Government audits are never the high point of managing a business; yet, great businesses are prepared to face the inevitable audit and use it to their advantage. Aside from the Federal Acquisition Regulation (FAR), Generally Accepted Accounting Principles (GAAP), and Cost Accounting Standards (CAS), most government contractors will also face an audit from the Defense Contract Audit Agency (DCAA).
The plethora of acronyms are confusing, and many businesses are nervous about their government contracts because of the depth of involvement. The DCAA’s Contract Audit Manual is a 15 chapter document available online, and this is only one of the many documents that covers accounting policies and procedures for government contractors.
Here, we’ve outlined the basics as a sort of policies and procedures manual that government contractors can review to be more informed of what the DCAA requires.
Policies, Planning and Practice
The best time to achieve success in an audit is before it ever happens. Businesses that assume they are going to be audited and prepare their policies and procedures for that fact will fare better in the inevitable audit.
Cash controls and budgeting need to be in place before pursuing a government contract. Since cost elements are the driving factors behind all government contracts, businesses must have an accurate and reliable way to track project costs, including direct and indirect costs, as well as the procedural understanding to know what are unallowable costs in the government contracting system.
Attribution and Allocation
Cost attribution and allocation, the tracking of money, time, capital and other items, must be defined and practiced before engaging in government contracting work. Any business working on more than one project will need to be able to attribute employee hours, capital costs, supplies and inventory and other costs according to each project.
If a business submits a cost for reimbursement that is not allowed by the agency requesting the work, the government accounting audit will uncover that discrepancy and disallow it. This move saves the taxpayer money but can cause unplanned costs for the contractor. In order to prevent this and provide the best return on any government contracting, contractors need to plan for these costs, have policies to track attribution and allocation and have practical procedures in place before they start contract work.
Allowable vs. Unallowable Costs
The Federal Accounting Regulation Cost Principles Guide mentions “unallowable” 268 times in 184 pages of policy. Although the DCAA has some higher-level information on what is allowable and not, the topic of allowable and unallowable costs is incredibly complex.
The most basic idea behind unallowable costs is that there are some items that a business will pay for that are not necessary for successfully implementing specific contracts with the U.S. government.
For a cost to be allowable, it must meet five basic standards:
- The cost must be reasonable;
- The cost must be allocable;
- The cost must meet the standards of the Cost Accounting Standards Board for accounting;
- The cost must meet the requirements of the contract; and
- The cost must meet the requirements laid out in federal code, specifically the cost principles guide.
Any cost that is reasonable and can be allocated to specific parts of the project—and does not violate any documented exceptions in FAR 31.205 and accounting principles—is allowable. The checklist is simple, but understanding whether a cost is allowable or not is complex.
Direct vs. Indirect Costs
Another item to give thought to when considering creating an accounting policies and procedures manual for government contractors is whether a cost is directly attributable to the project or indirectly attributable.
Segregation of direct and indirect costs is as important to DCAA compliant accounting as whether one of the costs is allowable or not. A direct cost is allocable directly to the projects defined in the contract. An indirect cost is one that either is allocated to more than one final cost objective or if it is an intermediary cost.
Both direct and indirect costs can be unallowable if they do not fulfill the auditors’ reasonableness standards or if they are defined as unallowable by federal law or code, by the specific contract or by generally accepted accounting principles.
How to Prepare for an Audit
Many business owners face the likelihood of a DCAA audit with a certain amount of fear and trepidation. Digging into the legal, financial and procedural requirements of the systems included in government contract work can make many businesses avoid government contracting.
It doesn’t have to be this way.
For many businesses, the best way to prepare for DCAA audits is simply to build and implement a policy manual for a DCAA compliant accounting system.
A good accounting system increases profits through proper cash management. Rather than having cost overruns and losing income during an audit, great accounting gives teams the controls to avoid unnecessary costs. Strong accounting also ensures that records are kept to demonstrate reasonableness, allocation and compliance for each item that is submitted as a cost for fulfilling a government contract.
Government contractors that need to develop their own policy manual and procedures for meeting DCAA and FAR requirements can use Warren Averett’s consultation for government contractors. Rather than reinventing a very big wheel, businesses who use Warren Averett are able to build on the expertise of leading accountants.