The Defense Contract Audit Agency (DCAA) has been refining its audit processes and procedures in light of criticisms from several Government Accountability Office reports. The agency also has been facing increasing demand for its services without a corresponding increase in staffing levels. This article addresses how the DCAA is changing and focusing its efforts and the possible impact to your organization from an audit standpoint.

DCAA’s Audit Services

     DCAA’s audit services are generally limited to acquisitions/contracts made under FAR Part 15 (Contract by Negotiation). This would exclude contracts awarded under General Services Administration Schedules and Commercial Contracts (FAR Part 12). The DCAA’s audit services typically include:

• Pre-award audits – Accounting system, Price proposals, Forward pricing
• Post-award audits – Incurred costs, CAS, claims
• Business systems – accounting and billing, estimating, material management
• Negotiation assistance.

     Thus, it is possible to have interaction with DCAA during all phases of the contract lifecycle.

Risk-based Audits

     To ensure that its limited resources are focused on efforts with the highest potential payback to the Pentagon, DCAA has adopted a “risk-based” audit model. It identifies the following factors as “high risk,” thus warranting more audit scrutiny of the contractor:

• High dollar value contracts
• Contractors with a history of poor performance
• Contractors who previously had high rates/amounts of questioned costs
• Contractors with weak internal controls.

     Contracts and companies that fall into any of these categories can expect increased audit scrutiny.

Priority-based Audits

     The DCAA also adopted a priority-based system for performing the various types of audits. The following have been designated as their highest-priority audits:

• Audits of Overseas Contingency Operations
• Forward Pricing Audits
• Equitable Adjustments and Termination Claims
• Incurred Costs Audits.

Incurred Costs Audits

     Unfortunately, in recent years, incurred costs audits have been among DCAA’s lowest-priority audits, causing contractors to have many years’ worth of incurred costs going unaudited. This has adversely impacted contractors by:

• Reducing cash flows resulting from unaudited rate differentials;
• Making the audits much more difficult to perform due to the challenge of locating records from years back;
• Creating issues in various mergers and acquisitions due to uncertainty regarding any liabilities that would result from unaudited years.

Multiple-year audits

     When DCAA finally does call you to perform the incurred cost audits for the open years, instead of doing one year at a time as they have in the past, expect them to perform multiple years at a single time.

     Among the areas for which you can expect scrutiny are the costs of professional and consulting services.

Professional and Consultant Services Costs

     Historically, this has been a cost category in which DCAA has found significant amounts of unallowable costs. FAR 31.205-33(f) places documentation requirements on contractors for these costs to be considered allowable. The FAR requires an agreement that explains what the consultant will be doing for the contractor; an invoice, including sufficient backup evidence on the time expended and nature of the services provided, to determine what was done; and final work product and/or related documents.

     Many contractors do not fulfill these documentation requirements and run the risk of having DCAA question these costs as unallowable.

Executive Compensation

     For privately-held companies, executive compensation is the cost category where DCAA has had the highest dollar amount of disallowed costs. DCAA will utilize salary surveys of companies comparable to yours to determine a “reasonable” level of compensation for your executives. Any amounts over the survey levels will be deemed unallowable.

     Contractors seeking to maximize their reimbursement of executive compensation should subscribe to salary surveys or hire a compensation advisor.

Allowable Cost and Payment Clause

     Per FAR 52.216-7(b)(1), contractors should only be reimbursed for allowable costs that are paid in the ordinary course of business (ordinarily within 30 days of the request for payment to the Government). Costs incurred and included in progress bills but not paid in the ordinary course of business can be deemed unallowable.

     Many contractors include the invoice of their subcontractors in a progress billing; however, they will not pay the subcontractor until payment is received from the government. If you are following this practice, you should have this provision included in your Subcontract Agreement so as to establish your “ordinary course of business” with this particular subcontractor.

Conclusion

     Contractors have been frustrated by both the increased scrutiny they have been receiving from DCAA and even by their lack of scrutiny (in the case of years of unaudited incurred costs submissions). Expect these trends to continue at least for the near term.

Michael Smigocki, CPA, CVA, ABV is the Senior Managing Director of Federal Strategies Group, LLC. He can be reached via email at MikeS@FedStrat.com.