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DCAA Contract Audit Manual: An Essential Guide for Government Contractors

Written by Hobie Frady on September 30, 2020

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Complying with the multitude of federal regulations is one of the critical aspects of being a government contractor. There are many essential regulations that contractors must adhere to, from the Generally Accepted Accounting Principles (GAAP) to the Federal Acquisition Regulation (FAR) and the Cost Accounting Standards (CAS).

The Defense Contract Audit Agency (DCAA) plays a crucial role in ensuring that contractors are compliant. The DCAA is responsible for conducting audits to ensure that government funds are used efficiently and in the best interests of the taxpayers who ultimately fund all projects performed by government contractors. After all, government contracts represent high-value financial instruments, and the DCAA guards taxpayer money closely to ensure that it is used responsibly.

The DCAA audit manual provides all the required information for government contractors; however, interpreting these guidelines can be cumbersome and time-consuming. This guide can help shine a light on the key requirements.

Navigating the DCAA Landscape

Government contractors face unique challenges that do not apply to private sector organizations. The DCAA, an agency of the United States Department of Defense (DoD), handles all contract audits and offers accounting and financial advice during contract negotiation, administration and settlement.

The DCAA oversees the close inspection of the accounting and financial structure of contractors who are awarded bids by the DoD. However, even before a contractor is awarded contracts with the DoD, the DCAA conducts pre-award audits to confirm that contractors that bid on contracts are sufficiently financially stable and have the capabilities needed to perform the duties of the contract.

DCAA Audits

Contractors must be prepared for audits by the DCAA, both pre-award and post-selection. These audits employ a broad range of guidelines and standards. All the guidelines and requirements are outlined in the DCAA audit manual.

Two particularly challenging aspects of DCAA compliance include Federal Acquisition Regulation (FAR) and the Incurred Cost Submission.

DCAA Compliance — FAR

The FAR standards apply a standard set of guidelines governing how federal agencies procure products and services. This step creates a uniform system that the federal government uses to:

  • secure fair pricing;
  • improve timeliness and service quality;
  • minimize the administrative operating costs; and
  • perform business with fairness and transparency.

Government contractors need to implement systems that help facilitate these fundamental principles. Having an accounting system that differentiates between direct and indirect costs is required to work with federal agencies.

  • Direct Costs — A direct cost is an expense that is incurred due to a single cost objective (e.g., task, contract, or project). Generally, these costs are required for contract performance. Some standard direct costs include equipment or materials used for only one cost objective. Also, labor costs or employees assigned to a single project would be considered a direct cost.
  • Indirect Costs — There are many costs that span multiple cost objectives. When costs cannot be attributed to a single task or project, these are known as indirect costs. For example, if a manager supervises many contracts, it would be challenging to try to allocate his time among each of the applicable projects. Allocating his portion of the total labor cost would be impractical.  Multiple projects that use the same pieces of equipment face the same difficulty. To address this problem, these indirect costs are handled differently than direct costs.
  • The Indirect Rate — Indirect costs are an essential component in the indirect rate. This measurement looks at a company’s financial situation. It also serves to fairly and equitably allocate indirect costs that are permitted in contracts.

“Pools” of indirect costs are used to allocate indirect costs to more than one project. This step involves employing either a two-tier or three-tier rate structure to effectively allocate costs across multiple projects.

DCAA Compliance — Incurred Cost Submission (ICS)

A particularly challenging aspect of DCAA compliance involves the Incurred Cost Submission. This is the most common audit performed by the DCAA and aims to ensure that claimed actual costs match the billed costs. But the identification of direct costs to contracts, the rate structure, as well as the indirect costs and unallowable costs, can be challenging to navigate, particularly for those without much prior experience.

Unallowable Costs vs. Allowable Reimbursements

It is important to note that contractors must provide sufficient documentation for all costs. Allowable costs must meet the five criteria outlined in the FAR:

  • Allocable (refers to costs that are attributed to the fulfillment of the contract, benefits the contract and its required work, and is necessary to the successful business operations)
  • Meet accounting standards determined by the Cost Accounting Standards (CAS) Board
  • Follow contract terms
  • Reasonable (requires that a cost does not exceed a typical cost for a prudent contractor)
  • Adhere to FAR subpart limitations

Costs that are considered allowable must follow generally accepted sound practices that adhere to all federal and state regulations, enable the contractors to effectively represent their stakeholders and be consistent with their established practices.

Simply put, DCAA contract audit manual unallowable costs include any cost that fails to meet each of the five criteria listed above or those listed as expressly unallowable in FAR 31.205.  So according to the guidelines outlined in the DCAA contract audit manual, unallowable costs represent a potentially significant share of costs for contractors.

Expert Help Is Available

Becoming a government contractor can be an extremely lucrative proposition. But with the increased opportunity comes a multitude of unique systems and regulations that contractors must follow.

Navigating the complexities of DCAA compliance and the DCAA contract audit manual can be challenging. But you do not have to face these difficulties alone. The expert team of professionals at Warren Averett can help make DCAA compliance much easier, leaving you more time to focus on operations.

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