Moving from a standard commercial accounting setup to one that meets Defense Contract Audit Agency (DCAA) requirements introduces significant operational changes.
Achieving compliance involves more than installing new software or updating a few procedures. It requires alignment with detailed federal standards, clear documentation, and consistent execution across all functions that touch cost accounting.
Treating DFARS Criteria as Guidelines Instead of Requirements
Many organizations underestimate the extent to which the 18 control objectives in DFARS 252.242-7006 shape every aspect of a DCAA-compliant accounting system. While some may approach these points as best practices or general recommendations, auditors do not.
Each item is treated as mandatory, and the DCAA Accounting System Audit Program (Activity Code 11070) instructs examiners to test each individually. A single deficiency, even in a seemingly minor area, can lead to a finding of system inadequacy.
That determination is reported to the Contracting Officer and can trigger payment withholdings under DFARS 252.242-7005. The audit process is structured, repeatable, and evidence-driven, leaving little room for informal interpretation or partial compliance.
Inflexible Chart of Accounts That Blocks Cost Segregation
A standard commercial chart of accounts typically groups revenue and expenses by department or business line, which works well in the private industry but falls short under government contract oversight.
The DCAA expects a chart that tracks direct and indirect costs by contract, task, and funding source. Without that level of segmentation, it becomes impossible to calculate provisional billing rates or submit accurate incurred cost proposals.
SF 1408 specifically inquires whether the accounting system supports cost segregation, and the Pre-Award Survey Audit Program (Activity Code 17740) includes walkthroughs of account mappings to confirm that the structure aligns with the contract objectives. Organizations often must rebuild account hierarchies to meet these standards.
Weak Timekeeping Practices That Trigger Audit Findings
Few areas receive more scrutiny during a DCAA review than timekeeping. Daily entries, signed by the employee and verified by supervisors, must directly tie labor hours to intermediate or final cost objectives.
Timesheet accuracy is evaluated through surprise floorchecks and interviews, often cross-referenced against payroll and job cost ledgers. Incomplete records, missing signatures, or late corrections often lead to audit findings.
The Real-Time Labor Evaluations guide and the Labor Floorcheck Audit Program (Activity Code 10310) provide the framework for conducting these reviews.
Misaligned Labor Charging That Skews Rate Calculations
The line between direct and indirect labor can be challenging, especially when employees work on multiple internal projects and billable contracts. Auditors examine labor distribution models to determine whether costs are charged consistently and whether indirect labor is allocated using a logical and supportable base.
Any misclassification in this area can distort indirect rates and affect contract profitability. The DCAA’s Accounting System Requirements guidance emphasizes that payroll dollars must be traceable through the job cost ledger with a clear audit trail. Inadequate labor allocation is a frequent source of questioned costs during the closeout process.
Gaps in Reconciliation Across Financial Ledgers
Many accounting systems allow for the automation of entries between subsidiary ledgers and the general ledger; however, federal auditors require more than automated processes. DFARS criterion 4 calls for documented, routine reconciliation between job cost modules, materials ledgers, labor distribution, and the GL.
During a system review, auditors will trace individual transactions from initiation to final posting. If discrepancies appear or if reconciliations are not available on demand, the system may be found inadequate. The DCAA Audit Program 11070 outlines specific reconciliation steps that must be performed and documented before audit fieldwork begins.
Lack of Written Policies That Explain System Operation
Auditors cannot rely on informal explanations or unwritten procedures. The Defense Contract Management Agency (DCMA) requires that contractors document how each DFARS requirement is met through formal, accessible policies and procedures.
Without this documentation, auditors are left without objective evidence to support claimed compliance. In many cases, long-standing internal practices exist, but the absence of a written policy still constitutes a deficiency.
DCMA Manual 2303-01 is the primary reference for what policy content is expected. Verbal walkthroughs or tribal knowledge do not substitute for documented internal controls.
Loss of Historical Data That Prevents Incurred Cost Audits
Current contract regulations require keeping historical cost data accessible for six years after final payment. Some organizations mistakenly remove or archive detailed records during a system cutover, making it difficult or impossible to support incurred cost submissions or respond to defective pricing allegations.
DCAA auditors test access to historical records during the system review. According to DCAAM 7641.90, failing to maintain full access to prior-year records can result in a finding of system inadequacy. Therefore, all data migrations must be planned appropriately to preserve transaction-level detail in a live or read-only environment throughout the audit window.
Shutting Down the Legacy System Too Early
During post-award audits, the DCAA traces sample transactions through old and new systems to verify data continuity.
Deactivating the legacy system too early prevents the completion of this audit step. Even if the new system is configured correctly, the inability to test historical transactions can disqualify the system from approval.
The best practice is to retain the legacy environment in read-only mode for at least one full fiscal year, allowing auditors to validate prior data during the transitional period.
Lack of Transparency in Subcontractor and Affiliate Costs
Prime contractors are responsible for the integrity of all subcontractor and inter-company billings. Prior GAO audits have highlighted gaps in oversight when primes do not obtain detailed support for lower-tier charges.
Timekeeping and material handling practices must flow down to subcontractors, and supporting documentation must be readily available at all times. Having inadequate oversight in this area introduces a risk of fraud and undermines system approval.
GAO-09-468 and GAO-25-107558 provide examples of how visibility gaps have led to cost disallowances and increased scrutiny over time.
Staying Ready Beyond Approval
Switching to a DCAA-compliant accounting system involves several technical upgrades that require operational discipline, policy clarity, and a firm-wide commitment to audit readiness to succeed. Common mistakes occur when organizations treat compliance as a static requirement rather than a continuous, dedicated effort.
At Diener & Associates, our experienced team works closely with government contractors to implement systems that meet federal expectations while supporting business growth. As a trusted partner since 1989, we combine deep regulatory knowledge with the personal attention and responsiveness of a dedicated CPA firm.
Schedule a consultation online or call 1-(703)-386-7864 to speak with our professionals about DCAA compliance, accounting system setup, and how we can provide long-term support to your organization.