Important New DOD Reg on Internal Controls for Contractor Business Systems

The Department of Defense (DOD) has promulgated DFARS 215.407-5-70 that demands almost perfect internal control for contractor business systems and includes significant sanctions and penalties for failure to comply. Failure to comply with the regulation may have dire financial consequences for DOD contractors due to these sanctions being more stringent than the traditional response to a weakness or lack of internal controls.

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The Department of Defense rule, published as an amendment to the Department of Defense Federal Acquisition Regulation Supplement (DFARS), became effective on May 18, 2011, and addresses contractor business systems allowing contracting officers to withhold contractor payments in response to business system deficiencies. The rule seeks to improve the effectiveness of the oversight of contractor business systems specifically by the Defense Contract Management Agency (DCMA) and the Defense Contract Audit Agency (DCAA).

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This rule provides a sanction of withholding of otherwise due and payable invoices for significant deficiencies in any of these business systems. The rule defines a "significant deficiency" as "a shortcoming in the system that materially affects the ability of officials of the Department of Defense to rely upon information produced by the system that is needed for management purposes." (Emphasis added.) Here the term "management" pertains to Department of Defense management (some might argue this is micro-management) because for company (contractor) purposes, internal control for its management functions are well established by the internal controls that have existed in various forms for many years. The new internal control criteria are not generated by a company need to go beyond traditional internal controls, but rather are generated by the DOD for their management purposes.

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The rule is many things to many people. To a taxpayer, additional internal controls for contractors and sanctions for non-compliance sound good. To a DOD contractor, fears of arbitrarily withholding funds immediately come to mind. To a "smaller government" proponent, additional rules might be viewed as an unnecessary intrusion. To a dispassionate observer, the rule may seem out of sync with traditional internal control concepts.

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