviewing the BOEs told us that 
he was aware that the resident auditor had threatened the senior 
auditor with personnel action if he did not change the workpapers. The 
Air Force official told us that he advised the DCAA senior auditor not 
to "lose his job" over the disagreement and to go ahead and make the 
changes to the working papers. 

Further, the Air Force procurement official involved in this case told 
us that while DCAA's CAP audit was ongoing, there was talk within DCMA 
of lowering the contractor's rating to red (unsatisfactory and 
unusable). He said that throughout the CAP process, Contractor A 
continued to deliver unsatisfactory BOEs that lacked information on 
scope, methodology, pricing estimates, and other critical elements. 
This official added that Contractor A was putting considerable pressure 
on the government to raise its estimating system rating to green 
despite these problems. 

In November 2002, while the CAP audit was still in draft, the original 
supervisory auditor was promoted and reassigned to another DCAA audit, 
even though he requested that he be allowed to complete this audit 
beforehand. The resident auditor was subsequently transferred to the 
branch manager position at location 2. In her new position, this 
individual was in charge of managing the audits associated with Cases 3 
through 7 and 9 through 13 (Case 8 occurred at a third DCAA office). 
Furthermore, Contractor A officials met with the Commander of DCMA and 
requested staffing changes in DCMA related to the audit. 

In a January 2007 memorandum, the DOD IG also concluded that the 
working papers supported the original draft "inadequate in part" 
opinion on the contractor's estimating system, not the "adequate" 
opinion that was actually reported. On May 17, 2007, the second 
supervisory auditor, who had signed the audit report, prepared a 
Memorandum for the Record documenting her conclusions on the 2002 
audit. Specifically, she stated that the draft "inadequate in part" 
opinion was based on draft BOEs, when the opinion should have only been 
based on the contractor's final certified BOEs, which she concluded 
were adequate. To support her opinion, the second supervisory auditor 
created a new workpaper on her analysis of the final, corrected BOEs 
that omitted the original analysis of BOEs at the initial and interim 
stages. The revised workpaper was consistent with the up-front 
agreement. 

Although the workpaper documentation clearly lays out the nature of the 
up-front agreement, DCAA disagrees that there was an up-front 
agreement. DCAA also stated that sufficient evidence was not collected 
by the original auditors to support the draft "inadequate in part" 
opinion. However, we found the workpaper evidence to be sufficient in 
this regard. 

Further, because of the well-known history of improper practices by a 
senior Air Force acquisition official, we believe that the DCAA 
Resident Office should have increased its audit scrutiny during the 
2002 estimating system follow-on audit. For example, in 1993, a senior 
Air Force acquisition official involved in procurements related to a 
company later acquired by Contractor A was investigated for involvement 
in a plan to speed up Air Force payments to that company. In 2000, 
during the earlier estimating system audit, the senior Air Force 
acquisition official sent the rï¿½sumï¿½s of her daughter, a recent college 
graduate, and her daughter's fiancï¿½, a published PhD aeronautical 
engineer, to Contractor A and both were hired. From 2000 through 2002, 
Contractor A was attempting to secure a $24.5 billion contract with DOD 
related to major weapon systems covered by the Contractor A's same 
estimating system. During this period, while the same senior Air Force 
acquisition official was negotiating this contract on behalf of DOD, 
the official was simultaneously negotiating for a high-paying job for 
herself with Contractor A. After resolving the contract negotiations in 
Contractor A's favor, this official then retired from the Air Force and 
accepted a $250,000 per year job with Contractor A, plus a $50,000 
signing bonus. She later pled guilty to 18 counts of conflict of 
interest violations. She received 9 months in jail, 7 months of halfway 
house/home confinement, and 150 hours of community service. Following 
this sequence of events, DCAA did not revisit the 2002 estimating 
system audit. 

Case 2: Continuing Audit Issues with Contractor A Related to a 2006 
DCAA Proposal Audit: 

A current GAO audit of a program to provide satellite launch capability 
identified audit issues that are similar to those involved in our 
investigation of the 2002 DCAA estimating system audit discussed in 
Case 1. Accordingly, we investigated issues related to (1) buying 
command and contractor pressure for a favorable audit opinion and (2) 
an unsupported change in the draft audit opinion directed by a DCAA 
Western Region official. DOD initiated the program in 1995 to develop a 
new generation of launch vehicles and provide assured, affordable 
access to space. The program was developed in three phases. The initial 
phase, low cost concept validation involved four separate $30 million 
contracts and was completed in November 1996. The second phase involved 
two $60 million contracts for preengineering and manufacturing. Phase 
three began in October 1998 with the award of two development 
agreements and two initial launch services contracts known as Buy 1 
totaling more than $3 billion. Additional launch service awards were 
made in Buy 2 and proposed in Buy 3. Buy 3 launch services awards are 
continuing. By mid-2004, program costs had increased by more than $13 
billion over the approved 2002 baseline estimate of $18.8 billion, 
resulting from the failure of the commercial market to materialize and 
other factors. The cost increase led the Secretary of Defense to 
certify that the program was critical to national security and that the 
revised program cost estimates were reasonable. DOD's Selected 
Acquisition Report as of September 30, 2007, estimated total program 
acquisition costs at $35.7 billion. 

Contractor A was one of two government contractors selected to provide 
two families of launch vehicles for this program, each using common 
components and common infrastructure. To meet reductions in projected 
life cycle costs, the program was expected to capture at least 15 
percent of the commercial market. However, Contractor A proceeded to 
develop launch capability based on 75 percent commercial participation-
-about 300 commercial launches compared to 100 government launches. 
Further, the contractor lacked negotiated contracts with interested 
private sector entities, primarily cell phone companies. During 1998 
and 1999 the cell phone companies decided to use communication towers 
instead of space satellite technology, and nearly all of Contractor A's 
anticipated commercial business fell through, leaving Contractor A with 
excess capacity associated with the operation of only one of two 
production lines, excess equipment and materials, and a corresponding 
shortfall in revenue to cover the related costs. Contractor A and DCAA 
refer to the commercial losses included in Contractor A's cost 
estimates as "unabsorbed costs" and "over average" costs rather than 
identifying them specifically as losses. 

In 2005, the government split the program into two efforts--expendable 
launch services (ELS) involving hardware (rockets) and expendable 
launch capability (ELC) involving support and maintenance. Up to this 
point, the government had actual cost data and pricing estimates on the 
cost to complete these efforts. Over $2.5 billion had been recorded as 
acquisition cost of commercial-type items. Under the two efforts, the 
contract changed from coverage under FAR Part 12--Acquisition of 
Commercial Items--to FAR Part 15--Contracting by Negotiation. FAR Part 
12 does not require contractors to submit cost or pricing data. FAR 
Part 15 places a higher burden on contractors for documenting costs and 
submitting cost or pricing data. ELS, which involved costs associated 
with construction of the production facility and associated tooling and 
equipment, involved firm, fixed-price contracts. ELC cost-type 
contracts covered launch operations, mission assurance, mission 
integration, supplier readiness, transportation, data reporting, 
unabsorbed program management and hardware support, and special studies 
to support launch requirements. 

In September 2006, we reported[Footnote 29] that Office of the 
Secretary of Defense guidance states that commercial acquisition was 
not intended to allow military-unique items to be purchased 
commercially. Misclassification of items as commercial can leave the 
Air Force vulnerable to accepting prices that are not the best value 
for the department. When an item is designated as commercial, the Air 
Force should be able to determine if the price is reasonable on the 
basis of prices in the commercial market. If the Air Force designates 
an item as being commercial when it is not really available in the 
commercial market, this limits its ability to assess the reasonableness 
of the contractor's price because it might, especially in sole-source 
situations, have less information on prices to make its decision. 

Details of the Audit (Case 2): 

The ELC proposal addressed in the May 8, 2006, DCAA audit report was a 
revision to the Buy 3 launch capability proposal[Footnote 30] for which 
the DCAA resident office at location 1 had rendered an adverse opinion 
[Footnote 31] in its July 29, 2005, audit report. On the revised $1.1 
billion proposal, the May 2006 DCAA audit report questioned about $88.6 
million[Footnote 32] and found that another $123.4 million in proposed 
costs was unsupported.[Footnote 33] The audit report also included a 
qualification related to the Air Force's refusal to provide DCAA 
auditors a copy of a technical evaluation on labor hours performed by 
DCMA to support the Buy 3 launch capability contract negotiation. As 
previously discussed, our investigation of Case 1 determined that 
Contractor A had uncorrected estimating system deficiencies related to 
labor-hour estimates, which could affect contract negotiations on 
future proposals. In addition, the workpapers documented the auditors' 
concerns that they were unable to evaluate the extent to which the 
contractor included costs related to lost commercial business in the 
ELC Buy 3 proposal because Contractor A did not provide all requested 
cost information. On April 28, 2006, the auditors submitted their draft 
report with an inadequate (meaning adverse) opinion for review. The 
final report issued on May 8, 2006, included an "inadequate in part" 
opinion. 

Results of Investigation (Case 2): 

Our interviews of DCAA auditors, review of DCAA workpapers, and 
analysis of related documentation on meetings and briefings obtained 
during our investigation substantiated concerns about (1) buying 
command and contractor pressure for a favorable audit opinion and (2) 
an unsupported change in the draft audit opinion that was directed by 
DCAA Western Region officials. Contractor A's noncompliance with CAS 
was viewed by the Space and Missile Systems Center (SMC)--the Air Force 
buying command--and DCMA as an obstacle to awarding the revised Buy 3 
launch capability contract. Documentation of meetings between SMC, 
DCMA, and the DCAA regional audit manager (RAM) noted discussions on 
how to resolve CAS issues so that the buying command would be in the 
best position to negotiate the ELC contract without CAS impediments. 
Air Force legal counsel had previously instructed the buying command 
that it could not negotiate this ELC contract if DCAA issued an adverse 
audit opinion. According to documentation by SMC and DCMA officials on 
meetings held in December 2005 at the beginning of the ELC Buy 3 
proposal audit, a senior buying command official stated that "CAS 
waivers [were] being considered to overcome DCAA's documented, adverse 
opinions on the Expendable Launch Capabilities (ELC) and the Expendable 
Launch Services (ELS) proposals." However, the official also noted that 
the "SMC proposed CAS waiver appears to be politically unacceptable in 
Washington, DC at this time." The official asked "[Contractor A], DCAA, 
DCMA, and SMC to reevaluate their respective positions to determine if 
there is some material way of overcoming the CAS Waiver challenges 
facing the Government and [Contractor A]." The meeting documentation 
revealed that a Contractor A official had stated that he considered the 
15-year duration of Lot 1 to be discretionary and a reasonable way to 
conduct business. The official stated that that he did not believe that 
his company had violated the CAS. The DCAA RAM agreed to revisit DCAA's 
position on CAS issues and provide a "recommendation to withdraw CAS 
406/411 [noncompliance issues]" by January 15, 2006 or shortly 
thereafter." When we asked the former RAM what was recommended, the 
former RAM explained that after observing Contractor A's "accounting 
demo" (demonstration), she had concluded that there were no CAS 406 or 
other CAS compliance issues. We do not consider an accounting 
demonstration to represent sufficient audit evidence without 
independent testing and confirmation. Further, our review of the audit 
workpapers revealed that Contractor A provided bulk cost data and bulk 
allocations to the auditors without necessary detail to trace costs to 
program components or contracts. 

DCAA's audit workpapers did not contain evidence of CAS compliance 
issues. The auditors told us that they were instructed by the RAM not 
to document CAS compliance issues in the workpapers. Further, other 
related documentation, including DCAA briefing documents and 
documentation of various meetings, showed that CAS compliance continued 
to be a significant issue. For example, although CAS 406 requires 
contractors to account for costs by annual periods,[Footnote 34] 
Contractor A used a lot costing methodology that covered multiple 
years.[Footnote 35] According to the auditors and our review of 
Contractor A's lot cost accounting definition, Contractor A's cost 
accounting for Lot 1 initially covered 2 years in 1997, but was 
extended to cover 15 years by 2005. In addition, Contractor A's Lot 1 
costs consisted of all production and launch capability costs to place 
a satellite in orbit, including a combination of costs and estimates 
for past and future years as well as costs for more than one contract 
(i.e., launch capability and launch services), which is a noncompliance 
with cost allocation guidance in CAS 418.[Footnote 36] Documentation of 
meetings with the Air Force, Contractor A, and the DCAA RAM also 
indicated concerns about compliance with CAS 411, which provides 
guidance on accounting for material inventory costs.[Footnote 37] 
During meetings with DCAA auditors, a senior Contractor A official and 
an Air Force buying command official verbally confirmed that Lot 1 
costs included the period of time during which Contractor A was 
incurring costs to gear up for a "robust commercial market.": 

According to the auditors, based on fixed costs of $600 million 
annually for ELC launch support and the limited number of launches, 
average launch costs had significantly increased. DCAA briefing 
documents showed that to address this problem, Contractor A used lot 
costing as a means of spreading costs over the 15-year period in Lot 1 
and increased the estimated number of government launches to 32 
launches using 42 common booster cores (rockets). One DCAA briefing 
document described this gradual reduction in costs over the 15-year 
period in Lot 1 as the wedge. The wedge includes unabsorbed costs, also 
referred to as over average costs, related to contractor commercial 
business losses. A wedge diagram showed declining costs per launch as 
additional government launches were projected and the time frame for 
accomplishing the launches stretched over several additional years 
based on Contractor A's lot-costing methodology. For example, the wedge 
diagram showed 4 launches from 1998 through 2005, with an additional 28 
launches projected through 2011. Because only 4 launches were 
accomplished in the first 7 years, the auditors considered the 28 
estimated launches to be unrealistic. As of June 2008, only 1 
additional government launch had been conducted. 

The auditors completed the workpapers and prepared a draft audit report 
on April 28, 2006. The audit workpapers showed that on that date, the 
RAM advised the resident auditor (FAO manager) at location 1 that DCAA 
"did not have an authoritative basis (such as allocability) to question 
the entire wedge." However, the workpapers also showed numerous auditor 
requests for cost information and meetings with contractor officials to 
request and discuss cost information. At the end of the audit, the 
workpapers indicated that Contractor A had not responded to several 
requests for information that would have helped the auditors identify 
costs related to lost commercial business. For example, Contractor A 
did not provide information on the cost of excess and obsolete 
materials, excess production facility capacity, and excess equipment. 
The audit findings on five significant issues/qualifications and access 
to records problems in the ELC Buy 3 proposal audit meet DCAA's 
criteria for an adverse (inadequate) opinion,[Footnote 38] particularly 
the criteria related to the lack of access to key records and related 
cost documentation. 

DCAA disagreed that the audit opinion was influenced by pressure from 
the contractor and the buying command. DCAA also stated that there is 
no evidence in the workpapers that the RAM directed the draft opinion 
to be changed from "inadequate" to "inadequate in part." However, 
according to the auditors, on April 28, 2006, the RAM directed the DCAA 
resident auditor to change the draft audit opinion on cost and pricing 
data from "inadequate" (adverse) to "inadequate in part" and add 
language to the report stating, "However, we consider it a procurement 
decision as to whether or not payment of these costs will further the 
objective to maintain Assured Access to Space as a vital national 
security interest." DCAA also stated that Contractor A did not have CAS 
and FAR compliance issues related to the 2006 proposal. However, the 
opinion paragraph makes reference to CAS and FAR noncompliance, 
although the referenced pages of the report do not discuss any CAS 
noncompliance. Further, although DCAA stated that the contractor did 
not substantively use lot costing in the 2006 proposal, this is not 
supported by the audit documentation or subsequent documentation on 
meetings related to approval of advance agreements related to the 
proposal, which were approved in November 2006. The final "inadequate 
in part" audit opinion allowed the Air Force to negotiate the contract. 
Following the report, on June 1, 2006, DOD approved a $967.8 million 
contract for Buy 3 launch capability for the period October 1, 2005, 
through September 30, 2007. The contract has since grown to over $1.2 
billion. 

During this audit, Contractor A was the subject of a well-publicized 
investigation of industrial espionage related to contract competition 
that was ongoing during the 2005 ELC Buy 3 proposal audit. Therefore, 
we would have expected DCAA to have been skeptical of contractor 
accounting practices and related assertions. During the investigation, 
the government charged Contractor A with hiring an engineer from a 
competing firm in 1996 and agreeing to provide pay raises in exchange 
for proprietary documents that later favorably aided Contractor A in 
contract negotiations during the development phase of the program. The 
theft of proprietary documents was identified in June 1999. An 
investigation ensued and the two former Contractor A managers--the 
engineer and his recruiting manager--were charged with conspiring to 
steal trade secrets concerning a multibillion-dollar rocket program. 
According to the civil settlement agreement entered on June 30, 2006, 
Contractor A did not admit liability, and agreed to settle the matter. 
Under the settlement agreement, Contractor A agreed to pay the 
government $565 million, withdraw any unallowable costs previously 
submitted to the government, and provide cognizant contracting officers 
or their designated representatives with a fiscal year schedule of all 
incurred costs excluded, withdrawn, or adjusted as a result of the 
settlement agreement. Costs that do not comply with CAS and FAR are 
generally unallowable. The government also divided future launches 
between Contractor A and the other contractor. 

Case 3: Three 2004 Defective Pricing Audits of Contractor B: 

We investigated allegations that the working papers for audits of three 
Contractor B divisions do not support the opinions because the DCAA 
branch manager and a supervisory auditor improperly made an advance 
determination that defective pricing did not exist based on their 
interpretation of one of the five defective pricing criteria. The 
audits, which were reported in a series of three reports (one on each 
of the contractor's Southern California divisions), were intended to 
determine whether Contractor B's method of charging transportation 
costs at three of its divisions from July 1998 through July 2003 
constituted defective pricing. Contractor B is a service, engineering, 
and technology development company with 57,000 employees in locations 
around the world. Contractor B's three Southern California divisions 
provide fuel systems, aerospace control systems, and military support 
services. DCAA reported that these three divisions had about $429 
million in government sales in fiscal year 2004. 

Details of the Audits (Case 3): 

A defective pricing audit of Contractor B was initiated in September 
2003 at the request of DCMA to resolve an issue that began in 1998. On 
July 13, 1998, Contractor B sent DCMA a letter stating that it would no 
longer use government shipping and would pay its own transportation 
costs instead. At that time, the contractor included its free-on-board 
(FOB)-origin[Footnote 39] freight costs in its material overhead pool, 
a practice that would inflate overhead and violate FAR if the 
contractor continued it while paying its own freight costs. FAR 
[Footnote 40] requires that such costs be billed as direct expenses. 
Given this fact, at an August 6, 1998, meeting, DCMA requested that the 
contractor provide a revised accounting disclosure statement. 
Contractor B agreed to revise its disclosure statement, but through 
July 2003, Contractor B's disclosure statement continued to show that 
it was including FOB-origin shipping costs in the material overhead 
pool, in violation of FAR. It was not until nearly 5 years after these 
events that a DCMA ACO realized that the company continued to include 
FOB-origin shipping costs in its material overhead pool. The ACO sent a 
letter to Contractor B notifying it that it was violating FAR and CAS. 
[Footnote 41] In response to the letter, Contractor B revised its 
practice and agreed to bill shipping costs directly as required by FAR. 

According to the workpapers, the specific objective of the audit was to 
determine whether Contractor B's practice of including transportation 
costs in the material-handling overhead pool for about 5 years--from 
July 1998 through July 2003--constituted systemic defective pricing. 
The audit focused on three Southern California divisions of Contractor 
B and consequently resulted in three separate audit assignments--one 
for each division. The auditor and supervisory auditor both concluded 
that defective pricing existed and documented this conclusion in the 
working papers. However, while the audit was still ongoing, the 
resident auditor discussed in Case 1 was assigned to be branch manager 
at this location. According to the auditor, the new branch manager then 
assigned a new supervisory auditor.[Footnote 42] The branch manager 
conferred with the new supervisory auditor and determined that 
defective pricing did not exist. The supervisory auditor subsequently 
issued three reports on September 28, 2004, stating that defective 
pricing did not exist at each of three Southern California divisions of 
Contractor B. Because DCAA determined that Contractor B's FAR and CAS 
noncompliance did not constitute defective pricing, no cost impact was 
assessed by DCAA, and DCAA did not audit the other 10 contractor 
divisions with regard to defective pricing. 

DCAA's CAM[Footnote 43] cites five criteria that must be met in order 
to make a determination of defective pricing.[Footnote 44] For example, 
the auditor must be able to show that the government was not aware of 
the defective pricing and its significance. The auditor must also show 
that the defective pricing caused an increase in government 
expenditures on an actual contract. The only documentation provided in 
the working papers to support the conclusion that defective pricing did 
not exist was a memorandum written by the supervisory auditor on the 
same day the reports were issued. The memorandum states that the five 
criteria for defective pricing were not met in this case because the 
government was aware of Contractor B's practice of including shipping 
costs in the material overhead pool and its significance. However, the 
supervisory auditor included no evidence to support this assertion, and 
as explained below, our review of DCAA documentation did not find 
sufficient evidence of knowledge by the government during contract 
negotiations. 

Results of Investigation (Case 3): 

Our investigation substantiated the allegations that a DCAA branch 
manager and a supervisory auditor improperly made an advance 
determination that defective pricing did not exist based on their 
interpretation of one of the five defective pricing criteria. We 
determined that the three defective pricing reports did not comply with 
GAGAS[Footnote 45] because sufficient evidence was not obtained to 
support the conclusion that defective pricing did not occur. Although 
the contractor's noncompliant practice was disclosed, under case law 
[Footnote 46] the disclosure must be obvious to the government during 
actual contract negotiations. According to our interviews with the ACO 
and our review of the workpapers, the ACO was not aware of the FAR 
noncompliance for 5 years, and DCAA's audits conducted up to that point 
did not report the noncompliance. Therefore, in order to make a 
determination of defective pricing, the auditor would have had to 
review all contracts containing the FOB-origin clause and show that the 
defective pricing caused an increase in the contract prices. However, 
there was no evidence of such a review in the working papers. 
Consequently, the working papers do not support the opinion and the 
draft conclusions in the working papers were changed without adequate 
documentation. However, because the branch manager and supervisory 
auditor predetermined that defective pricing did not exist, they chose 
not to pursue a review of contracts with an FOB-origin clause. In 
addition, to document this unsupported determination, the auditor, 
under the branch manager's and second supervisor's direction, changed 
the draft conclusions in the working papers. 

Without DCAA audit support for defective pricing, the contracting 
officer instead pursued a CAS 405 noncompliance for improper recording 
of FOB-origin costs in the material overhead pool. DCAA policy[Footnote 
47] supports pursuing defective pricing issues under CAS when 
applicable because CAS provide for greater recovery by the government. 
For example, CAS allow for consistent recovery across all contracts 
while defective pricing is pursued under specific individual contracts. 
After considerable communication between DCMA, DCAA, and the 
contractor, in July 2007, DCMA sent Contractor B a letter offering to 
settle with the three Southern California divisions for $71,000, and 
the contractor subsequently refunded the government that amount. DCAA 
officials advised us that they will notify cognizant DCAA offices of 
other contractor segments for follow-up on this issue. 

In addition to our investigation of the allegations surrounding this 
defective pricing audit, DCIS pursued a criminal investigation of 
potential defective pricing by the same contractor. This defective 
pricing issue related to the contractor negotiating a firm, fixed-price 
contract with the intent to manufacture F-18 parts. Instead, another 
DCAA auditor found that the contractor had purchased the parts from a 
vendor at a lesser cost and did not remit the savings to the 
government. When faced with legal action on this defective pricing 
allegation, the contractor agreed to settle with the government. At the 
time we issued this report, a settlement agreement was under 
negotiation. 

Case 4: 2005 Billing System Audit of Contractor C: 

We investigated allegations that the working papers for this audit do 
not support the opinion because a DCAA supervisory auditor (1) removed 
some draft findings from the report without adequate support and (2) 
evidence of deficiencies documented in the working papers was not 
reported. The objective of a billing system audit is to evaluate the 
contractor's adequacy of and compliance with billing system internal 
controls. Those controls should provide reasonable assurance that 
billings applicable to government contracts are prepared in accordance 
with applicable laws, regulations, and contract terms, and that 
material misstatements are prevented, or detected and corrected, in a 
timely manner.[Footnote 48] Contractor C produces and supports military 
display systems, global positioning systems (GPS), and satellite 
communications systems. DCAA reported that for calendar year 2004, 
Contractor C generated sales of over $99 million, including $92 million 
from DOD contracts. 

Details of the Audit (Case 4): 

The first auditor on this engagement completed her working papers, 
summary of audit findings and results, and draft audit report on June 
23, 2005. The draft report included six significant system deficiencies 
and an "inadequate" opinion on the contractor's billing system 
controls. For example, the auditor identified about $3.5 million in 
potential overbillings for unallowable costs. The auditor wrote an 
explanatory note that these billings were for subcontract claims that 
the contractor had not paid within 90 days, and that the contractor 
admitted to including these charges in its billings to the government 
even though the contractor had never actually paid the subcontractors 
who performed the work. FAR precludes including such costs in billings 
to the government.[Footnote 49] However, the auditor did not include 
sufficient working paper support to show that the $3.5 million that the 
contractor owed its subcontractor was over 90 days delinquent or that 
it had been included in billings to the government. In addition, the 
auditor identified about $246,000 in billings in excess of contract 
ceilings or funding limits. Although the contractor eventually 
reimbursed the government for this amount, the auditor noted that a 
lack of policies and procedures in this area could constitute a 
significant deficiency. Contractors are required to have policies and 
procedures to detect and correct overbillings.[Footnote 50] After 
submitting her workpapers for review, in July 2005, the first auditor 
was transferred to a DCAA office in Europe. According to the original 
acting supervisor, because he was too busy to review the working 
papers, the audit was transferred to a different supervisory auditor on 
July 26, 2005. Workpaper documentation showed that several days later, 
the new supervisory auditor[Footnote 51] reviewed and approved the 
working papers that supported four of the six significant deficiencies 
identified by the auditor, including the $3.5 million and $246,000 
overbillings.[Footnote 52] The new supervisory auditor then requested 
that a second auditor review the first auditor's findings. 

In August and September 2005, the second auditor, with review and 
approval by the supervisory auditor, changed several working papers and 
removed the original six significant system deficiencies from the draft 
report. In the interim, on August 22, 2005, the supervisory auditor 
signed off on a draft report with an "inadequate in part" opinion and 
three significant deficiencies: (1) failure to monitor and adjust 
indirect billing rates, (2) billing of $246,000 in excess of contract 
cost ceilings, and (3) inadequate policies and procedures to ensure 
that billings comply with applicable regulations and contract 
provisions. Under DCAA policy, a branch manager was required to sign an 
audit report with significant deficiencies. Although we could not find 
any documentation of the branch manager's review of this draft report 
or of a branch manager decision regarding the final audit opinion, the 
draft opinion was changed. On September 15, 2005, the supervisory 
auditor signed and issued the final report with all deficiencies 
removed and an "adequate" opinion. We found no documented reason for 
the supervisory auditor's reversal of her decision on the "inadequate 
in part" opinion that she had approved earlier. 

Results of Investigation (Case 4): 

Our investigation substantiated the allegations. We determined that 
this audit did not comply with GAGAS[Footnote 53] because the working 
papers did not support an "adequate" opinion and the draft conclusions 
in the working papers were changed without adequate support. Moreover, 
four of the six significant deficiencies were adequately supported in 
the working papers but were not reported. For example, according to the 
supervisory auditor on this audit, the finding of $246,000 in 
overbillings due to exceeding contract limits was dropped because it 
was "insignificant" and because the contractor had identified and 
repaid the amount. However, the working papers show that at least two 
of the overbillings were identified by the government, not the 
contractor. In addition, the original working papers and the results of 
a prior audit explained that the billing personnel did not have correct 
information on contract terms, including cost ceilings, indicating a 
systemic internal control weakness. This was not addressed in the 
revised working papers or the final audit report. For the other two of 
the six findings, neither the original auditor's nor the final working 
papers supported a determination of whether a finding existed. For 
example, regarding the $3.5 million overbilling reported by the first 
auditor, neither the first auditor nor the second auditor performed 
sufficient work to determine whether the contractor adhered to FAR 
requirements to only bill subcontract costs that the contractor had 
paid in a timely manner. The first auditor documented this potential 
finding in March 2005. Despite the magnitude of this finding, however, 
no one reviewed the first auditor's support until late the following 
July, although this supervisor was aware of the auditor's findings. By 
the time the supervisor's review took place, the first auditor was 
working in Europe. Neither the second supervisor nor the second auditor 
asked the first auditor for support of her finding. Instead, the 
finding was dropped without working paper support. 

In its January 2007 memorandum, the DOD IG concluded that the working 
papers for this audit supported, at best, an "inadequate in part" 
opinion and that reliance on data and information generated by these 
systems puts users and decision makers at risk. Therefore, the DOD IG 
recommended that DCAA rescind this audit report, gather and evaluate 
additional evidence, determine the appropriate conclusion, and reissue 
the report. DCAA stood by its findings and did not rescind the report. 
According to the DOD IG memorandum, the unsupported "adequate" opinion 
on this report may have resulted in narrowed audit scopes for other 
concurrent audits. Moreover, on the basis of the "adequate" audit 
opinion on its billing system controls, DCAA authorized Contractor C to 
bill the government directly--without review of its invoices prior to 
payment--for the first time. Officials at the DCAA Western Region told 
us that as a nonmajor contractor, Contractor C was not required to 
undergo a billing system audit. We acknowledge this point. However, 
because the branch office performed an audit and issued a report with 
an "adequate" opinion on the contractor's billing system, it must have 
adequate support for that opinion per GAGAS. In this case, the 
workpapers did not support an adequate opinion. On September 16, 2005, 
the day after the audit report was issued with an adequate opinion, 
Contractor C was approved for direct billing. However, based on work 
paper evidence of significant deficiencies, the contractor should not 
have been eligible for direct-billing privileges. 

In response to our investigation, the DCAA Western Region Deputy 
Director stated that both auditors had used the wrong contractor report 
for their test work. On May 22, 2008, DCAA rescinded the audit report 
and notified the ACO that the report could no longer be relied upon for 
any matters relating to the contractor. However, DCAA did not revoke 
Contractor C's direct-billing privileges, stating that subsequent paid- 
voucher audits did not identify billing problems. In addition, the 
Deputy Director advised us that as a result of our findings on 
inadequate supervisory review, the region established a policy to 
require supervisory auditors to review audit sampling plans at the time 
they approve the audit risk assessment. 

Case 5: 2005 Estimating System Audit of Contractor C: 

We investigated allegations that the working papers for this audit do 
not support the opinion because a DCAA supervisory auditor removed 
audit findings from the draft report. As an estimating system audit, 
this audit was intended to determine whether the contractor's method of 
estimating costs for contract proposals was adequate. As discussed 
above, Contractor C produces and supports military display systems, 
global positioning systems (GPS), and satellite communications systems. 
DCAA reported that for calendar year 2004, Contractor C generated sales 
of over $99 million, including $92 million from DOD contracts. 

Details of the Audit (Case 5): 

On August 9, 2005, the auditor tested six contract proposals from 
Contractor C. He found errors on two of the six proposals related to 
FAR noncompliance.[Footnote 54] For these two proposals, the auditor 
documented that cost analyses were not performed before contract 
negotiation, BOEs were not signed by a reviewer, and there was no 
consolidated bill of materials. These were noted as three separate 
significant deficiencies. The auditor also performed additional testing 
on the BOEs and found that Contractor C did not provide its estimating 
methodology when submitting its BOEs. Moreover, for four of the six 
proposals the auditor reviewed, he documented that he was unable to 
determine what methodology Contractor C used to estimate labor hours. 
This was noted as a fourth significant deficiency. Finally, the auditor 
documented a "lack of use of historical experience" in the estimating 
process, noting that he could not find any instance in which the 
contractor used historical incurred-cost records to develop estimates. 
He also noted that engineers did not have access to historical cost 
data when determining their estimates of engineering hours. This was 
originally listed as a fifth significant deficiency. The auditor 
concluded that Contractor C's estimating system had five significant 
deficiencies and was "inadequate in part." The deficiencies were 
reported in the following order: (1) failure to perform cost analyses 
on subcontracts greater than $550,000 prior to award of the prime 
contract, (2) lack of an estimating methodology; (3) lack of additional 
review of estimated engineering hours, (4) lack of the use of 
historical experience, and (5) failure to provide a consolidated bill 
of material. 

The draft report and working papers were forwarded to the supervisory 
auditor (the same person as the replacement supervisor in Case 3) for 
review throughout August and September 2005. Upon her initial review, 
the supervisory auditor approved the "inadequate in part" opinion and 
four of the five deficiencies, deleting the finding of a lack of an 
estimating system methodology. Then on September 23, 2005, she 
submitted the working papers to the branch manager for review. The 
branch manager told us that "after taking one look at the working 
papers" she felt the supervisory auditor needed to review the auditor's 
support for the audit findings. 

Following the branch manager's review, the supervisory auditor reviewed 
the working papers again. During her final review, the supervisory 
auditor revised several working papers and signed one revised working 
paper herself as the preparer and reviewer, a noncompliance with GAGAS. 
[Footnote 55] Regarding significant deficiencies one, three, and five, 
the supervisor noted that they were suggestions for improvement rather 
than significant deficiencies, and edited the auditor's summary of test 
results to conclude that the findings "do not appear to be systemic 
problems as they were limited occurrences in our sample." Although 
audit work was based on a small judgmental sample, the supervisory 
auditor did not explain why she considered deficiencies in three of six 
sample items to be insignificant or why she summarily concluded that 
there was no systemic problem without additional test work to determine 
the extent of the deficiencies. In our judgment, to determine whether 
the errors were systemic, the supervisory auditor should have 
instructed the auditor to expand his testing and perform additional 
work. The supervisory auditor deleted the second and fourth 
deficiencies entirely. Regarding the second deficiency, the supervisory 
auditor wrote a comment that the contractor told her that although the 
estimating methodology details were not in the BOEs, they were 
documented with the contractor's supporting documentation. However, the 
supervisory auditor did not review or request that the auditor review 
this additional documentation to test the contractor's assertion. This 
should have been done in order to verify the contractor's statements. 
The supervisor did not initially document why she deleted the fourth 
deficiency. However, in a Memorandum for the Record dated May 21, 2007, 
the supervisor stated that the auditor was "probably not qualified to 
judge" the basis for using historical engineering hours, and that the 
auditor's working papers were not sufficient to support this finding. 
If the supervisor was correct about the auditor's qualifications to do 
this work, she should have increased her supervisory guidance or 
requested assistance from a technical expert.[Footnote 56] However, our 
investigation determined that the auditor was an experienced senior 
contract auditor who was subsequently detailed to DCAA location 3 to 
help provide needed experience to assist that resident office with its 
forward pricing proposal audits. Further, there was no evidence in the 
working papers that a technical expert who would be qualified to judge 
the basis for using historical engineering hours was consulted on this 
audit. The supervisor's rationale for dropping the fourth finding is 
not supported by factual evidence. 

On September 23, 2006, the supervisory auditor held an exit conference 
with Contractor C's pricing manager without the auditor's presence. A 
record of the meeting shows that the supervisory auditor told the 
pricing manager that the final report would include several suggestions 
for improvement. On September 25, 2005, the supervisory auditor 
transmitted suggestions for improvement via e-mail to the pricing 
manager. After receiving the suggestions for improvement, on September 
29, 2005, the pricing manager told DCAA he had to take care of a family 
emergency and requested that DCAA wait for his response. However, DCAA 
issued the report with the suggestions for improvement before the 
pricing manager returned. 

According to the auditor, his supervisor told him that the branch 
manager did not agree with the first and fifth deficiencies (lack of 
timely cost analysis and lack of bill of material), but that the branch 
manager did agree with the fourth deficiency (failure to use historical 
experience) and that the opinion would remain "inadequate in part." On 
September 29, 2005, the auditor documented his disagreement with the 
decision on the first and fifth deficiencies in the working papers. 

On September 30, 2005, DCAA issued its estimating system audit report 
with an "adequate" opinion and suggestions for improvement related to 
three of the five significant deficiencies the auditor identified 
originally (late cost analysis on subcontracts, lack of review of 
engineering hours, and failure to consistently provide consolidated 
bills of material). The auditor told us that he was surprised by the 
final opinion. He told us that the fourth deficiency (failure to use 
historical experience) represented, in his view, the greatest risk to 
the government of all his findings. In particular, DFARS[Footnote 57] 
specifies that the failure to ensure that historical data is available 
to, and utilized by, cost estimators where appropriate is an indicator 
of a potentially significant estimating system deficiency. 

Results of Investigation (Case 5): 

Our investigation substantiated the allegations. We determined that 
this audit did not comply with GAGAS because the working papers did not 
support the "adequate" opinion that was issued on the last day of 
fiscal year 2005, and the draft conclusions in the working papers were 
changed without adequate documentation. Further, some of the original 
auditor's findings were not adequately supported in the working papers, 
but the supervisory auditor dropped the findings or concluded that they 
were insignificant without appropriate support for her position in the 
working papers. In its January 2007 memorandum, the DOD IG recommended 
that DCAA rescind this audit report, gather and evaluate additional 
evidence, determine the appropriate conclusion, and reissue the report. 
DCAA stood by its findings and did not rescind the report. In addition, 
on May 21, 2007, the supervisory auditor prepared a Memorandum for the 
Record documenting her conclusions on the first, fourth, and fifth 
deficiencies, but not the second and third deficiencies. In this 
memorandum, the supervisor included supporting documentation that was 
not considered at the time the audit was performed and reviewed, and 
the supervisor made several statements that contradicted her judgments 
as documented during the performance and review of the audit. 

DCAA Western Region officials told us that the findings related to 
Contractor C not performing cost analysis on subcontracts greater than 
$550,000 were justifiably dropped because subsequent analysis showed 
that this requirement was met. Western Region officials also stated 
that Contractor C used parametric estimating techniques to determine 
the number and type of spare parts and, therefore, would not be 
required to have a bill of materials. However, FAR does not preclude 
use of a bill of materials when parametric estimating is used. Further, 
historical experience on repairs could serve as a basis for a bill of 
materials. Although the officials stated that they believe the reported 
opinion is correct, they did not validate Contractor C's estimating 
methodology or address Contractor C's failure to use historical 
experience, which is a significant estimating deficiency. As a result, 
the change to an "adequate" opinion was not supported. On June 27, 
2008, a DCAA Western Region official informed us that after further 
review, DCAA had rescinded this report and notified the ACO that the 
report could no longer be relied upon for any matters relating to the 
contractor. 

Case 6: 2005 Accounting System Audit of Contractor D: 

This audit was requested by a Department of Energy ACO. We investigated 
allegations that the working papers for this audit do not support the 
opinion because (1) sufficient work was not performed to support the 
audit opinion and (2) a DCAA supervisory auditor[Footnote 58] removed 
audit findings from the draft report without adequate support. 
According to the allegation, the working papers support an "inadequate 
in part" opinion on Contractor D's accounting system and related 
controls. Contractor D is a publicly traded engineering, construction, 
maintenance, and project management company. Contractor D has provided 
temporary housing to victims of Hurricane Katrina and performed work in 
Iraq and Afghanistan. For calendar year 2006, Contractor D reported 
over $14 billion in revenue, including $2.9 billion in revenue from 
government business. 

Details of the Audit (Case 6): 

While performing this work, the auditor (the same auditor as in Case 3) 
identified costs that were misallocated among the contractor's directly 
allocated corporate expense pools. The auditor reviewed $203,263 in 
transactions from the contractor's population of about $11 million in 
directly allocated expense pools. The auditor found that $47,955 (i.e., 
about 24 percent) of the reviewed costs were corporate-level direct 
charges that were miscoded and should have been passed directly to 
federal government business units, but were instead charged to the 
contractor's federal services segment, which serves as an 
administrative office for the federal government business units. In 
this situation, the federal services segment costs would be inflated. 
The auditor also noted that the federal services segment was adding on 
a general and administrative (G&A) overhead expense as the direct costs 
were passed through it. The inflated federal services segment costs, 
combined with the added G&A expenses, would serve to inflate costs to 
the government overall. The auditor identified a 100 percent error rate 
for miscoding in two of the pools and high error rates in two other 
pools. Even though the auditor identified no errors in certain material 
cost pools, the testing performed was very limited. For example, the 
information technology pool contained $2,772,630 in allocated costs, 
but the auditor only reviewed $81 in costs allocated to this pool and 
did not find any errors. The auditor said that she asked the 
supervisory auditor to allow her to perform further transaction 
testing, but her request was denied. No further testing is documented 
in the working papers. 

On September 4, 2005, the auditor submitted her working papers and 
draft report to the supervisory auditor. The draft report concluded 
that the contractor's accounting system was "inadequate in part." 
Working papers indicate that the supervisory auditor initially 
concurred with the auditor's opinion. However, when the supervisory 
auditor discussed the findings with the branch manager at this 
location, the branch manager stated that she did not understand how the 
findings constituted an "inadequate in part" opinion and suggested that 
the issue be referred to a different DCAA office. The supervisory 
auditor subsequently agreed with the branch manager. At a September 26, 
2005, meeting, the branch manager and supervisory auditor questioned 
the auditor about whether the miscoded costs were material and 
recommended that the issue be referred to a different DCAA office with 
audit responsibility for Contractor D's federal services business 
segments. The auditor disagreed with the supervisory auditor and branch 
manager. In accordance with DCAA policy, the auditor documented her 
disagreement in the working papers. The supervisory auditor also 
documented her disagreement with the auditor. 

On September 28, 2005, the supervisory auditor revised the auditor's 
summary working papers to state that the contractor's accounting system 
was "adequate" and to cite one suggestion for improvement. The 
supervisory auditor signed these working papers as both the preparer 
and reviewer. To justify the position that the miscoded costs were not 
material, the supervisory auditor told us that the $47,955 in miscoded 
costs was immaterial in relation to the contractor's approximately 
$1.05 billion in total G&A overhead costs. The supervisory auditor also 
told us that testing of transactions in the two pools containing the 
majority of directly allocated costs--the real estate pool and the 
information technology pool--had not found any errors. The report was 
issued on September 29, 2005, with an "adequate" opinion and one 
suggestion for improvement. The report included as a suggestion for 
improvement that relevant Contractor D employees receive additional 
training on the allocation of corporate direct costs to the benefiting 
segments. The branch manager also told us that her office had referred 
the miscoding errors to the DCAA office responsible for auditing 
Contractor D's federal services segment. 

Results of Investigation (Case 6): 

Our investigation substantiated the allegations. We determined that the 
audit did not comply with GAGAS[Footnote 59] because the working papers 
did not contain sufficient audit evidence to support an "adequate" 
opinion and the draft conclusions in the working papers were changed 
without adequate supporting documentation. Our investigation found that 
the supervisory auditor made an incorrect determination that the nearly 
$48,000 in miscoded costs did not provide evidence of a material 
weakness. In fact, it represented a significant percentage (24 percent) 
of the costs that were tested. However, because additional testing was 
not performed, the full extent of misallocated costs is unknown. Test 
work in the real estate and information technology cost pools was also 
too limited to conclude that miscoding errors did not exist in those 
pools. Further, the supervisor's comparison of the misallocated direct 
expenses to the G&A cost base, representing indirect costs, is not 
relevant. Moreover, the working papers that summarized the final audit 
findings and conclusion were prepared and reviewed by the supervisory 
auditor. In order to comply with GAGAS,[Footnote 60] evidence of 
supervisory review--for example, by the branch manager--should have 
been documented in the working paper files. 

Further, the referral of the corporate-level misallocations to the 
branch office responsible for Contractor D's federal services segments 
was not appropriate and did not address the underlying concerns with 
the corporate accounting system. DCAA Western Region officials told us 
that the other DCAA branch office had audited corporate costs during 
its most recent incurred cost audits of Contractor D's federal services 
segment, and provided us with the related audit reports, in which that 
branch office questioned 100 percent of one of the corporate cost pools 
(legal expenses). However, the branch manager at the other DCAA office 
told us that his office only audited the federal services segments' 
portion of the corporate costs, not the entire pools, and that his 
office does not review corporate cost allocations. DCAA agreed that the 
working papers do not adequately document the issues associated with 
the "miscoded" costs. DCAA advised us that a separate assignment has 
been established to test the contractor's internal controls related to 
the proper coding of corporate costs. 

Our review of the audit workpapers and interviews with the supervisory 
auditor identified two qui tam[Footnote 61] cases involving allegations 
that Contractor D had improperly charged government business segments 
for corporate G&A overhead and various unallowed costs. Based on this 
history of overcharging corporate overhead to the government, we would 
have expected the auditors to assess risk as high and increase testing. 
The first qui tam case, filed in December 1997, alleged that 
unallocable indirect costs incurred by a Contractor D division for 1995 
through 1997 were charged to government contracts in violation of 
applicable FAR and CAS requirements and the False Claims Act. 
Contractor D denied the allegations, but agreed to settle the case for 
$8.2 million. The second qui tam case filed in March 2000 involved 
similar allegations, specifically, that Contractor D knowingly 
misrepresented costs of an accounting system conversion and improperly 
allocated a disproportionate share of general and administrative costs, 
capital facilities interest rate, executive and management bonuses, 
computer network costs, and certain unallowable cost, including 
lobbying, international sales, and luxury items, to government 
contracts. This case was settled in October 2005 for $12.4 million. 

Case 7: 2005 CAS 403 Compliance Audit of Contractor D: 

We investigated allegations that the working papers for this audit do 
not support the opinion because a DCAA supervisory auditor removed 
audit findings from the draft report and asked another auditor to write 
a "clean (adequate) opinion" report. The purpose of the audit was to 
determine whether Contractor D's corporate office was in compliance 
with CAS 403 requirements regarding allocation of home-office expenses 
from January 1, 2004, through September 15, 2005. Contractor D is a 
publicly traded engineering, construction, maintenance, and project 
management company. Contractor D has provided temporary housing to 
victims of Hurricane Katrina and performed work in Iraq and 
Afghanistan. For calendar year 2006, Contractor D reported over $14 
billion in revenue, including $2.9 billion in revenue from government 
business. 

Details of the Audit (Case 7): 

This audit also was requested by the Department of Energy ACO. From 
June 28, 2005, through approximately September 15, 2005, the same 
auditor as in Case 6 performed this audit under the supervision of the 
same supervisory auditor from Case 6. According to the audit working 
papers, the auditor originally identified six potential instances of 
noncompliance with CAS 403. On the basis of our review of the working 
papers and our discussions with the auditor, we determined that two 
findings were substantially the same as others and did not warrant 
presentation as separate findings. The four key findings related to (1) 
allocation of Group Executive--Government Services costs, (2) 
misallocated corporate expenses, (3) add-on of G&A pass-through 
expenses after directly allocating costs,[Footnote 62] and (4) 
allocation basis for liability insurance. The auditor was assigned to 
another team before she could complete the audit and transferred the 
working papers to the supervisory auditor on October 3, 2005, for her 
review. The supervisory auditor subsequently reviewed the working 
papers and partially documented her disagreement with the auditor's 
work, but no additional audit work was performed. 

* The auditor documented that the contractor incorrectly used the three-
factor formula to allocate Group Executive--Government Services costs 
home-office expenses. The auditor concluded that this was a 
noncompliance with CAS 403,[Footnote 63] because such costs are 
homogeneous costs, which are required to be allocated using a causal or 
beneficial relationship instead of using a three-factor formula. The 
supervisory auditor disagreed and eliminated this finding. 

* The auditor believed that Contractor D was not in compliance with CAS 
403[Footnote 64] because it improperly allocated corporate charges that 
benefited other nongovernment business units to its federal services 
segment. According to the working papers, the DCAA branch office 
provided an audit lead on this issue via e-mail to a different DCAA 
office with responsibility for auditing this contractor's federal 
services segment costs on September 6, 2005, for follow-up. The 
supervisory auditor used this referral as justification for eliminating 
the finding from the final report, stating in the working papers that 
it was not within the scope of the audit to pursue the potentially 
misallocated expenses. This was similar to the referral of two findings 
in Case 6. 

* The auditor believed that corporate project costs related to certain 
government business units had been inflated, in noncompliance with CAS 
403.[Footnote 65] The auditor explained in her working papers that 
Contractor D passed these costs through its federal services home 
office, which improperly added G&A expenses. The supervisory auditor 
disagreed and eliminated this finding. The supervisory auditor also 
referred this finding to the other DCAA office noted in Case 6 to 
determine the cost impact, if any. 

* The auditor believed that the contractor's use of a total labor 
dollar base to allocate General Liability and Excess/Umbrella Liability 
Insurance did not comply with CAS 403,[Footnote 66] because the 
allocation base should have been based on both payroll and revenue 
dollars. The supervisory auditor disagreed and eliminated this finding 
without documenting the reason for doing so. 

In addition to providing inadequate documentation to justify the 
elimination of the draft audit findings, the supervisory auditor did 
not provide documentation in the workpapers to show that she discussed 
her disagreement on these findings with the auditor as required by the 
CAM.[Footnote 67] Instead, nearly 3 months after the auditor submitted 
the working papers for review, on December 30, 2005, the supervisory 
auditor asked another auditor to write a "clean opinion" report for 
this audit using "boilerplate" (i.e., standardized) language. The 
second auditor was the same individual as the acting supervisor in Case 
4. According to the second auditor, the supervisory auditor asked him 
to use boilerplate language because she sought to issue the report the 
same day. The second auditor told us that he did not review the audit 
working papers because he had "too much work" on the day the 
supervisory auditor wanted to issue the report. The final report was 
issued on December 30, 2005, and stated that the contractor complied 
with CAS 403 in all material respects. The original auditor told us 
that she did not learn the report had been issued until she was 
contacted by a Department of Energy procurement official in February 
2006. The procurement official was aware of the original preliminary 
findings of noncompliance and wondered why they had been removed from 
the final report. 

Results of Investigation (Case 7): 

Our investigation substantiated the allegations. We confirmed that 
another auditor wrote the "clean" opinion report without looking at the 
supporting working papers. We also determined that this report did not 
comply with GAGAS[Footnote 68] because the working papers did not 
support the reported adequate opinion that Contractor D was in 
compliance with CAS 403, and the draft conclusions in the working 
papers were changed by the supervisory auditor without adequate audit 
evidence. We concluded that the supervisory auditor was correct in 
eliminating the first finding related to the contractor's use of the 
three-factor formula for allocating corporate expenses to the federal 
services group and the fourth finding related to the allocation base 
for liability insurance cost. However, despite the claims of the 
supervisory auditor, we determined that referring the potential 
deficiencies related to misallocated costs (findings two and three) to 
a different DCAA office was not appropriate. These findings indicated 
corporate-level CAS 403 noncompliances related to misallocations of 
home-office expenses. The branch manager of the FAO to which these 
issues were referred told us that his office does not audit corporate 
costs of this contractor. Therefore, the corporate-level CAS 403 
noncompliance issues were not fully audited by either office. Moreover, 
by asking an auditor who was unfamiliar with the work to write a "clean 
opinion" in 1 day using boilerplate language and without reviewing the 
working papers or obtaining additional audit support, the supervisory 
auditor deviated significantly from GAGAS requirements for performing 
sufficient testing and obtaining sufficient audit evidence to express 
an opinion and support conclusions.[Footnote 69] The supervisory 
auditor later explained her reasons for disagreement with the original 
auditor's findings more fully in a May 21, 2007, Memorandum for the 
Record. The explanation in the memorandum was similar to the 
explanation given by the DCAA Western Region on July 27, 2007, in its 
response to the DOD IG findings. The supervisory auditor's memorandum 
presented the rationale noted above for transferring corporate cost 
allocation issues to another FAO that we determined does not review 
corporate cost allocations, and it contained several errors and 
miscalculations related to the basis for allocating liability insurance 
costs. 

While conducting our investigation, we learned that DCAA contradicted 
its 2005 "clean opinion" of Contractor D's compliance with CAS 403 in a 
report issued on September 21, 2007. This report expressed the opinion 
that Contractor D was, in fact, not in compliance with CAS 403 from 
January 1, 2004, through December 31, 2004, part of the time period 
covered by the "clean" opinion reported in 2005. The basis for 
noncompliance identified in the 2007 report was not mentioned in the 
2005 audit working papers. The noncompliance related to an "uplift" in 
costs for doing work in the Iraq war zone, which affected Contractor 
D's labor allocation base. DCAA Western Region officials stated that at 
the time the 2005 audit was being performed, Iraq work was "ballooning" 
at DCAA, but DCAA often did not have much information available on 
increased costs associated with this work. In addition, during 2005, 
Contractor D was in the process of settling a qui tam suit related to 
misallocations of costs, including CAS 403 noncompliance. The 
contractor had also settled a similar qui tam suit in 2001. Until the 
second qui tam suit was settled, Contractor D was under a "suspension 
of administrative process" under which its incurred cost claims could 
not be audited. However, the FAO did not include a cautionary note in 
the audit report that other information could become available when 
ongoing issues are resolved that could affect the audit opinion, and 
the report did not include a discussion of a scope limitation related 
to insufficient documentation on war-related costs. 

In response to our corrective action briefing, DCAA agreed that the 
working papers do not fully explain the supervisor's rationale for 
eliminating some of the auditor's draft findings. However, DCAA 
disagreed with our position that two findings should not have been 
referred to the other DCAA office. DCAA also disagreed that the audit 
report should have included a scope limitation for the lack of incurred 
cost proposals and the ongoing qui tam investigation. However, DCAA 
stated that during discussions with us and the DOD IG during the past 
several months a number of questions were raised regarding the 
accounting methodology at both the corporate office and the federal 
services group regarding corporate cost allocations. As a result, DCAA 
said it has expanded the scope of the 2008 CAS 403 compliance audit to 
thoroughly address these questions. 

Case 8: 2004-2006 Forward Pricing Audits of Contractor E: 

We investigated allegations of problems with the audit environment at 
this resident office--location 3. Specifically, we received allegations 
that this resident office was issuing audit reports before work was 
completed. In addition, the two forward pricing audit supervisors at 
location 3 told us that inexperienced trainees were being assigned to 
complex forward pricing (proposal) audits without proper supervision, 
and one supervisor noted problems that resulted in losing control over 
the audit workpapers. Although these audits were not part of our 
original investigation, a DCAA employee came forward while we were 
conducting our work and alerted us to this issue. We investigated the 
complaints by interviewing the two supervisory auditors, both of whom 
retired from DCAA in early 2007, who had supervised 62 forward pricing 
audits at this location from fiscal year 2004 through 2006. We also 
reviewed documentation relevant to the case. The forward pricing audits 
in question were related to Contractor E, a publicly traded company 
that designs government business and defense weapons systems. For 
calendar year 2006, the contractor reported that the division under 
which this California office is grouped generated about $5.28 billion 
in revenue from government sales. Contractor E is one of the five 
largest DOD defense contractors in terms of contract dollars. 

Details of the Audit (Case 8): 

During fiscal years 2004 through 2006, the DCAA resident office and its 
suboffices issued 113 reports on forward pricing audits[Footnote 70] 
related to Contractor E. Of the 113 forward pricing audits, 62 audits 
were led by the two supervisory auditors assigned to the resident 
office location. Forward pricing audits are important because they 
affect how much the government pays for goods and services. They are 
complex engagements, requiring the auditor to have years of contract 
auditing experience and a proficient understanding of CAS, FAR 
requirements for cost and price analysis, unallowable costs, and 
details of the contractor's industry. For example, the auditor must 
know the types of materials at risk of overcharges and how to look at 
related sources of information for cost comparisons. 

Newly hired trainee auditors are required to take extensive in-house 
DCAA training. Within the first 2 months of being hired, trainees spend 
2 weeks at DCAA's Defense Contract Audit Institute in Memphis, 
Tennessee,[Footnote 71] where they receive mandatory new-hire technical 
indoctrination training. This training covers topics such as ethics, 
contract auditing procedures, and unallowable costs under FAR Part 31. 
Six months after the indoctrination training, new hires may begin 
taking other courses, such as intermediate contract auditing. In 
addition, trainees take online computer managed training library 
courses. DCAA's practice is to use senior auditors as advisors or 
mentors to trainees and to assign trainees to work with journey-level 
auditors (generally grade GS-12) who are to assist supervisors with on- 
the-job training and development of new hires. On-the-job training 
plays a large role in trainee development. 

As a part of their initial training, new hires are also instructed on 
the purpose and use of DCAA's Audit Planning and Performance System 
(APPS). APPS operates as a stand-alone system at each FAO and is used 
to store workpapers for ongoing audits. Workpapers are exported as 
auditors need to work on them and then imported so that supervisors can 
export them for review. When audits are completed, DCAA policy requires 
the workpapers to be archived in the Integrated Recorded Information 
Management System within 10 days. 

Results of Investigation (Case 8): 

Our investigation substantiated the allegations. DCAA partially agreed 
with our findings, as noted in the following discussion. 

* Workpaper review. The two supervisors, who approved and signed 62 of 
the 113 forward pricing reports issued by this resident office during 
fiscal years 2004 through 2006, admitted that they generally did not 
review workpapers in final form until after reports were issued. 
According to GAGAS, working papers should contain evidence of 
supervisory review prior to report issuance.[Footnote 72] The DCAA 
Western Region Quality Assurance Manager told us that errors had been 
identified on some of these reports after they were issued. DCAA agreed 
that the two supervisors did not always properly review the working 
papers prior to report issuance. When the new FAO manager became aware 
of this practice, she counseled one supervisor to discontinue this 
practice immediately (although he retired 3 days later). The FAO 
manager followed up with an e-mail to the entire staff that this 
practice was not acceptable. The second supervisor has since retired. 

* Assignment of trainees to complex audits without adequate expertise. 
Trainee auditors were assigned to complex forward pricing audits as one 
of their first assignments because management believed that information 
on labor and overhead rates was available and that these audits were 
straightforward. However, one former supervisory auditor pointed out 
that the trainees had no institutional knowledge about the types of 
materials at risk of overcharges, how to look at related sources of 
information for cost comparisons, or how to complete the analysis of 
complex cost data required by FAR.[Footnote 73] The two former 
supervisors told us that trainee auditors assigned to them had only 
worked for DCAA for a few months and that they lacked the experience 
needed to perform these audits. For example, the trainees were not 
capable of discerning whether (1) materials identified in proposals 
were appropriate for the product being developed, (2) contractor 
personnel assigned to projects had the right skills to perform the 
required work, and (3) estimates submitted met relevant FAR 
requirements. 

DCAA did not agree that auditor trainees were assigned to complex 
forward pricing audits without requisite skills. DCAA stated that 
during their first year, trainees have up to 300 training hours to 
apply directly to audits to ensure that they spend an adequate amount 
of time on audits. Based on our investigation, the 300 hours is on-the- 
job training hours that are allowed in addition to planned audit hours 
on particular assignments. This does not mean that trainees always 
receive on-the-job training. For example, trainees and supervisors that 
we interviewed during our investigation at locations 2 and 3 told us 
that DCAA classroom training is high level and does not provide 
insights or expertise needed to perform all the technical aspects of 
various contractor audits. To provide on-the-job guidance, location 2 
had provided increased supervision for trainees by assigning them to 
one supervisor with responsibility for trainees and also assigning a 
senior-level auditor to work with them on their audit assignments. One 
of the former supervisory auditors at location 3 told us that there is 
disconnect between DCAA training and what trainee auditors are required 
to do on the job. The former supervisor told us that at one point when 
she was acting supervisor at the resident office, she was "tasked with 
training seven new hires working on seven separate projects and this 
was not possible." The other former supervisor told us "the lack of 
experience of these auditors and the pressure to complete the proposal 
audits in limited time was ridiculous." 

DCAA also stated that trainee auditors worked on 18 of the 62 
assignments, and that several of these assignments were not complex 
based on audit scope and dollar amount. However, the summary-level 
documentation that DCAA provided was incomplete, and we have not seen 
or reviewed the underlying supporting documentation. Further, while we 
recognize that some types of audits, such as forward pricing rate 
agreements, pose less risk than other audits, we do not agree with DCAA 
that as a general matter cost-type audits are not inherently less risky 
because, unlike a fixed-price contract where the government has agreed 
to pay an established amount, the government agrees to pay all 
reasonable and allocable costs the contractor incurs during contract 
performance. 

* Lack of proper supervision and review of work. Our investigation 
determined that supervisors did not always have the benefit of 
experienced journey-level auditors to assist them in supervising the 
trainees. As a result, supervisors were overwhelmed by their dual 
responsibility for supervising numerous trainees and completing forward 
pricing audits within 20 to 30 days to meet time frames for contract 
negotiations. Further, supervisors did not always review audit work 
performed by senior auditors that they trusted. GAGAS state that 
assistants shall be properly supervised.[Footnote 74] 

* Lack of understanding of the electronic workpaper system. One former 
supervisor told us that newly hired auditors and administrative staff 
did not have an adequate understanding of DCAA's electronic workpaper 
filing systems. The former supervisor explained that APPS training on 
the automated workpaper system for trainee auditors sometimes would be 
delayed for 3 to 4 months in order to focus on getting the audits done. 
He said this lack of understanding contributed to the resident office 
losing control of audit documentation. For example, trainees would 
export audit workpaper sets to document their work and forget to import 
them or they would duplicate the files and then forget which version 
was updated. In this environment, workpapers did not always get 
imported and some were lost and had to be recreated later. 

With regard to late filing of audit documentation for completed audits, 
one former supervisory auditor told us that the resident office 
administrative employee responsible for archiving workpaper sets for 
completed audits did not always do so. The former supervisor also told 
us that during 2006, this resident office worked with the Western 
Region to reconcile completed audit workpaper sets to final, archived 
files for fiscal years 2004 through 2006. According to the former 
supervisor, there were about 20 to 30 audits going back to 2004 that 
were not closed out properly. He said that there was significant 
improvement during 2006, but there were still some problems. GAGAS 
state that auditors should collectively possess adequate professional 
competence for the tasks required and assistants shall be properly 
supervised, and that audit organizations need to adequately safeguard 
audit documentation associated with any engagement.[Footnote 75] 

DCAA disagreed with our conclusion that trainee auditors had an 
inadequate understanding of the electronic workpaper system. In 
addition, DCAA Western Region officials stated that they provided us 
with results of quarterly reconciliations for 2006 and 2007 that showed 
no more than seven assignments per quarter had not been filed timely. 
However, the period identified in the allegations covered fiscal years 
2004 through 2006. Documentation provided by DCAA Western Region 
officials showed that 6 of 520 total audits issued by the resident 
office had not yet been archived. The officials did not discuss or 
provide documentation for audits that were archived in fiscal years 
2004 and 2005. However, based on the limited number of assignments that 
had not been archived at the end of fiscal year 2006, we concluded that 
this problem had been addressed. 

* Pressure to complete audits in short time frames. Moreover, two 
former supervisory auditors told us that the volume of requests for the 
audits, short time frames demanded by customers for issuing reports to 
support contract negotiations (e.g., 20 to 30 days), and limited 
resources affected their ability to comply with GAGAS. Both former 
supervisors told us that the failure to issue forward pricing audit 
reports on time would have negatively affected their performance 
appraisals. They told us that they retired from DCAA in 2007 because 
they no longer wanted to face the risk associated with performing 
forward pricing audits in this environment. 

Productivity rate, or contract dollars audited per hour, is a leading 
metric DCAA uses to measure the efficiency of its audits. DCAA 
supervisory auditors at this location told us that pressure to meet 
this metric drives down the amount of time spent auditing, compromises 
audit quality, and increases the risk of financial harm to the 
government. Auditors said that they felt pressure to complete forward 
pricing audits because (1) contracting officers require short 
turnaround, generally 30 days, to meet contract negotiation time frames 
and (2) DCAA considers meeting customer requirements to be a top 
priority. The supervisory auditors said that this does not provide 
sufficient time for them to complete all the required audit steps. 
Moreover, one supervisor told us that contracting officers would 
sometimes tell auditors to issue proposal audit reports in as few as 20 
days with whatever information the auditor had at that time, and the 
contracting officers would then begin contract negotiations. The 
contracting officers would ask the auditors not to cite a scope 
limitation in the audit reports, as required by GAGAS,[Footnote 76] 
because they could not use such a report in contract negotiations. 
Yielding to contracting officer pressure to limit audit scope without 
proper disclosure is an impairment to auditor independence. As a 
result, the contracting officers could be negotiating contracts with 
insufficient information to support the associated rates. The problems 
at this location call into question the reliability of at least the 62 
forward pricing audits reports signed by the two supervisory auditors 
at this office from fiscal years 2004 through 2006, which were related 
to pricing proposals totaling over $6.4 billion. 

DCAA commented that its agencywide goal is to issue forward pricing 
audits in an average of 30 days in order to support the procuring 
community with timely audits. Further, DCAA stated that although the 
supervisors may have felt pressure to issue forward pricing audits in 
20 to 30 days, 5 of the 18 audits were issued in 30 or more days. DCAA 
officials stated that executive management continually stresses that 
management should provide auditors the appropriate time for completing 
the audit in accordance with GAGAS and the goal does not mean that all 
audits must be issued within 30 days. 

We also learned that in preparation for a DOD IG audit quality review 
at the resident office, the DCAA Western Region performed a quality 
review of selected audits performed by this resident office to assess 
its vulnerability and to take any needed corrective actions before the 
upcoming DOD IG review.[Footnote 77] The Western Region's quality 
assurance manager and the resident auditor told us that the quality 
review had found "a few" errors in issued forward pricing audit 
reports. Our review of the Western Region's quality assurance report 
showed that the Western Region reported 28 total systemic weaknesses in 
9 of 11 selected forward pricing audits performed by the resident 
office in fiscal year 2006. Identified systemic deficiencies included: 

* no documentation of supervisory review, or supervisory review 
comments were not addressed until after report issuance; 

* audit criteria not included in the audit documentation; 

* no draft report in the working papers, or draft reports not 
sufficiently cross-referenced to working papers; and: 

* no documentation of approved extensions for audit report issuance 
dates. 

The issues identified in the Western Region's quality review 
demonstrate noncompliance with several GAGAS standards, which state 
that assistants shall be properly supervised, suitable criteria must be 
available to users of the engagement, audit documentation should 
support the audit conclusions, and audit documentation should contain 
evidence of supervisory review before report issuance.[Footnote 78] 

DCAA does not agree that the quality review identified systemic 
deficiencies in forward pricing audits most of which relate to GAGAS 
noncompliance and stated that our conclusion overstates the results of 
the review. DCAA noted that the review disclosed that the overall 
compliance rate for forward pricing audits was 93 percent based on 
"yes" and "no" responses to over 1,000 questions. We disagree with 
DCAA's review methodology, which formed the basis for DCAA's 
conclusions. For example, because the design of questionnaires and 
tabulations of "yes" and "no" responses can bias the results, we 
analyzed the individual findings of systemic deficiencies that were 
documented in the DCAA quality review report. Our analysis showed that 
the review identified a total of 28 systemic deficiencies, including 
one or more systemic deficiencies on 9 of the 11 audits reviewed. Of 
the 28 systemic deficiencies, 23 related to the allegations we 
investigated. 

DCAA management noted that since fiscal year 2006 they have taken 
several steps to address the issues noted above. For example, after a 
Western Region quality assurance review found that audit reports at 
this location were being issued without proper workpaper review, the 
resident auditor counseled the two supervisory auditors and sent a 
notice to audit personnel that this practice was not acceptable. In 
addition, the Western Region began temporarily assigning more 
experienced auditors from other field offices to work at this location. 
Further, Western Region officials acknowledged that there was a period 
of time when working papers were not being archived timely. The 
officials told us that they made improvements and now have effective 
controls in place. 

DCAA Management Actions Intimidated Auditors, Impaired Some Audits, and 
Created a Generally Abusive Environment: 

During the DOD IG and GAO investigations, we documented a pattern of 
frequent management actions that served to intimidate some of the 
auditors and create an abusive environment at two of the three 
locations covered in our investigation--locations 1 and 2. These 
actions were documented in e-mail guidance from the Western Region and 
FAO managers and supervisors, instructions at staff meetings, and 
meetings with individuals. Our review of the documentation and 
interviews with numerous current and former auditors, supervisors, and 
managers concluded that they set an authoritative and abusive tone in 
which several auditors told us they preferred to speak with us on a 
confidential basis without their management or supervisors present. A 
few auditors were hesitant to speak with us even on a confidential 
basis. Examples of specific management actions include the following: 

* We learned of reassignments of auditors and were told of verbal 
admonishments and threats of disciplinary action against auditors who 
raised questions about management guidance or who spoke with or 
contacted GAO, contracting officers, or investigators within DOD 
without prior management approval. As a result, at least two DCAA 
auditors have filed complaints as whistleblowers with the Office of 
Special Counsel. 

* During one of the audits we investigated, a field office manager 
threatened a senior auditor with personnel action if he did not change 
a draft audit opinion to "adequate." An Air Force official, who was 
aware of this situation, told us that he advised the auditor to make 
the requested changes rather than risk losing his job. 

* During the DOD IG investigation, management provided notices to 
auditors regarding release of audit information to outside parties. For 
example, we were told that management at one FAO instructed auditors 
not to provide any internal documents to investigative units. 
Management at this location also advised auditors in staff meetings 
that they could be suspended or terminated for speaking ill of the 
agency or making false accusations against a coworker or speaking ill 
of a coworker. This guidance was perceived by some audit staff as 
including submission of hotline referrals and discussions with 
investigators. 

* During our on-site interviews, management at all three locations 
required documentation requested by GAO to be provided through them. 
This is a normal management procedure to ensure the consistency and 
accuracy of information provided to outside parties. However, at one 
location, some auditors were permitted to give us information directly 
while others were required to submit information through their 
management. At two locations, several auditors indicated that they 
wanted to provide us certain information, but they were afraid of 
reprisals if their management learned they had done so. 

* After our investigative interviews, supervisory auditors and the 
branch manager at one location asked some of the auditors, including 
trainees who were in probationary positions, to disclose to them what 
they told us. Some of the probationary trainees told us that this 
questioning made them feel pressured or uncomfortable. 

* Excessive written documentation was required following some auditor 
meetings with our auditors and investigators. Although DCAA's CAM 
requires that contacts with GAO and other outside parties be documented 
to keep management informed, we learned of examples where auditors had 
been required to write memorandums up to 30 pages in length to document 
the details of their discussions. The requirement to document 
discussions with GAO discouraged some auditors from talking to us 
because it affected time frames for completing their audit assignments. 
For example, one auditor had to stay late on a Friday and use personal 
time to meet this requirement. The auditor was subsequently told that 
his shorter memorandum was sufficient. 

Corrective Action Briefing and Agency Response: 

On June 20, and 25, 2008, we briefed DCAA and DOD on the results of our 
investigation. On July 3, 2008, DCAA provided a response to our 
briefing that stated that the three FAOs whose audits we investigated 
are currently operating at a satisfactory level of compliance with 
GAGAS. DCAA's response also stated that it did not agree with the 
"totality" of our overall conclusions. However, DCAA acknowledged that 
shortcomings existed in the working paper evidence and documentation to 
support the final audit conclusions in several of the assignments we 
investigated. DCAA's response noted that the rationale for dropping 
many of the significant deficiencies from audit reports was not 
adequately supported or documented and stated that DCAA has no evidence 
that the supervisor "willfully" removed findings from the audit 
reports. DCAA also acknowledged that in some cases additional work 
should have been performed to support the final audit opinion. In 
response to our investigation, DCAA rescinded audit reports related to 
Cases 4 and 5, and removed one contractor's authority to directly bill 
the government without review of invoices prior to payment (Case 11). 
In addition, DCAA performed new audits related to several of our cases. 
New audits related to Cases 7, 9, and 12 overturned previously reported 
"adequate" opinions by reporting "inadequate in part opinions," and 
noting several significant deficiencies. According to DCAA officials a 
new audit related to Case 13 validated the earlier unsupported 
"adequate" opinion. We did not review the support for the new audits. 
For Cases 3, 6, and 10, DCAA officials told us that although work paper 
documentation could have been better, they believe that the reported 
opinions are correct. GAGAS[Footnote 79] require that opinions rendered 
for these types of attestation engagements (assessments of contractor 
controls and compliance with CAS) be supported by sufficient testing 
and workpaper documentation. 

DCAA officials did not agree with our conclusions on Cases 1, 2, and 8. 
For example, DCAA officials did not agree that the audit in Case 1 was 
based on an up-front agreement. However, the workpaper documentation of 
the audit entrance conference and the "letter of understanding" sent to 
the contractor a few days later are clear evidence that there was an 
agreement between DCAA and the contractor on scope of work at the 
beginning of the audit that gave the contractor advance notice of the 
BOEs that would be covered in the estimating system audit. Further, the 
agreement that DCAA auditors would review BOEs at three phases, provide 
corrections, and base the audit opinion on the final, corrected BOEs 
served as an agreement on the basis for the audit opinion. 

With regard to Case 2, documentary evidence obtained from multiple 
sources, including the contractor's own definition of lot costing, 
substantiated that the cost and pricing data provided in the 
contractor's ELC proposal did not comply with CAS. Further, 
documentation by multiple sources of meetings between SMC, the Air 
Force buying command; DCMA; DCAA; and the contractor evidenced pressure 
to resolve CAS compliance issues and obtain a favorable audit opinion 
so that the ELC contract could be awarded. The former DCAA RAM told us 
that she concluded that there were no CAS compliance issues based on a 
contractor accounting demonstration. However, the former RAM did not 
provide any evidence that the contractor's assertion was independently 
tested and confirmed. Further, DCAA auditors told us that the DCAA RAM 
instructed them not to include documentation on CAS compliance issues 
in the audit workpapers and directed the resident auditor to change the 
opinion in the draft report. 

DCAA partially concurred with our conclusions on Case 8, involving 
forward pricing issues at a third DCAA location. DCAA agreed that the 
two former supervisory auditors did not always properly review the 
working papers prior to report issuance. DCAA disagreed that the 
forward pricing proposal audits were complex, but did not provide 
sufficient documentation to support its position. DCAA also stated, but 
did not provide adequate documentation to support its position, that 
trainees worked on 18 of the 62 forward pricing audits. Further, 
although DCAA noted that other auditors charged time to some of the 
assignments the trainees worked on, DCAA did not provide evidence that 
the other individuals performed a supervisory role. Finally, DCAA's 
assertion that the Western Region's quality review of forward pricing 
audits at location 3 found a 93 percent compliance rate and that the 
systemic deficiencies did not represent noncompliance with GAGAS is 
based on a flawed methodology. This methodology involved "yes" and "no" 
responses to over 1,000 questions. Because questionnaire design can 
bias study results, we analyzed the specific findings of systemic 
deficiencies that were documented in the DCAA quality review report. 
Our analysis showed that the review identified a total of 28 systemic 
deficiencies, including one or more systemic deficiencies on 9 of the 
11 audits reviewed. Of the 28 systemic deficiencies, 23 related to the 
allegations we investigated, most of which were GAGAS noncompliance 
issues. 

Finally, DCAA management stated that they found no evidence to support 
our conclusions that DCAA managers at locations 1 and 2 took actions 
against their staff that created a generally abusive work environment. 
DCAA management's response stated that we did not provide their 
management with specific evidence or notify DCAA headquarters of this 
problem during our investigation. Our conclusions are based on numerous 
confidential interviews of numerous DCAA auditors and supervisors as 
well as e-mail documentation. Several statements made during our 
interviews were corroborated by other interviewees as well as e-mail 
communication. We advised DCAA headquarters of our conclusions in 
February 2008. Because of the fear of retaliation expressed by several 
interviewees, we have not provided DCAA with names of individuals or 
specific incidents. DCAA indicated that it has begun actions to assess 
the existence of management abuse. 

Conclusions: 

In the cases we investigated, pressure from the contracting community 
and buying commands for favorable opinions to support contract 
negotiations impaired the independence of three audits involving two of 
the five largest government contractors. In addition, DCAA management 
pressure to (1) complete audit work on time in order to meet 
performance metrics and (2) report favorable opinions so that work 
could be reduced on future audits and contractors could be approved for 
direct-billing privileges led the three DCAA FAOs to take inappropriate 
short cuts--ultimately resulting in noncompliance with GAGAS and 
internal DCAA CAM guidance. Although it is important for DCAA to issue 
products in a timely manner, the only way for auditors to determine 
whether "prices paid by the government for needed goods and services 
are fair and reasonable" is by performing sufficient audit work to 
determine the adequacy of contractor systems and related controls, and 
contractors' compliance with laws, regulations, CAS, and contract 
terms. Further, it is important that managers and supervisory auditors 
at the three locations we investigated work with their audit staff to 
foster a productive, professional relationship and ensure that auditors 
have the appropriate training, knowledge, and experience. 

We are sending copies of this report to interested congressional 
committees, the Secretary of Defense, the Under Secretary of Defense 
(Comptroller), the Under Secretary of Defense for Logistics and 
Materiel Readiness, the Secretary of the Army, the Secretary of the 
Navy, the Secretary of the Air Force, the Director DCAA, the Director 
of DCMA, and the Director of the Office of Management and Budget. We 
will make copies available to others upon request. In addition, this 
report will be available at no charge on the GAO Web site at [hyperlink 
http://www.gao.gov]. 

If you or your staff have any questions concerning this report, please 
contact Gregory D. Kutz, Managing Director, Forensic Audits and Special 
Investigations, at (202) 512-6722 or [email protected] or McCoy Williams, 
Managing Director, Financial Management and Assurance, at (202) 512- 
2600 or [email protected]. Contact points for our Offices of 
Congressional Relations and Public Affairs may be found on the last 
page of this report. Major contributors to this report are acknowledged 
in appendix III. 

Signed by: 

Gregory D. Kutz: 
Managing Director: 
Forensic Audits and Special Investigations: 

Signed by: 

McCoy Williams: 
Managing Director: 
Financial Management and Assurance: 

[End of section] 

Appendix I: Comments from the Department of Defense: 

Defense Contract Audit Agency: 
Office Of The Director: 
Department Of Defense: 
8725 John J. Kingman Road, Suite 2135: 
Fort Belvoir, VA 22060-6219" 

July 11, 2008: 

Mr. Gregory Kutz: 

Managing Director for Forensic Audits and Special Investigations: 
U.S. Government Accountability Office (GAO): 
441 G. St., NW: 
Washington, DC 20548: 

Subject: Response to GAO Correction Action Briefing of June 20 and 25, 
2008 on GAO Investigation of Hotline Allegations Regarding Certain 
Defense Contract Audit Agency (DCAA) Audits (Code 195132): 

Dear Mr. Kutz: 

This is the Department of Defense (DoD) response to the GAO corrective 
action briefing, GAO Investigations of Hotline Allegations Regarding 
Certain DCAA Audits, dated June 20, 2008 (195132). 

Thank you for the opportunity to respond to the subject briefings 
provided by the GAO. This response is being submitted without the 
opportunity for DCAA to review the draft report as the GAO has denied 
DoD a copy of the report. However, we have been permitted to submit our 
July 3, 2008, written comments in response to the GAO briefing of June 
20, 2008, provided the response is redacted for For Official Use Only 
data. As a result, enclosed is DCAA's previous response appropriately 
redacted. We request DCAA comments be included as part of GAO's final 
report. 

As discussed with you on July 7, 2008, although we do not concur with 
the totality of the GAO's overall conclusions, DCAA has taken prompt 
and immediate action to correct the issues and is committed to promptly 
addressing any remaining significant issues identified by the GAO. We 
believe the three field audit offices at issue are currently operating 
at a satisfactory level of compliance with Generally Accepted 
Government Auditing Standards. 

Regarding the GAO's finding that "DCAA managers took actions against 
their staff that hindered their investigations and creating a generally 
abusive work environment," we were provided no facts that support this 
conclusion. As I discussed with you on July 7, 2008, in order to 
properly address this management issue, we request that the GAO provide 
the specific facts supporting this finding. Please be assured that DCAA 
is committed to supporting any GAO review or investigation and is 
prepared to take the necessary actions to address and resolve the 
findings. 

Any questions regarding this memorandum should be directed to the 
undersigned at (703) 767-3200. 

Sincerely, 

Signed by: 
April G. Stephenson: 
Director: 

Enclosure: 

DCAA Policy and Plans' Response to GAO Corrective Action Briefing 
(Project No. 195132): 

Document redacted on 7/9/08 to remove FOUO data and markings. For
unredacted copy, contact DCAA, Policy and Plans Directorate. 

Defense Contract Audit Agency: 
Department Of Defense: 
8725 John J. Kingman Road, Suite 2135: 
Fort Belvoir, Va 22060-6219: 

In reply, refer to: PQA 225.4 (GAO 195132): 

July 3, 2008: 

Mr. Gregory Kutz: 
Managing Director for Forensic Audits and Special Investigations: 
Government Accountability Office (GAO): 
441 G. St., NW: 
Washington, DC 20548: 

Subject: Response to GAO Correction Action Briefing of June 20 and 25, 
2008 on GAO Investigation of Hotline Allegations Regarding Certain 
Defense Contract Audit Agency (DCAA) Audits (Code 195132) 

Dear Mr. Kutz: 

Thank you for the opportunity to respond to the subject briefings and 
talking points provided by the GAO. This response is being submitted 
without the opportunity for DCAA to review the draft report. DoD has 
requested a copy of the draft report to ensure our comments are 
responsive to the issues presented by the GAO, however, the GAO has 
denied DoD a copy of the report. Please be assured that based on the 
briefings provided and information shared throughout the review, DCAA 
has taken prompt and immediate action to correct the issues and is 
committed to promptly addressing any remaining significant issues 
identified by the GAO. 

We believe the three field audit offices (FAOs) at issue are currently 
operating at a satisfactory level of compliance with GAGAS. For 
example, in FY 2008 the DCAA Headquarters Quality Assurance Division 
performed PCIE-based reviews of internal control audits at [redacted] 
and [redacted] Resident Offices and found those offices to be operating 
at a satisfactory level of compliance with GAGAS. 

The GAO briefings relate to a two-year investigation of hotline 
complaints about certain audits at three DCAA southern California field 
audit offices (FAO). The subject briefings did not contain any 
recommendations. Our comments and positions relating to the GAO 
conclusions and findings are summarized below and detailed by GAO case 
number in the enclosed memorandum, dated July 3, 2008, from the 
Regional Director, Western Region. 

The GAO states that it substantiated hotline complaints relating to 
certain assignments that alleged (1) DCAA supervisors dropped findings 
and changed audit opinions without adequate audit evidence for their 
changes, (2) sufficient audit work was not performed to support audit 
opinions and conclusions, and (3) inadequate supervision existed of 
certain forward pricing audits. The GAO also concluded that during the 
audits as well as during the GAO and DODIG investigations, DCAA 
managers took actions against their staff that hindered their 
investigations and created a generally abusive work environment. 

We do not concur with the totality of the GAO's overall conclusions. 
However, we do acknowledge that shortcomings existed in the working 
paper evidence and documentation to support the final audit conclusions 
in several of the reviewed assignments. We found in many of the cases 
cited by the GAO, the deficiencies originally cited by the DCAA auditor 
(that the GAO contends where dropped) were not supported with 
sufficient evidence required by the auditing standards. We have no 
evidence that the supervisor willfully removed findings from the audit 
reports. We acknowledge that in some cases additional work should have 
been performed to support the final audit opinion. As detailed in the 
enclosed memorandum, we have taken the necessary actions to correct 
these deficiencies to protect the Government's interests (e.g., perform 
additional audit work to support audit opinion). 

In addition to the actions noted in the enclosed response from the 
Western Region, it should be noted that DCAA Headquarters has taken 
subsequent actions that relates to the performance of internal control 
audits. In February 2008, DCAA revised its DCAA Regulation 5600.1, 
Delegation of Signature Authority for Audit Reports and Other Audit 
Related Documents, to require FAO managers to sign all internal control 
audit reports. Previously, FAO managers could delegate this 
responsibility to supervisors. Many of the assignments reviewed by the 
GAO were internal control audit reports signed by the supervisor. 

We found no evidence to support the GAO's conclusions that "DCAA 
managers took actions against their staff that hindered their 
investigations and creating a generally abusive work environment." The 
GAO has not provided any evidence to support these assertions and did 
not notify DCAA Headquarters during the investigations that its review 
was being "hindered." DCAA is committed to supporting any GAO review or 
investigation and is prepared to take the necessary actions once 
apprised by the GAO of the factual information supporting its 
statements. In the interim, due to the significance of these alleged 
issues, DCAA has already commenced actions to assess the existence of 
an "abusive work environment." These actions will include a management 
visit to the Western Region by the Director, DCAA within the next two 
months. 

In summary, although we don't agree with the totality of the GAO's 
conclusions, we appreciate the GAO identifying certain shortcomings 
with these 13 cases. We would like to point out that these 13 
assignments represent a very small portion of the audit work performed 
by these FAOs. For the three offices involved in this investigation, 
the FAOs completed over 2800 assignments from Fiscal Years 2005 through 
2007. As stated above, we believe the three field audit offices (FAOs) 
are currently operating at a satisfactory level of compliance with 
GAGAS. 

Any questions regarding this memorandum should be directed to the 
undersigned at (703) 767-3280. 

Sincerely, 

/s/
Kenneth J. Saccoccia: 
Assistant Director: 
Policy and Plans Directorate
Enclosure: 

Western Region's response to GAO Corrective Action Briefing (Project 
No. 195132). 

[End of section] 

Appendix II: Additional Investigative Case Study Results: 

Table 3 provides details of the additional five case studies we 
examined from location 2, a Defense Contract Audit Agency (DCAA) branch 
office in Southern California. As with the five cases discussed in the 
body of this report, none of these audits complied with generally 
accepted government auditing standards (GAGAS). We found that reported 
opinions were not supported because findings of significant 
deficiencies were dropped or downgraded to suggestions for improvement 
without audit evidence, or the work performed was not sufficient to 
support the reported opinion. For example, on the audit of Contractor 
F's billing system, which was reviewed and approved by Western Region 
management, we found a lack of audit evidence to support dropping six 
of eight findings of significant deficiencies. Further, although the 
branch office reported an "inadequate in part opinion," it used the 
audit as support for maintaining this contractor's direct-billing 
privileges. The branch office justification for maintaining Contractor 
F's direct-billing status was not supported given the significant 
deficiencies that were identified but not reported. As a result of this 
decision, the government was put at risk of paying Contractor F for 
overbilled amounts with no government review of its invoices prior to 
payment. On March 12, 2008, after we met with Western Region officials 
on this issue, the branch office rescinded Contractor F's direct- 
billing privileges. 

Table 3: Additional Case Studies of DCAA Audits at Location 2: 

Case: 9; 
Type of audit: Compensation system (2005); 
Contractor: Contractor D; 
Case details: 
* Three different auditors worked on this audit; 
* Original auditor did not follow DCAA guidance when developing audit 
plan and was reassigned after audit work began; 
* Second auditor was inexperienced and noted in her working papers that 
she was "floundering" and could not finish the audit by the September 
30, 2005, deadline; 
* Third auditor was assigned 10 calendar days before the audit was due 
to be completed; 
* Although audit was issued with an "adequate" opinion, insufficient 
work was performed on this audit and, therefore, working papers do not 
support the final opinion; 
* Significant system deficiencies noted in the working papers were not 
reported; 
* The Department of Defense Office of Inspector General recommended 
that DCAA rescind the final report for this audit, but DCAA did not do 
so. Instead, DCAA initiated another audit during 2007; 
* DCAA agreed with our finding that this audit did not include 
sufficient testing of executive compensation. In June 2008, the branch 
office issued a new audit report on Contractor D's compensation system 
which identified seven significant deficiencies and an "inadequate in 
part" opinion; 
* DCAA stated that it is currently assessing the impact of these 
deficiencies in current incurred cost audits. 

Case: 10; 
Type of audit: Purchasing system (2005); 
Contractor: Contractor F; 
Case details: 
* Auditor found that the contractor was not fulfilling its Federal 
Acquisition Regulation-related obligations to ensure that 
subcontractors' cost claims were audited; 
* This issue was not reported as a significant deficiency in the 
contractor's purchasing system. The opinion on the system was 
"adequate"; 
* The working papers did not include sufficient evidence to support the 
final opinion. DCAA relied on a 2004 Defense Contract Management Agency 
(DCMA) review in which the conclusions were based word for word on the 
contractor's response to a questionnaire without independent testing of 
controls; 
* DCAA stated that the overall opinion was not based on DCMA's review. 
However, DCAA stated that it will address the issue of the contractor's 
procedures for ensuring subcontract audits are performed during the 
next purchasing system audit, which is expected to be completed by 
December 30, 2008. 

Case: 11; 
Type of audit: Billing system (2006); 
Contractor: Contractor F; 
Case details: 
* The branch manager allowed the original auditor to work on this audit 
after being assured that the auditors would help the contractor correct 
billing system deficiencies during the performance of the audit; 
* After the original auditor identified 10 significant billing system 
deficiencies, the branch manager removed her from the audit and 
assigned a second auditor to the audit; 
* With approval by the field audit office (FAO) and region management, 
the second auditor dropped 8 of the 10 significant deficiencies and 
reported 1 significant deficiency and one suggestion to improve the 
system. The final opinion was "inadequate in part"; 
* Six of the findings were dropped without adequate support, including 
a finding that certain contract terms were violated and a finding that 
the contractor did not audit subcontract costs; 
* Despite issuing an "inadequate in part" opinion, the FAO decided to 
retain the contractor's direct-billing privileges. After we brought 
this to the attention of region officials, the FAO rescinded the 
contractor's direct-billing status; 
* DCAA did not agree with our finding that the working papers did not 
contain adequate support for dropping six draft findings of significant 
deficiencies. 

Case: 12; 
Type of audit: Labor floor check (2005); 
Contractor: Contractor C; 
Case details: 
* Auditor performed sampling to determine whether sufficient controls 
over employee time cards existed; 
* Although the work was based on a limited judgmental sample, the 
auditor found three errors out of 18 employee time cards tested and 
concluded that controls over time cards were inadequate; 
* Supervisory auditor initially agreed with the findings, but later 
modified working papers to change the draft audit conclusion from 
"certain labor practices require corrective actions" to "no significant 
deficiencies"; 
* Working papers did not properly document the reason for the change in 
conclusion and therefore, do not support the reported conclusion; 
* Supervisory auditor later stated that the initial sampling plan was 
flawed, but eliminated the deficiency finding rather than asking the 
auditor to redo the work; 
* On April 9, 2008, DCAA issued a new labor floor check audit for this 
contractor that identified eight significant deficiencies and concluded 
that corrective actions were needed in the contractor's labor 
accounting system. 

Case: 13; 
Type of audit: Compliance, Cost Accounting Standard (CAS) 418 (2006); 
Contractor: Contractor G; 
Case details: 
* After original auditor was transferred to another audit, a second 
auditor significantly limited the scope of the audit with supervisory 
approval, deleting most of the standard audit steps; 
* Second auditor performed very limited testing and relied on 
contractor assertions with little or no independent verification; 
* Supervisory auditor approved issuance of the final audit with an 
opinion that the contractor complied with CAS 418 in all material 
respects; 
* Insufficient work was performed on this audit and therefore the scope 
of work and the working paper documentation does not support the 
opinion; 
* Region officials acknowledged that work was insufficient and stated 
that another CAS 418 audit has been initiated; however, DCAA did not 
rescind the misleading report; 
* On June 25, 2008, DCAA officials told us that the new CAS 418 audit 
was completed with an "adequate" opinion. 

Source: GAO analysis. 

[End of table] 

[End of section] 

Appendix III GAO Contacts and Staff Acknowledgments: 

GAO Contacts: 

Gregory D. Kutz, (202) 512-6722 or [email protected] McCoy Williams, (202) 
512-2600 or [email protected]: 

Acknowledgments: 

In addition to the contacts named above, Gayle L. Fischer, Assistant 
Director; Andrew O'Connell, Assistant Director and Supervisory Special 
Agent; F. Abe Dymond, Assistant General Counsel; Barbara C. Lewis, 
Assistant General Counsel; Richard T. Cambosos; Jeremiah F. Cockrum; J. 
Andrew Long; Andrew J. McIntosh; Ramon J. Rodriguez, Senior Special 
Agent; and Daniel E. Silva made key contributions to this report. 

[End of section] 

Footnotes: 

[1] GAO, High-Risk Series: An Update, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-07-310] (Washington, D.C.: 
January 2007). 

[2] DCAA Contract Audit Manual (CAM), DCAAM 7640.1. 

[3] GAO, Government Auditing Standards: 2003 Revision, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G] (Washington, D.C.: June 
2003). This was the version of GAGAS in effect at the time of all the 
DCAA audits that GAO investigated, except for the audit discussed in 
case 1. The version of GAGAS applicable to case 1 was the August 1999 
revision. 

[4] Certain assignments covered in case 8 were performed as agreed-upon 
procedures assignments. No opinion is issued on these types of 
assignments. 

[5] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ 
6.02a. 

[6] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ 6.22. 

[7] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ 
6.24e. 

[8] We handled our investigation of 3 related audits of one contractor 
as one case. 

[9] DCIS is a component of the DOD IG. 

[10] CAS 403 establishes criteria for allocation of the expenses of a 
home office to the segments of the organization. 

[11] The two supervisors were responsible for all forward pricing 
audits at the Resident Office location. The remaining 51 of the 113 
audits were performed by separate suboffice locations of the Resident 
Office and were signed by the supervisory auditors at those locations. 

[12] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ 
6.27c. 

[13] DCAA auditors and workpaper documentation use the terms deficiency 
and significant deficiency interchangeably. For consistency, we use the 
term significant deficiency throughout this report. 

[14] CAM 5-109d. 

[15] DCAA Regulation 5600.1. On December 3, 2007, the DCAA Western 
Region changed its policy to require branch manager or resident auditor 
signature on all internal control audit reports. DCAA adopted this 
policy change agencywide on February 13, 2008. 

[16] FAR 42.101 and DFARS 242.803. 

[17] FAR 42.803(b); DFARS 242.803; and CAM 6-1007. 

[18] CAM 6-1008. 

[19] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ 
3.03. 

[20] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ï¿½ 
6.02a, 6.04a, and 6.04b. 

[21] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ 
3.34. 

[22] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ 
6.22. 

[23] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ï¿½ 
3.39 and 6.04a. 

[24] Case 3 involved three related defective pricing audits at the same 
contractor. 

[25] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ï¿½ 
6.02a, 6.04a, and 6.04b. 

[26] CAM 5-1215a. 

[27] FAR 15.404-1, 15.407-3, and 15.407-5, table 15-2. 

[28] GAO, Government Auditing Standards, August 13, 1999, update, ï¿½ï¿½ 
3.17a-b. 

[29] GAO, DOD Contracting: Efforts Needed to Address Air Force 
Commercial Acquisition Risk, [hyperlink, http://www.gao.gov/cgi-
bin/getrpt?GAO-06-995] (Washington, D.C.: Sept. 29, 2006). 

[30] The original Buy 3 launch capability proposal totaled nearly $2.6 
billion for the 3-year period from October 1, 2005, through September 
30, 2008, and the revised proposal was reduced to a little over $1.1 
billion for the 2-year period from October 1, 2005, through September 
30, 2007. 

[31] CAM 9-212 explains the four types of audit opinions used in price 
proposal audit reports, including (1) an unqualified opinion (submitted 
cost or pricing data or cost information other than cost or pricing 
data are considered by the auditor to be adequate, acceptable, and in 
compliance with applicable FAR, DFARS, and CAS provisions); (2) a 
qualified opinion (cannot be issued when there are inadequacies with 
the cost or pricing data or cost information other than cost or pricing 
data, noncompliance with FAR, DFARS, and CAS provisions, or other 
problems not related to contractor actions or inactions), (3) an 
adverse opinion (used when there is denial of access to records or data 
having a significant effect on the examination, or when significant 
inadequacies or significant noncompliance requiring corrective action 
by the contractor prior to negotiation is noted); and (4) a disclaimer 
(when the auditor does not express an opinion on the cost or pricing 
data or information audited because the auditor has not performed an 
audit of sufficient scope to form an overall opinion). 

[32] CAM 10-304.8b defines questioned costs as those amounts on which 
audit action has been completed and which are not considered acceptable 
as a contract cost. 

[33] CAM 10-304.8c defines unsupported costs as costs for which a 
contractor does not furnish sufficient documentation to enable a 
definitive conclusion. 

[34] FAR 9904.406.40a states that a contractor is to use a fiscal year 
as its cost accounting period except as provided in 9904.406.50(d) when 
the government agrees that a contractor may use a fixed annual period 
other than a fiscal year. 

[35] Our review of DCAA documentation on meetings with the contractor 
identified Contractor A's definition of its lot accounting methodology. 
Contractor A defines lot accounting as synonymous with lot costing and 
states that its use of lot costing is a method of accounting that is 
applicable to products manufactured for delivery under multiple 
production-type contracts over multiple years. Under lot accounting, 
direct charge costs and associated indirect expense allocations are 
accumulated and charged to units or contracts at the average cost 
determined for the production lot. A lot consists of the total 
estimated number of units (accounting quantity) of a product to be 
produced in a continuing, long-term production effort for delivery 
under existing and anticipated contracts. To establish the average cost 
to be assigned from inventory to individual units or contracts under 
lot accounting, the number of units to be produced in a lot is 
established as the denominator, and the total cost estimated to 
complete the units in the lot is established as the numerator. 
Contractor A's definition referred specifically to the program in Case 
2. 

[36] FAR 9904.418.20 states the purpose of CAS 418, which is to provide 
for consistent determination of direct and indirect costs and 
accumulation of indirect costs and provide guidance on selection of 
allocation measures between an indirect cost pool and cost objectives. 

[37] FAR 9904.411 states the purpose of CAS 411, which is to provide 
criteria for accounting for the acquisition costs of material and the 
consistent measurement and assignment of costs to cost objectives, 
including direct and indirect cost allocations (CAS 411.40). 

[38] CAM 9-212 and 9-213. 

[39] FOB-origin is used to describe a shipment in which the buyer of 
the goods--in this case, the government--assumes risk of loss for the 
goods at the point of shipment. It is contrasted with FOB-destination, 
in which the buyer does not assume this risk until receipt of the 
goods. 

[40] FAR ï¿½ 47.104-2(b). 

[41] CAS 405--Expressly Unallowable Costs. 

[42] This supervisory auditor subsequently managed the audits 
associated with Cases 5, 6, 7, 9, and 12. 

[43] CAM 14-102b. 

[44] CAM 14-102a states that defective pricing occurs when a contractor 
does not submit or disclose to the government cost or pricing data that 
are accurate, complete, and current prior to reaching a price 
agreement. Generally, the auditor establishes the existence of 
defective pricing in a postaward audit by examining and analyzing the 
records and data available to the contractor as of the date of prime 
contract price agreement and comparing them with the submitted cost or 
pricing data. Defective pricing occurs when a contractor does not 
submit or disclose to the Government cost or pricing data that is 
accurate, complete, and current prior to reaching a price agreement. 
Generally, the auditor establishes the existence of defective pricing 
in a postaward audit by examining and analyzing the records and data 
available to the contractor as of the date of prime contract price 
agreement and comparing them with the submitted cost or pricing data. 

[45] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ 
6.02a and 6.04b. 

[46] The Armed Services Board of Contract Appeals (ASBCA) has held that 
disclosure to the government can be adequate if relevant cost or 
pricing data are made available to a person who participates in 
negotiations and if the significance of those data should be "obvious" 
to that person. (ASBCA Nos. 50447, 50448, 50449, Aug. 29, 2000.) 

[47] CAM 14-120.2. 

[48] CAM 5-1104a-b. 

[49] FAR 32.504(b). 

[50] FAR 52.216-7e and FAR 42.704 (b) and (c). 

[51] This supervisory auditor also managed the audits associated with 
cases 9, 10, and 13. 

[52] One of the other two originally documented deficiencies had been 
reviewed by the original acting supervisor as part of the risk 
assessment process. The other documented deficiency was not approved by 
a supervisor at that time. 

[53] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ï¿½ 
6.02a, 6.04b, and 6.22. 

[54] FAR 15.403-4(b) requires contractors to provide support for 
estimates, including cost and pricing data and a certification from the 
contractor that those data are accurate, complete, and current. FAR 15, 
table 15-2, provides instructions for submitting pricing proposals, to 
include judgmental factors, mathematical methods, and, depending on the 
system, support for labor, materials, and other costs. 

[55] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ 
6.24e. 

[56] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ï¿½ 
6.39 and 6.04a. 

[57] DFARS 15.407-5-70(d)(3)(i). 

[58] The supervisor for this audit was the same supervisory auditor in 
Cases 5, 7, 9, and 12 and the replacement supervisor in Case 3. 

[59] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ 
6.22. 

[60] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ 
6.24e. 

[61] The False Claims Act (31 U.S.C. ï¿½ï¿½ 3729-3733) establishes civil 
penalties against persons who commit certain acts, for example, 
knowingly presenting a false or fraudulent claim for payment to the 
United States. In addition to the Attorney General, private persons may 
enforce the False Claims Act in a qui tam action and be paid a 
percentage of the proceeds of such the action or settlement. 31 U.S.C. 
ï¿½ 3730 (b), (d). 

[62] The second and third findings noted were also identified during 
the accounting system audit discussed in Case 5. 

[63] CAS 403-40(b)(3). 

[64] CAS 403-40(a)(1). 

[65] Ibid. 

[66] CAS 403-40(b)(4). 

[67] CAM 4-403f(2). 

[68] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ 
6.22. 

[69] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ï¿½ 
6.02a, 6.04b, and 6.22. 

[70] As defined in CAM 9-001, forward pricing audits involve the 
evaluation of cost elements used in contractor estimates supporting 
price proposals in connection with the award, administration, 
modification, and repricing of government contracts. Although DCAA 
generally uses the term audits, it performed some of these forward 
pricing assignments as examination-level attestation engagements and 
others as agreed-upon procedures assignments. No opinion is issued on 
agreed-upon procedures work. 

[71] According to DCAA headquarters officials, the Defense Contract 
Audit Institute is registered with the National Association of State 
Boards of Accountancy. 

[72] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ 
6.24e. 

[73] FAR 15.404-1, 15.407-3, and 15.407-5, table 15-2. 

[74] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ï¿½ 
3.39 and 6.04a. 

[75] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ï¿½ 
3.39, 6.04a, and 6.26. 

[76] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ 
6.27c. 

[77] This is not the same review as discussed in the DOD IG's January 
24, 2007, memorandum of investigation. 

[78] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ï¿½ 
6.04a, 6.03, 6.22, and 6.24e. 

[79] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-673G], ï¿½ï¿½ 
6.02a and 6.22. 

[End of section] 

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