Many businesses actively pursue contracts with the U.S. federal government. With federal government spending exceeding $600 billion annually, these contracts can ensure a company’s long-term success.
Since the onset of the COVID-19 pandemic, the government has focused on contracting with small businesses, particularly those run by underrepresented groups. While this is good news for small and medium businesses, it’s crucial for these businesses to familiarize themselves with the government’s rules and requirements for contracting. This includes understanding DCAA audits, an integral part of the government contracting process.
What Is A DCAA Audit?
The Defense Contract Audit Agency (DCAA) is a branch of the federal government that provides auditing and financial advisory services to the Department of Defense (DoD) and other federal entities involved in acquisitions and contract dealings. The DCAA ensures proper use of federal funds in accordance with contract stipulations and provides financial oversight to the government, ensuring the DoD gets optimal value from its defense contracts.
In addition to conducting contract audits, the DCAA provides financial advisory services. They independently review financial representations made by defense contractors and confirm whether contract costs are allowable, allocable, and reasonable.
If your company has a current or upcoming contract with the government, consult with professional DCAA auditors to learn how to prepare for all types of audits.
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The Five DCAA Audit Types
The DCAA conducts several types of audits for government contractors, each designed to ensure compliance with specific aspects of federal contracting. Here are the five key DCAA audit types:
Accounting System Review Audits
Companies trying to secure a contract from the federal government must have a well-designed and accurate government approved accounting system. This is because the first thing that government agencies do is check whether or not your company is following proper accounting policies. The government always ensures that your accounting procedures are by the book before approving funds for any cost type work.
To check that the contractor strictly follows the appropriate accounting process, the DCAA office follows two accounting system reviews practices:
- Pre-award audits
- Post-award audits
Pre-Award DCAA Audit
A pre-award audit is the first step in securing a contract with the government. This audit determines if your organization’s accounting system can manage the scope of work and what is expected by the end of the contract.
An officer from either the DCAA or DCMA (Defense Contract Management Agency) begins the audit process with a Standard Form 1408, covering accounting system requirements. The form covers these accounting system requirements:
- Proper segregation of costs
- Identifying direct costs
- Total direct costs
- Ability to classify indirect costs
- Cost objectives
After submitting the form to the DCAA/DCMA office, the assigned officer checks your company’s accounting system to see if it performs all the functions mentioned in SF 1408. Then the officer reviews your accounting system’s policies and procedures according to DCAA audit requirements.
Post-Award DCAA Audit
Unlike a pre-award audit, a post-award audit is conducted after the contractor has completed three to six months on the assigned job. The post-award audit allows the DCAA to check the contractor’s accounting system performance and check how much it aligns with the contract’s requirements.
When the auditors conduct this accounting system review audit, they do a more thorough job of observing the actual accounting system than in the pre-award audit phase. The DCAA/DCMA will test:
- Data entry policies and procedures
- Review accounting items
- Transaction testing
- Invoice and general ledger testing
- Segregation of duties
- Proper data access levels
- Expense recognition
- Accurate labor distribution
The goal of the post-award audit is to guarantee you are operating according to the commitment you made pre-award. Therefore, the officer conducts an in-depth analysis to check that your system does not have any loopholes. Ultimately, the main goal of the audit is to determine that your financial system is operating in a manner which is DCAA compliant.
Real-time labor evaluation audits are a sudden and unannounced appearance of DCAA auditors to check if you are working on their contract on the operational timings you have provided. As service-based contractors bill the DCAA on the labor hours, the government wants to be certain that the contractor is billing them for the actual hours worked.
The DCAA auditors show up without notice and conduct a floor check. The auditors randomly select employees during the DCAA floor check to ask them about timesheet procedures and performance. Most of the questions are about inputting and adjusting time entries, creating charge codes, submitting timesheets, approving the timesheet, and having timesheet access.
After completing the floor check, the auditors move on to accounting staff to review the process of timesheet collection and labor cost distribution. The primary reason for doing this check is to ensure that labor costs in the ledger match the timesheets. With this review, the auditors can determine if the contractor charges them more by showing them false labor time.
As the DCAA conducts these visits without notifying the contractor, it is crucial to maintain timesheets daily. Ideally, the contractor should record their hours worked as they are working but sometimes, there are situations which prevent that from happening.
The inability to produce timesheets or providing incomplete timesheets results in significant penalties. Moreover, you want to build trust in the first labor evaluation audit to show honesty and consistency. Once you establish confidence in your initial audits, the rest will be more straightforward.
Public Voucher Audit
Public voucher audits, also called “progress payments,” vary in variety because the contractor defines the parameters of the invoices. This is because you are billing the government, and it requires certain elements to prove and justify all the items mentioned in the final bill. Regardless, the DCAA has its own requirements, and you have to follow them across the board.
In addition, the DCAA looks for consistency in accounting records and billing to prevent fraud. Therefore, all payments are conducted through the Standard Form 1034 public voucher or its equivalent. DCAA auditors sample test a set of individual invoices before submitting them to the government. During the sample test, they review general ledgers, job cost reports, and the source documents that support the billed voucher.
If the DCAA auditors find inconsistencies during the record check,, the voucher and progress payment is held until you perform appropriate measures to remove the discrepancies and adjust your invoices accordingly. As a contractor, you should avoid this delay at all costs as it hurts your cash flow, reflects negatively on your company, and affects the processing of your future invoices.
Therefore, always make sure your accounting records are updated, especially when it comes to:
- Conformity between invoice and contract terms
- Consistency between billed costs and recorded costs
- Fair labor distribution
- Accurate allocation of indirect costs
- Separation of allowable costs from unallowable costs
- Complete documentation of billed charges
- Proof of timely payment to vendors and subcontractors
Incurred Cost Audits
Before sending a bill, you must submit the total incurred costs, with the related documents, to the DCAA to initiate the approval of the billing cost. Once your request has been processed and accepted, the DCAA reviews your accounting system by running tests to check incurring and direct costs. These tests confirm the status and adequacy of all the items you have mentioned in your bill.
The DCAA reviews the company’s employee rates, fringe and overhead costs, and G&A rates in allowable expenses. Evaluation of these components helps the DCAA finalize the reimbursement of the contract. The DCAA will further check if the billable items fall under allowable expenses or not before giving their final approval. And if the incurred cost audit is successful and the DCAA finds everything accordingly, it helps ensure your invoices are cleared and paid on time.
Provisional Billing Rates
Depending on your cost-type document, you may be eligible to be compensated for indirect costs through interim payments. If this is a clause in your contract, you will not have to wait for your agreement to end to be paid for indirect costs. However, the government uses FAR 42.704 billing rates to determine the final provisional billing rates. This is a very effective billing method, giving an approximate idea of the final billing rate at the end of the contract and making it easier to adjust for any unallowable costs.
The DCAA auditor checks your accounting system to see whether or not it is adequate to provide accumulated and current claimed amounts. The DCAA needs your financial reports to ensure your accounting system is qualified for all the required processes of the Accounting System Review audit.
Even after obtaining the approval, you must submit a provisional billing rates report to the DCAA office every fiscal year. The DCAA audit has specific instructions for provisional billing rates that mandate that:
- You must submit provisional billing rates at the beginning of every fiscal year or if it no longer represents the final year rates due to any circumstances.
- The provisional billing rates report must be submitted physically. But if it is possible, the contractor should also submit it electronically.
- The provisional billing rates report should be created in Excel format.
- The report must contain proposed billing rate calculations, prior and current fiscal year pool and base, current fiscal year budget pool and base, comparative analysis, and an explanation of all differences.
Consult A Professional DCAA Auditor
Each audit type serves a unique purpose and demands a specific set of preparation steps from the contractor. It’s important to fully understand the purpose, procedure, and expectations of each audit type to ensure a smooth and successful audit process. If your business is uncertain about its present or future DCAA compliance, or struggling with the preparation for DCAA accounting, proposal, and contract management audits, it’s crucial to seek professional help. Learn more about DCAA compliance here.
About Diener & Associates CPAs LLC
Diener & Associates CPAs LLC has been a leading provider of professional CPA services in the DC metropolitan area since 1989. We offer a range of consulting/advisory, outsourced accounting, and tax services to assist businesses with their most challenging processes. Regardless of your industry of operation, Diener & Associates CPAs LLC can maximize your organization’s efficiency, scalability, and profitability.