Column: Plan for DCAA audits even before you win

A Defense Contract Audit Agency (DCAA) audit is an evaluation of your company against government standards and regulations. This column addresses the types of DCAA audits, the conditions that initiate them, the purpose of the audit, and how to prepare, in order of the life cycle of a typical contractor.

1) Preaward Pricing Proposal Review

Condition: The contractor has submitted a cost proposal on a Negotiated Contract procurement (Federal Acquisition Regulations Part 15).

Purpose: To determine if the proposed pricing in the cost proposal is fair and reasonable. Pricing is considered fair and reasonable if there is adequate competition or if the pricing is based on projected costs that are reasonable, allocable, and allowable per the FAR. The auditor will examine the contractor’s basis and support for the projected costs. The auditor will produce a report that projects the evaluated price of your cost proposal. This could determine win versus loss of this procurement.

Preparation: All proposed costs should have a valid basis with supporting documentation. The ideal would be to utilize FAR Table 15-2 as a basis to prepare every cost proposal.

2) Preaward Accounting System Review

Condition: The contractor has submitted a cost proposal on a FAR Part 15 Negotiated Contract procurement. (Both cost plus and time and material are considered cost reimbursable contracts.)

Purpose: The auditor’s job is to evaluate the contractor’s accounting system to determine if it is adequate. To be determined responsible, the contractor must have necessary accounting and operational controls in place. The auditor uses the SF1408 from FAR Part 53 as a guideline, checking “Yes”, “No”, or “N/A” to every applicable criteria. Any “No” will result in the system failing the review.

Preparation: Make sure your accounting system meets the guidance of FAR Part 31 and the SF1408. Design and develop effective written accounting policies and procedures. Conduct a mock audit in preparation for the DCAA audit. Make necessary corrections before the audit begins. Pay special attention to timekeeping procedures as these cause the most failed reviews.

3) Financial Capability Review

Condition: The contractor has submitted a cost proposal on a Negotiated Contract procurement. The contracting officer is concerned that the contractor may not have the financial resources required to successfully perform the contract.

Purpose: The auditor’s job is to collect financial information to determine if the offeror has the financial capability to perform the contract.  The auditor will request financial statements and conduct a financial analysis on them. The auditor will focus on key financial ratios.

Preparation: The contractor should monitor its financial statements and financial ratios on a regular basis. Key items to monitor are:

• Equity on the Balance Sheet. It needs to maintain a positive amount.
• The current ratio. It needs to be above 1.0.
• The debt to equity ratio. It should be 3.0 or below.

4) Floorcheck Review

Condition: The contractor already has a cost reimbursable contract and a substantial number of employees.

Purpose: To evaluate the accuracy of labor hour charges to contracts, indirect accounts, or other cost objectives. Typically, this review is done without prior notification. This could determine the level of scrutiny the government uses in reviewing billings or even whether the government chooses to continue your current cost reimbursable contracts.

Preparation: The contractor must maintain an effective timekeeping and labor distribution system. Design and develop effective written timekeeping policies and procedures. Ensure that employees know and understand the policies and procedures.

5) Incurred Cost Audit

Condition: The contractor is performing on cost reimbursable contracts and is required to submit an annual incurred cost submission per FAR 52.216-7.

Purpose: To evaluate the accuracy of the incurred cost submission, and ultimately determining whether you have under-billed or over-billed the government. The auditor will conduct transaction testing of your general ledger and support documents to determine the total costs per contract with indirect costs applied. An important aspect is the determination of allowability, allocability, and reasonableness of costs.

Preparation: The contractor’s invoices must reconcile to the general ledger. An effective filing and record retention system is vital. Cost will be considered valid only if the auditor can substantiate them. The review of the source documents is required.

Anticipating these audits in advance, and preparing for them early, will make it easier for both you and the auditor. Audits are a necessary fact of life for government contractors; preparation reduces the time expended on audits – a win-win for both parties.

Kevin Duncan, CPA, MBA has over 30 years of experience in areas of accounting and financial management in the government contracting industry. Since 1994, Mr. Duncan has served as principle of KDuncan & Company. The firm specializes in providing accounting systems, indirect rate development, cost proposals, FAR compliance, and DCAA interface services to government contractors. Contact him at kevin@kduncan.com .

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Column: Plan for DCAA audits even before you win

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