DCAA Audits: How to Prepare and What to Expect

The Defense Contract Audit Agency (DCAA) is the federal agency responsible for auditing Department of Defense contractors. DCAA also performs audits for other federal agencies that request their services.

DCAA's mission:

• Audit contractor proposals and billing systems
• Verify that contractor costs are allowable, allocable, and reasonable
• Assess contractor accounting system adequacy
• Identify fraud, waste, and abuse

When you'll encounter DCAA:

• Cost-type contracts — Reimbursed costs must be verified
• Cost proposals — Forward pricing proposals over certain thresholds
• T&M contracts — Labor rates may be audited
• Progress payments — Liquidation rates reviewed
• Subcontracting — If you're a sub on audited prime contracts

DCAA authority:

DCAA is an advisory agency — they make recommendations to contracting officers, who make final decisions. However, contracting officers typically follow DCAA recommendations. A negative DCAA finding can kill a contract or proposal.

DCAA vs. DCMA:

DCAA audits costs and accounting systems. DCMA (Defense Contract Management Agency) manages contract administration. They're separate agencies with different responsibilities, though they coordinate on contractor oversight.

Accounting System Audits:

Reviews whether your accounting system meets government requirements. Looks at:

• Proper segregation of direct and indirect costs
• Timekeeping procedures
• Labor distribution
• Cost accumulation by contract
• Internal controls

Result: System approved/adequate or inadequate. Inadequate systems can't be used for cost-type contracts.

Pre-Award Audits:

Reviews cost proposals before contract award. Examines:

• Labor rate reasonableness
• Indirect rate validity
• Other direct cost support
• Proposed profit reasonableness

Result: Questioned costs recommendations to CO.

Incurred Cost Audits:

Reviews actual costs incurred during performance. Most comprehensive audit type. Covers:

• All direct and indirect costs claimed
• Final indirect rates
• Unallowable costs
• Compliance with CAS

Result: Final billing rate determination, potential repayment demands.

Other Audit Types:

• Post-award — Reviews after contract award
• Floor check — Unannounced visits to verify timekeeping
• Compensation — Executive compensation reasonableness
• CAS compliance — Cost Accounting Standards adherence

To be DCAA compliant, your accounting system must meet requirements in DFARS 252.242-7006. Key elements:

Cost segregation:

• Separate direct costs (charged to specific contracts)
• Separate indirect costs (pooled and allocated)
• Identify unallowable costs
• Track by contract, task order, and CLIN

Timekeeping:

• Daily recording of labor hours
• Employee signature/certification
• Supervisor approval
• Audit trail for changes
• Proper coding to projects/indirect pools

Job cost ledger:

• Accumulate all costs by contract
• Track labor, materials, subcontracts, ODCs separately
• Reconcile to general ledger

Billing system:

• Invoice generation matches cost records
• Provisional billing rates applied correctly
• Progress payments tracked

Internal controls:

• Policies and procedures documented
• Segregation of duties
• Regular reconciliations
• Management oversight

Software options:

Deltek Costpoint, Unanet, PROCAS, and similar systems are designed for DCAA compliance. QuickBooks can work for small contractors with proper configuration, but requires disciplined use.

Before the audit notice:

Don't wait for an audit to get compliant. Ongoing preparation includes:

• Maintain organized, accessible records
• Regular internal audits and reconciliations
• Policies and procedures documented and followed
• Staff trained on compliance requirements

When you receive audit notification:

1. Don't panic — Audits are routine for cost-type contractors
2. Review the request — Understand scope and document requests
3. Designate a point of contact — One person manages audit communication
4. Gather documents — Organize requested materials
5. Pre-screen for issues — Identify potential problems before auditors find them

Document organization:

• General ledger and subsidiary ledgers
• Timesheets and labor distribution
• Invoices and billing records
• Policies and procedures manuals
• Bank statements and reconciliations
• Tax returns

Consider engaging an expert:

For significant audits, consider hiring a CPA or consultant experienced in government contract auditing. They can help you prepare, identify issues, and interface with auditors.

Entrance conference:

The audit starts with a meeting to discuss scope, timeline, and process. Use this to:

• Understand what auditors are looking for
• Establish communication protocols
• Clarify any questions about requests

Best practices during fieldwork:

• Be cooperative but careful — Provide what's requested, don't volunteer extra
• Respond promptly — Delays create negative impressions
• Document everything — Keep records of all auditor requests and your responses
• Ask for clarification — If you don't understand a request, ask
• Review before providing — Check documents for accuracy before submission

Auditor interviews:

DCAA may interview employees about timekeeping, procedures, and job duties. Prepare staff:

• Answer questions honestly
• Don't speculate or guess
• It's OK to say "I don't know" or "I need to check"
• Don't volunteer information beyond what's asked

Managing issues that arise:

If auditors identify potential problems:

• Understand their concern fully before responding
• Provide additional documentation if available
• Explain context and business rationale
• Don't argue — discuss professionally

Timekeeping deficiencies:

• Employees not recording time daily
• Missing supervisor approvals
• Changes without proper documentation
• Mischarging labor between contracts

Unallowable costs:

FAR 31.205 lists costs that cannot be reimbursed under government contracts:

• Entertainment and alcohol
• Lobbying and political contributions
• Bad debts
• Interest (with limited exceptions)
• Excessive executive compensation
• Advertising (except recruiting)

Indirect rate issues:

• Costs in wrong pools
• Inconsistent allocation bases
• G&A base errors
• Unallowable costs not segregated

Internal control weaknesses:

• Lack of written policies
• No segregation of duties
• Missing reconciliations
• Inadequate documentation

Material misstatements:

• Billing errors
• Cost transfers without justification
• Rate calculation errors

Most findings are fixable with proper documentation and explanations. The goal is minimizing findings, not eliminating them entirely.

Draft audit report:

Before finalizing, DCAA provides a draft report for your response. This is your opportunity to:

• Correct factual errors
• Provide additional documentation
• Explain context for questioned costs
• Dispute findings you believe are incorrect

Writing your response:

• Respond to each finding specifically
• Provide supporting documentation
• Be professional — avoid emotional language
• Concede valid points; contest others factually

Final audit report:

DCAA issues final report to the contracting officer with recommendations. The CO makes final decisions on:

• Questioned costs
• System adequacy
• Required corrective actions

Negotiating with the CO:

If you disagree with DCAA's recommendations, negotiate with the CO. The CO has discretion to accept or reject DCAA's findings. Provide:

• Business rationale
• Supporting documentation
• Alternative interpretations

Corrective action plans:

For system deficiencies, you'll need to develop and implement corrective actions. Document:

• What you're fixing
• How you're fixing it
• Timeline for implementation
• Evidence of completion

If you have cost-type contracts, you must submit an Incurred Cost Submission (ICS) annually.

What is an ICS:

A certified report of actual costs incurred during the fiscal year, including:

• Direct costs by contract
• Indirect cost pools and allocation
• Final indirect rates
• Schedule of cumulative direct and indirect costs

When to submit:

Due within 6 months after your fiscal year end. For calendar year contractors, that's June 30.

What happens if you don't submit:

• Contract payments may be withheld
• Indirect rates may be unilaterally determined
• Future contracts may be affected

ICS format:

DCAA publishes a model incurred cost submission format. Use it — deviations create problems. Required schedules include:

• Schedule H — Contract Brief
• Schedule I — Cumulative Allowable Cost Worksheet
• Schedule J — Direct Cost by Contract
• Schedule K — Indirect Cost Pools

Certification:

The ICS must be certified by an authorized company official. False certification can result in False Claims Act liability.

Audit backlog:

DCAA has a significant audit backlog. Your ICS may not be audited for years. This doesn't mean you can be sloppy — when the audit comes, you need to be ready.