Auditors Monitor Troubled Firms By Glenda Tysinger, CPA The economic predicament has had an impact on everyone in the past year and the government contracting marketplace is no exception. The current conditions in our financial markets have prompted the Defense Contract Audit Agency to believe there is a high risk factor of a contractor’s ability to maintain a favorable cash flow and sustain performance on government contracts. DCAA recently issued an Audit Alert to emphasize that auditors are to be alert to adverse financial conditions that might impede a contractor’s ability to perform on government contracts (CAM 14-300). The memorandum states that if such unfavorable conditions became known, auditors should immediately commence a financial capability risk assessment/audit. What impact will this alert have on the contractor? You can be assured that DCAA will be scrutinizing financial reports for any unfavorable financial conditions in any audit they perform (e.g., progress payment audits, annual testing of contract eligibility for direct billing, billing systems, and interim voucher reviews). Auditors have also been alerted to take notice of situations where the contractor may be accelerating the billing costs to the government in order to improve its cash flow. Examples identified by DCAA of the indicators of possible unfavorable financial conditions include, but are not limited to, the following: •Increase in the aging and amounts of accounts payable •Defaults on loan/line-of-credit agreements •Denial of usual trade credit from suppliers •Restructuring of debt with higher interest rates •Noncompliance with loan/line-of-credit covenants •Loss of principal customers/suppliers •Unpaid or late payment or state, local, and federal tax liabilities •Deteriorating bond ratings •Failure to fund pension plans •Loans from employees or issuing stock to employees in lieu of salary •Significant unpaid debts and/or liabilities •Unusual progress payments or other billing concerns •Poor physical condition of the work facilities If the auditor uncovers any indicator of financial predicament, a financial condition risk assessment could be initiated (CAM 14-304). The assessment will determine if a financial capability audit is warranted. A financial capability audit would include an analysis of the following: •any significant events impacting financial capability •key financial statement ratios •key financial statement elements (profit/loss, sales, etc.) •off-balance sheet arrangements and related party transactions •timely payments of payroll taxes •parent company’s management of subsidiary’s cash, if applicable An unfavorable financial capability audit can have a very negative impact on the future of the company. The government may terminate contracts out of fear that the company will not be financial capable to perform through the contract’s duration. This could be the nail in the coffin for certain struggling companies. The best way to avoid this situation if a company is struggling financially is to have a management plan dictating its future plans and the strategies for righting the ship. This plan should be prepared before DCAA identifies the problems to demonstrate that management is taking proactive measures to address and resolve the issues. Not having such a plan at the ready will only create further uncertainty as to the viability of the company in the eyes of DCAA. Glenda Tysinger, CPA is a senior manager with Federal Strategies Group LLC. She provides government contract and management consulting, M&A advisory, forensic accounting and expert testimony to the government contracting industry. She can be reached at GlendaT@FedStrat.com.