Subcontractor compliance plays a significant role in the success of a prime contractor’s audit readiness and overall contract performance. With increased scrutiny from the Defense Contract Audit Agency (DCAA), gaps in a lower-tier vendor’s systems can directly impact the prime’s risk exposure, payment flow, and business system ratings.
As the DCAA continues to trace questioned costs back through the subcontractor chain, primes must take an active role in verifying and maintaining compliance across all tiers.
Why Subcontractor Compliance Matters
Greater attention from the DCAA to prime contracts has led to increased scrutiny of subcontractor systems and practices. When weaknesses in a subcontractor’s accounting or estimating system surface, consequences often extend directly to the prime contractor.
Under DFARS 252.242-7005, deficiencies in any covered business system can trigger payment withholds, delay contract execution, or create exposure to False Claims allegations.
DCAA audit trails frequently identify lower-tier vendors as the source of questioned costs, putting pressure on primes to actively manage and monitor subcontractor compliance throughout the lifecycle of the agreement. A failure to do so introduces both financial and reputational risks that may be difficult to recover from once raised.
Regulatory Framework Binding the Prime
Several clauses and regulations define the compliance responsibilities of prime contractors with respect to subcontractors. FAR 52.216-7 requires the prime to settle subcontractor final indirect rates, track audit status, and make adjustments to billed costs accordingly.
Under FAR Part 42, contracting officers gain access to subcontractor records through the prime. FAR Part 44 governs subcontracting policies and links purchasing system approvals to Government consent thresholds.
DFARS 252.244-7001 outlines 24 required purchasing system criteria that must be flowed down when subs issue lower-tier agreements, making the prime responsible for more than just direct subcontractor oversight.
DFARS 252.242-7005 and the related DFARS 242.70 framework authorize withholds for deficiencies in any covered business system, including those operated by subcontractors.
What The DCAA Expects From Primes
Before awarding a subcontract, the DCAA expects the prime to verify that the subcontractor’s accounting system meets audit standards.
The Information for Contractors guide lists 18 elements that auditors evaluate, such as proper segregation of direct and indirect costs, timekeeping integrity, and provisional billing logic. Evidence of compliance can take various forms, including completed accounting system checklists, independent CPA assessments, or recent DCAA audit letters.
Cost or price analysis must also be documented and retained. The DCAA Monitoring Subcontracts guide warns that failure to conduct adequate analysis can lead to estimating system findings and negotiation delays.
Subcontract files should contain price analysis memos, commercial item determinations, and cost realism assessments that reflect a consistent application of acquisition policy and internal review.
For cost-type or flexibly priced subcontracts, audit-access and business-system clauses must be incorporated in full. FAR 52.215-2 and 52.216-7, along with applicable DFARS clauses, grant the Government or its auditors direct access to the subcontractor’s books if necessary.
These terms should be embedded in both the subcontract’s statement of work and the purchase order conditions to avoid disputes later in performance.
Maintaining a purchasing system that meets CPSR (Contractor Purchasing System Review) standards further strengthens the prime’s compliance posture. DCMA’s CPSR Guidebook describes required file documentation practices, small business subcontracting plans, and counterfeit part controls.
When the prime’s system lacks proper documentation or controls, similar weaknesses may be present at the subcontractor level, compounding audit exposure.
Monitoring business system health continuously is another expectation. DCAA guidance explains that disapproved accounting, estimating, or purchasing systems of any subcontractor can lead to payment withholds against the prime’s invoices.
A practical approach involves establishing a compliance dashboard that tracks business system status and corrective action plans across subcontractors.
Framework for Managing Subcontractor Compliance
During pre-award, primes should issue accounting system questionnaires, collect indirect rate support, and confirm that there are no unresolved DCAA findings against the subcontractor. Artifacts such as audit letters, survey results, and rate files help build an early compliance record.
At award, full-text clauses granting audit access and laying out business system expectations must be incorporated into the subcontract. Monthly cost reporting in work breakdown structure (WBS) format should be established to support earned value analysis and contract tracking. These elements help maintain transparency throughout performance.
During execution, quarterly file reviews against CPSR checklists provide early identification of documentation or system gaps. Comparisons between billed and earned hours, provisional rate monitoring, and annual post-award meetings with subcontractor CFOs provide oversight and encourage the resolution of any emerging issues.
Close-out responsibilities include collecting the subcontractor’s incurred cost proposal and tracking its audit status. Adjustments to the prime’s final voucher must reflect settled indirect rates once audits conclude.
Maintaining an audit log and a final voucher file package supports this reconciliation and contributes to clean contract closure.
Role of Outsourced Accounting Support
Specialized outsourced providers can play an active role in helping primes and their subcontractors stay within DCAA expectations. Centralized chart-of-accounts design allows subcontractors to align their data directly with the prime’s cost structure.
Cloud-based timekeeping and expense platforms with role-based access meet DCAA requirements for real-time entry and historical audit trails.
Automated scans for labor exceptions, such as labor-to-leave variances, push alerts to both prime and sub-teams. A shared audit-ready data room containing provisional rate packages, pooling calculations, and supporting schedules streamlines audit preparation.
Providers can also support subcontractor teams during walk-throughs and maintain the corrective action tracker used to monitor ongoing business system status.
Staying Ahead of Subcontractor Compliance Risk
Managing subcontractor compliance under DCAA standards demands more than one-time checks or clause inclusion. It requires a continuous, structured process backed by strong systems, clear documentation, and proactive oversight.
Diener & Associates works closely with government contractors to strengthen internal controls, guide subcontractor oversight, and prepare for DCAA scrutiny. Schedule a consultation online or contact our professional team of CPAs at 1-(703)-386-7864 to discuss how our accounting and compliance services can support contract performance and audit success.