Government Contract Audits: Complete Preparation and Compliance Guide
Learn how to prepare for DCAA audits, understand audit types, maintain compliant accounting systems, and navigate the federal contract audit process successfully.
Quick Overview: Government Contract Audits
Government contract audits verify that contractors comply with federal regulations and charge appropriate costs. The Defense Contract Audit Agency (DCAA) conducts most audits, reviewing thousands of contractors annually. Proper preparation and compliant systems are essential for successful audits.
What is DCAA?
The Defense Contract Audit Agency (DCAA) is the primary audit agency for government contracts. While focused on defense contracts, DCAA also supports other agencies and provides contract audit services government-wide.
DCAA's Mission
- ✓Verify contractor cost proposals and claims
- ✓Audit incurred costs on flexibly-priced contracts
- ✓Evaluate contractor accounting and business systems
- ✓Support contracting officers with financial advisory services
When DCAA Gets Involved
- •Cost-reimbursable contracts
- •Time and materials contracts
- •Price proposals over thresholds
- •Incurred cost submissions
- •System reviews and approvals
Types of Government Contract Audits
Different audits serve different purposes. Understanding each type helps you prepare appropriately and maintain ongoing compliance.
Accounting System Audit
Evaluates whether your accounting system meets government requirements for tracking and accumulating costs on government contracts.
- • Required for cost-type contracts over $750K
- • Reviews policies, procedures, and controls
- • Tests transaction processing
- • Results in adequate/inadequate determination
Incurred Cost Audit
Reviews actual costs claimed against flexibly-priced contracts to verify they are allowable, allocable, and reasonable.
- • Based on annual incurred cost submission
- • Examines direct and indirect costs
- • Determines final billing rates
- • May result in questioned costs
Proposal Audit
Evaluates cost proposals to help contracting officers negotiate fair and reasonable prices.
- • Reviews proposed rates and costs
- • Verifies cost estimating methodology
- • Checks for compliance with cost principles
- • Required for large sole-source awards
Business Systems Review
Comprehensive review of contractor business systems required for large DoD contracts.
- • Accounting system
- • Estimating system
- • Purchasing system
- • Property management system
Accounting System Requirements
A DCAA-compliant accounting system must meet specific criteria outlined in FAR 16.301-3 and DFARS 252.242-7006. Meeting these requirements is essential for winning and performing cost-reimbursable contracts.
Key System Requirements
Segregate Costs by Contract
Track direct costs separately for each contract, task order, and CLIN
Accumulate Indirect Costs in Pools
Properly allocate overhead, G&A, and other indirect costs to appropriate pools
Distinguish Direct from Indirect
Maintain clear policies for classifying costs as direct or indirect
Exclude Unallowable Costs
Identify and exclude costs not allowed under FAR Part 31
Provide Timely Reporting
Generate reports showing costs at the contract level when needed
Common Unallowable Costs
These costs cannot be charged to government contracts:
- • Entertainment
- • Alcoholic beverages
- • Donations
- • Lobbying
- • Bad debts
- • Fines and penalties
- • Most interest costs
- • Organization costs
- • Personal use items
Incurred Cost Submissions (ICS)
Contractors with flexibly-priced contracts must submit annual incurred cost proposals within 6 months of their fiscal year end. This submission documents all costs claimed and supports final contract billing.
| Schedule | Description | Key Content |
|---|---|---|
| Schedule A | Transmittal Letter | Cover letter with certifications |
| Schedule B | Indirect Expense Pools | Overhead, G&A breakdown |
| Schedule H | Contract Summary | Direct costs by contract |
| Schedule I | Rate Calculation | Indirect rate computations |
| Schedule J | Billing Rate Comparison | Provisional vs. actual rates |
Penalty for Late Submission
Failure to submit an adequate ICS within 6 months can result in unilateral establishment of final indirect cost rates by the contracting officer, withholding of payments, or contract termination. Timely submission is critical.
Audit Preparation Strategies
Proactive preparation significantly improves audit outcomes. The best time to prepare for an audit is before it begins—preferably throughout the year.
Pre-Audit Checklist
Document Policies and Procedures
Written policies for timekeeping, purchasing, travel, and cost allocation
Reconcile Accounts Monthly
Ensure general ledger matches subsidiary ledgers and billings
Maintain Supporting Documentation
Keep receipts, approvals, and business purpose for all costs
Review Timekeeping Records
Daily time entries with supervisor approval and proper coding
Conduct Internal Audits
Self-review systems and transactions before DCAA arrives
Common Audit Findings
Understanding common deficiencies helps you focus compliance efforts where problems typically occur.
Timekeeping Deficiencies
Labor is the largest cost category and most frequently questioned. Common issues include late time entries, missing supervisor approvals, improper corrections, and failure to charge leave properly.
Unallowable Cost Inclusion
Charging unallowable costs like entertainment, alcohol, or excessive executive compensation to contracts. Inadequate systems to identify and exclude these costs.
Indirect Rate Issues
Improper allocation of indirect costs, inconsistent treatment between periods, or failure to segregate B&P and IR&D costs properly.
Inadequate Documentation
Missing receipts, lack of business purpose documentation, or failure to maintain contemporaneous records supporting claimed costs.
Subcontract Administration
Failure to obtain required cost or pricing data from subcontractors, inadequate consent documentation, or lack of subcontract audit requirements.
Best Practices for Audit Success
1. Establish Compliance Culture
Make compliance a company-wide priority from leadership down. Train employees on proper procedures and emphasize the importance of accurate record-keeping.
2. Invest in Systems
Use accounting software designed for government contracting with proper job costing capabilities. Consider specialized government contracting accounting systems like Deltek, Unanet, or similar platforms.
3. Cooperate with Auditors
Provide requested information promptly and completely. A cooperative approach builds credibility and can lead to more favorable outcomes. However, consult with counsel before admitting issues.
4. Address Findings Promptly
When auditors identify issues, take immediate corrective action. Document your response and implement systemic fixes to prevent recurrence.
5. Know Your Rights
Understand the audit process and your rights as a contractor. You can dispute findings through the contracting officer and ultimately through the appeals process if necessary.
Frequently Asked Questions
How far back can DCAA audit?
DCAA can audit any year for which final indirect rates have not been established. Maintain records for at least 6 years after final payment on a contract. Some contractors have audits covering multiple years simultaneously.
What happens if my accounting system fails audit?
An inadequate system determination can result in payment withholdings, inability to receive new cost-reimbursable awards, or requirements to fix deficiencies. Work with DCAA to develop a corrective action plan.
Do I need an audit for fixed-price contracts?
Fixed-price contracts generally don't require incurred cost audits since you're paid a set price regardless of actual costs. However, proposal audits may still occur for large sole-source awards, and system reviews may be required.
Can I dispute DCAA findings?
Yes. DCAA provides recommendations to contracting officers, who make final decisions. You can present additional information or arguments to the CO. If disagreements persist, the Contract Disputes Act provides appeal rights.
How do I prepare for a floor check?
Floor checks are unannounced visits to verify employees are working as charged. Ensure timekeeping is accurate daily, employees know their charge codes, and records reflect actual work being performed.
Find Audit-Friendly Opportunities
BidFinds helps you find government contracts that match your capabilities and compliance readiness. Start with contracts appropriate for your systems maturity.
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