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Three Broad Issues a DCAA Audit Can Uncover for Government Contractors

Written by S. Hobie Frady, CPA on August 12, 2020

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Without question, the best way to ensure DCAA audit success is preparation. If there are any inaccuracies or problems with your systems and processes, you want to find them — and fix them ­— before the audit begins.

So, what can you do to get ready and give your company the best chance of achieving DCAA audit compliance?

The DCAA auditor’s perspective

A good place to start is to understand what a DCAA audit focuses on and the areas that attract scrutiny.

There are different types of audits, with incurred cost and pre-award being the most common. Given DCAA’s objective of protecting taxpayer money—by securing the best value contracts for the Department of Defense and preventing fraudulent billing to the government—the auditor’s primary concern is around costs (how they are classified, segregated, allocated and reported).

Consequently, there are three broad types of issues the auditor will look to uncover:

1. Time keeping issues

Problems related to time tracking are often discovered during an audit. There are extensive and onerous rules around how timesheets should be prepared and submitted to ensure the correct labor cost can be calculated.

Some requirements include:

  • All employee hours should be recorded, including both direct and indirect work;
  • Employees should record their timesheets daily (supervisors cannot complete timesheets on employees’ behalfs);
  • Supervisors need to sign and approve every timesheet;
  • Employees cannot record time in advance of the work being done;
  • A record of the hours worked by each employee for each project must be maintained; and
  • time must be charged accurately against each charge code.

Unfortunately, a government contracting company will not meet DCAA audit requirements if its time tracking procedures and processes do not follow guidelines contained in the FAR or if its policies are not clearly documented.

While the timekeeping can be done in ink or through software, an auditor may conclude that the system of recording is inadequate to track the time spent and cost per contract.

Additionally, there could be issues with audit trail if the auditor cannot trace a transaction through the accounting system all the way back to an approved timesheet.

Of course, lack of employee training or training gaps regarding timesheets could lead to non-compliance, and red flags will be raised if there are not regular floor checks to ensure correct time tracking procedures are followed along with ongoing training.

2. Accounting system issues

A DCAA audit can also uncover issues related to how your company accounts for financial transactions. Ideally, your accounting system should be integrated with your timekeeping system, be capable of separately tracking direct, indirect and unallowable costs, and identify direct costs by contract.

GAAP compliance

To satisfy DCAA audit requirements, you’ll need to demonstrate that your accounting system adheres to Generally Accepted Accounting Principles, or GAAP.

For example, financial transactions should be accounted for on an accrual rather than cash basis. That means recognizing revenues or costs when you have earned the right to receive money or when you’ve incurred the obligation to pay.

If your chart of accounts is missing receivable/payable accounts or unearned revenue/prepayment accounts, then you could be accounting on a cash rather than accrual basis.

Revenue recognition

Inaccuracies with revenue recognition are common too.  Revenue recognition is centered around agreed deliverables under contract, and can become highly complex depending on:

  • The type of government contract, such as Time and Materials (T&M), Firm Fixed Price (FFP) and Cost-Plus-Fixed-Fee (CPFF), amongst others;
  • Whether two or more separate contracts need to be combined to identify deliverables and transaction price; and
  • Whether there are multiple deliverables in a single contract.

Revenue recognition rules have changed with the recent implementation of ASC 606, so if you have not updated your revenue recognition policies to be compliant you need to do so.

Direct, indirect and unallowable costs

According to Federal Acquisitions Regulations (FAR) 31 — Contract Cost Principles and Procedures, direct, indirect and unallowable costs need to be segregated for DCAA audit compliance. Every direct cost transaction should have a job number or project number assigned to it.

Indirect cost is where disputes often arise.  These costs must first be grouped into logical categories, such as general and administration, fringe and overhead, then allocated to every contract using a clear methodology. Contractors potentially need to keep track of multiple overhead and/or fringe pools.

Auditors will examine the government contractor’s indirect rates, which could be based on a two-tier or three-tier structure.

Additionally, FAR 31 stipulates certain costs (such as unapproved overtime premiums) are unallowable. To comply with DCAA audit requirements, these need to be tracked but made clear that they will not be billed.

3. Documentation and record keeping issues

Finally, documentation and record keeping problems often become apparent during a DCAA audit.

Your business systems, including timekeeping and accounting systems, processes and policies, should be written down.

Supporting evidence for expenses such as company records, reports and receipts should be filed in an organized way so that they’re easily made available. Remember, the auditor will want to trace some transactions, say a travel expense, from trial balance to an expense report, then all the way back to proof of payment.

Adopting best practices for a DCAA audit

Having DCAA compliant business systems requires adopting best practices, and this means your company will have accurate data for better business decisions, ultimately increasing your competitiveness.

Achieving DCAA audit compliance from an accounting perspective takes time, effort and specialist knowledge. Apart from FAR and GAAP, understanding of Cost Accounting Standards (CAS) is also required. If you’re in doubt about your company’s accounting system and data, Warren Averett’s industry experts can help identify and resolve issues before an audit begins.

Now that you know the types of issues a DCAA audit can reveal, how will you go about identifying problems with your current systems and processes, and proactively fix them, before the audit begins?

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