When is a DCAA Audit Required?

There’s a standard quip in government contracting circles: “75% of the Earth is covered in water – the rest is covered by auditors.”

This may seem especially true depending on the type of contract you have with the government or a prime contractor. While a fixed price contract places most of the risk burden on the contractor to deliver products and services on time and on budget, a cost-reimbursement contract is quite different. In this case, the burden of risk shifts to the government. There’s a risk that the project could go over budget, with the government (and taxpayers) potentially on the hook. While fixed price contracts are typically financed through milestone payments, reimbursing contractors or subs on a “cost-basis” opens intriguing issues and risks with accounting and performance.

In order to manage this risk, the government has developed a number of risk-mitigating approaches, many of which are “surveillance” or audits.

With so many different types of DCAA audits, and events that can trigger them, many contractors will often ask "when is a DCAA audit required?"  The standard answer DCAA gives is simply that audits are triggered when a contracting officer needs a contractor to be audited, due to the type of contract being awarded or based on the compliance requirements of an award (and it is important to note that DCAA does not perform audits on request by contractors, rather, they only perform audits based on a request or established need from a federal government entity).

But, as with everything in life, the answer is more nuanced, and there are numerous events that can trigger a DCAA audit (and each audit type is different, and serves a different purpose).

Let's cover some of the most important examples:

DCAA Pre-award Accounting System Survey

A government contracting office may initiate their own review of an accounting system or ask the Defense Contract Audit Agency (DCAA) to conduct a formal “pre-award survey”. The objective of the review is to vet a contractor’s accounting system so that it can efficiently and accurately account for costs under a cost-reimbursement type contract (which is why it is so common with SBIR Ph II awards, and other awards with the DoD and DHS). In engineering terms, this is a “design review” of the accounting system setup including timekeeping and labor distribution processes, identifying project costs from administrative costs, and calculating indirect rates, among other steps. This is a rather speedy process since passing this exam is required before a contract is signed. Passage of this step is not guaranteed, and those without a deep understanding of special cost accounting rules will either suffer or fail, potentially losing out on a contract award. 

To learn more about the SF1408 preaward audit survey, download "ReliAscent's Quick Guide to the DCAA Compliant Accounting System - Understanding the SF1408."

Regulatory References: FAR 9.104-1, 9.105-1, 9.106-4, FAR Part 31, SF1408

Post Award Accounting System Audit

After the first hurdle is passed with the accounting system survey, the government imposes the right to audit contractors’ accounting systems either on a routine basis or in case some minor deficiencies were detected during the pre-award survey or other government audits. The scrutiny is more intense since it examines actual accounting data against criteria established by the government for a suitable accounting system. This audit may take months to complete with multiple rounds of calls for raw data, written processes, and detailed cost justifications. This audit may also encompass ethics, and contract or subcontract management. Major defects detected are passed on to the contracting officer who has a variety of options they can impose to include immediate corrective action, partial or total withholding of payments, or termination of the contract and referral to the Department of Justice.

Regulatory References: FAR 42.1, 42.302, 42.603, DFARS 252.242-7006, FAR Part 31, FAR 52.232-20/-22

Timekeeping Floor Check

While not officially called an audit, this is the only time the DCAA is allowed to visit a contractor unannounced. The floor check is an examination of employee timecards, timekeeping policies, and the reliability of the timekeeping system. Results are shared with the contracting officer which can lead to any number of undesirable outcomes if major non-compliances are detected.

Regulatory Reference: FAR 31.201-4

Invoice (Voucher) Audit

Contractors having cost-plus type contracts may bill the government for their ongoing costs, including indirect costs, as well as fee. Billed costs for a period should include accrued labor and other non-labor project costs. Approved indirect rates (see PBR below) are added, along with the negotiated fee.

The DCAA may initiate an audit of one or more invoices to make sure costs are justified as contract costs, that indirect rates are being applied appropriately, and that certain contract cost limits are being observed. This may lead to an examination of timesheets and purchase orders or supplier invoices. Invoicing the government may be paused to correct any deficiencies.

Regulatory References: FAR 4.703, 52.216-7

Provisional Billing Rate (PBR) Proposal Review (annual)

Once a contractor has been awarded a cost-type contract, they are allowed to bill for actual costs plus a predetermined indirect billing rate. Unless a contractor has negotiated a multi-year Forward Pricing Agreement (unusual for SBIR and small business contractors), they must provide the DCAA with their Provisional Billing Rate Proposal at the beginning of a contract (if this is their first cost-plus type contract) or at the beginning of each fiscal year of the contract. This represents the proposed indirect billing rate for a particular fiscal year. The DCAA will make assessments of the adequacy and accuracy of your calculations. This may lead you to revisions and negotiations before billing rates are approved.

Regulatory References: FAR 42.7, 52.216-7

Incurred Cost Proposal (ICP) Audit (annual)

While the PBR proposal above negotiates the projected indirect billing rate to use for cost-plus type contracts, the Incurred Cost Proposal looks back on an accounting period to calculate actual indirect rates, and applies those rates to the jobs costs for cost-type contracts. Cumulative costs are compared between what was billed and what actual costs are derived from the ICP.

The ICP is due to the DCAA six (6) months after the fiscal year ends. The DCAA evaluates the ICP for “adequacy” (errors and omissions), then schedules an audit. This audit is perhaps the most intense and can take longer than the accounting system audit since this serves as the government’s final determination and agreement of contract costs over any number of years. All ICPs for all contract years must be “closed” before a contract can be closed.

Fortunately for many small businesses, the government and DCAA agreed to a sampling technique to identify low-risk ICPs, making ICP audits less frequent. However, this agreement can be rescinded at any time.

Regulatory References: FAR 42.7, 52.216-7, DoD Class Deviation 2012-O0013

Proposal Cost and Pricing Data

Many firms new to government contracting are surprised that scrutiny of their accounting system may be conducted when negotiating the budget for a contract. Budgets are organized in essentially the same manner across all contract and grant agencies. Project costs (labor and non-labor) are first estimated. Indirect or administrative costs are then added as a percentage of the project costs. The negotiating agency may require justification of the indirect rates in a manner that may be foreign to a contractor or grantee. If an applicant can’t readily identify production costs from administrative costs in their accounting system, the government will have little confidence in their proposal price.

The DCAA or another government pricing expert may take the lead on this review.

Regulatory References: FAR 15.404-1

The Tip of the Iceberg...

The DCAA may get involved in other audits which primarily only affect large businesses:

• Defective Pricing
• Cost Estimating
• Earned Value Management
• Material Management
• Forward Pricing Proposals

DCAA Audit Support

As you can tell, the government goes to great lengths to reduce the risk of procuring products and services. This means that government contractors with cost type contractors (or those with FFP contracts having cost reimbursable CLIN's, and even some subcontractors), will eventually need audit support from experts. If your business needs DCAA compliance and audit support, or if you need to install a DCAA compliant accounting system, contact us today. ReliAscent provides both monthly accounting and as-needed consulting and audit support services to government contractors and grantees, and we are happy to help.