What Is a DCAA Audit for Government Contractors?

The Defense Contract Audit Agency (DCAA) conducts specialized audits for government contractors. These audits determine if costs charged to government contracts are allowable, allocable, and reasonable, ensuring appropriate use of government funds. The DCAA’s oversight helps contractors adhere to established regulations and contract terms. This auditing process is distinct from typical financial audits focused on Generally Accepted Accounting Principles (GAAP) for financial reporting. It is a key part of the federal acquisition process, applying to businesses that seek or have obtained government contracting work with the federal government.

DCAA audits can occur at various contract stages, from pre-award assessments to post-award reviews and special investigations. Compliance with DCAA requirements is essential for contractors. Non-compliance can lead to significant consequences, including penalties, contract termination, or disqualification from future government projects.

Understanding the DCAA’s Role

The Defense Contract Audit Agency (DCAA) operates under the Under Secretary of Defense (Comptroller)/Chief Financial Officer. Established in 1965, its mission is to provide audit and financial advisory services to the Department of Defense (DoD) and other federal entities involved in acquisition and contract administration.

The DCAA conducts independent audits of DoD contractors, including prime contractors, subcontractors, and even small businesses performing cost-reimbursement or time and materials federal contracts. These audits evaluate financial representations and assess compliance with federal regulations and contract terms.

The agency’s work helps determine if contract costs are allowable, allocable, and reasonable, preventing overpricing and fraud. DCAA provides recommendations to government officials who select contractors and negotiate prices. While the DCAA does not directly award contracts, its findings significantly influence contracting decisions and the procurement process’s financial integrity. The DCAA maintains the Defense Contract Audit Manual (DCAM), detailing audit processes and procedures.

Different Types of DCAA Audits

The DCAA conducts various audits tailored to different stages of the contracting lifecycle and specific financial areas. These audits ensure compliance with regulations like the Federal Acquisition Regulation (FAR) and Cost Accounting Standards (CAS).

Pre-Award Audits

These audits occur before a contract is awarded to assess a prospective contractor’s financial and accounting systems, internal controls, and pricing practices.
Pre-award Survey of Prospective Contractor Accounting System: Uses Standard Form 1408 (SF 1408) to determine if the contractor’s accounting system is adequate for a government contract. This review ensures the contractor can segregate costs, track expenses by contract, and meet timekeeping requirements.
Proposal Audits: Examine cost estimates and pricing methodologies for new contracts or modifications to ensure proposed costs are reasonable.
Forward Pricing Rate Proposal (FPRP) Reviews: Identify fair price allocations for various pricing elements within a contract.

Post-Award Audits

These audits occur after a contract is awarded to verify that incurred costs align with contract terms and regulations.
Incurred Cost Audits: Common post-award reviews assessing the accuracy of a contractor’s annual costs for allowability, reasonableness, and allocability. These scrutinize direct and indirect costs, ensuring compliance with contract terms, Cost Accounting Standards, and government laws. Contractors must submit annual Incurred Cost Submissions (ICS) to the DCAA, detailing actual costs incurred, typically within six months after the fiscal year end.
Accounting System Audits: Focus on the contractor’s accounting system and internal controls to verify compliance. They examine the system’s ability to segregate direct from indirect costs, track labor, and reconcile financial data.
Billing System Audits: Verify that payments submitted by the contractor are accurate and adhere to contract details, including avoiding overbilling.
Timekeeping System Audits: Assess timekeeping practices, ensuring accurate recording of labor hours and compliance with labor charging regulations.

Special Audits

The DCAA also conducts special audits at the request of contracting officers for independent financial opinions. These can include:
Reviews of financial capability.
Compliance with the Truth in Negotiations Act (TINA).
Investigations into potential fraud.
Performance audits evaluating contractor operational effectiveness and efficiency.
System audits assessing internal controls across business systems like estimating, purchasing, and property management.

Navigating a DCAA Audit

A DCAA audit typically follows a structured sequence from initial notification to the issuance of a final report. The specific method of audit performance can vary based on the contract type and the government agency involved.

An audit begins with a formal notification from the DCAA, outlining the scope of the review. Contractors should designate a knowledgeable individual as the primary point of contact to coordinate information requests and interact with the auditor.

An entrance conference often follows, where the DCAA auditor meets with the contractor to discuss objectives, timelines, and expectations. The auditor may also tour facilities. During fieldwork, the DCAA auditor evaluates financial records, requesting documentation like general ledgers, indirect expense statements, trial balances, invoices, receipts, and timecards. The auditor traces transactions through the accounting system to their source, ensuring proper support for claimed costs.

Maintaining organized and readily available records is important. Contractors must retain records for a specified period, and preparing these documents in advance streamlines the audit. After fieldwork, an exit conference is typically held. Here, the DCAA auditor discusses preliminary findings, allowing contractors to address issues or provide additional documentation.

Following the exit conference, the DCAA issues a draft audit report. The contractor can then provide a formal response, outlining disagreements or corrective actions. This response becomes part of the final audit report, submitted to the contracting officer. The DCAA aims to complete incurred cost audits within 12 months from submission, though many finish sooner.

Key Areas of DCAA Review

DCAA auditors meticulously examine specific financial and accounting areas to ensure compliance with government contracting regulations. These examinations focus on the substance of a contractor’s financial practices, not just procedural steps. The primary objective is to verify that costs charged to government contracts meet established criteria for allowability, allocability, and reasonableness.

Cost Allowability

Determined by Federal Acquisition Regulation (FAR) Part 31, a cost is allowable only if it complies with applicable laws, regulations, contract terms, and FAR cost principles. For example, entertainment costs are generally unallowable. Airfare exceeding the lowest available fare is also unallowable unless specific exceptions apply. Contractors must identify and exclude unallowable costs from direct billings or indirect rates.

Cost Allocability

A cost is allocable if it is assignable or chargeable to one or more cost objectives, such as contracts. A cost is allocable if incurred specifically for the contract, benefits both the contract and other work, can be distributed proportionally to benefits received, or is necessary to the business’s overall operation. This requires contractors to segregate direct costs (attributable to a specific contract) from indirect costs (benefiting multiple contracts or the business as a whole).

Cost Reasonableness

This ensures the cost, in its nature and amount, does not exceed what a prudent person would incur in a competitive business environment. Auditors evaluate if the cost is a recognized expense, consistent with sound business practices, and not significantly deviating from established practices or market prices. This assessment involves reviewing supporting documentation and market conditions.

Accounting System Adequacy

The DCAA emphasizes the adequacy of a contractor’s accounting system. An acceptable system, as defined by DFARS 252.242-7006, must ensure compliance, provide reliable cost data, minimize misallocations, and ensure billing consistency. Key requirements for a DCAA-compliant system include:
Adherence to Generally Accepted Accounting Principles (GAAP).
Ability to segregate direct and indirect costs.
Detailed job costing by contract line item.
Robust timekeeping.
Monthly reconciliation of indirect and direct costs in the general ledger.
A thorough audit trail.

Internal Controls

DCAA reviews a contractor’s internal control environment to assess how management ensures compliance and financial integrity. This includes evaluating segregation of duties, proper authorization for purchases, and monitoring subcontractor costs. Strong internal controls help prevent errors, fraud, and mischarging. Failure to maintain adequate internal controls can lead to questioned costs and potential penalties. Compliance with contract terms and government regulations, such as those in FAR Part 52, is also verified.