DCAA Approval – A Checklist for Success

A Defense Contract Audit Agency (DCAA) audit is an evaluation of a condition within your company measured against particular government standards and/or regulations. This post will address the types of DCAA audits, the conditions that initiate them, the purpose of the audit, and how to prepare. Below is a list of the various types of DCAA audits in order of the life cycle of a typical contractor, along with some helpful tips to ensure DCAA approval.

Preaward Pricing Proposal Review

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

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. Ultimately, the auditor will produce information for the government to project the real price of your cost proposal. For the contractor, this could determine win versus loss of this procurement.

Preparation: Proposed costs should have a valid basis with supporting documentation for DCAA approval. The ideal would be to treat every cost proposal as if the Government is referencing FAR Table 15-2 and requiring detailed support (see below).

The Ultimate Checklist for DCAA Approval

View Text Version of Table Above

Preaward Accounting System Review

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

Purpose: The auditor’s job is to evaluate the design of contractor’s accounting system to determine if it is adequate for prospective contract. Per FAR 9.104-1(e), to be determined responsible, the contractor must have the necessary accounting and operational controls in place. The auditor uses the SF1408 from FAR Part 53 as a guideline. The form is a checklist of criteria. The auditor must check “Yes” to all applicable criteria or you and your system fail the review. When you pass, you will move forward to the next step of the procurement process. Note: With DCAA approval, we find that most contractor deficiencies occur in the area of timekeeping.

Preparation: Get guidance in setting up your accounting system from an accounting professional that is familiar with FAR Part 31 and the SF1408. Design and develop effective written accounting policies and procedures. Have a mock audit conducted in preparation for the DCAA audit. Make the necessary corrections before the audit begins.

Financial Capability Review

Condition: The contractor has submitted a cost proposal on a Federal Acquisition Regulations (FAR) Part 15, Negotiated Contract procurement. The contracting officer has concerns that the contractor may not have the financial resources required to successfully operate the contract.

Purpose: Under FAR 9.104-1, decisions on contractor responsibility must consider whether the offeror has adequate financial resources or the ability to obtain them. The auditor’s job is to collect financial information to determine if the potential contractor has the financial capability required to perform the contract.  The auditor will request financial statements and conduct a financial analysis on them. The auditor will focus on 8 key financial ratios.

Preparation: The contractor should monitor its financial statements and financial ratios on a regular basis and make financial decisions that will maintain a healthy financial condition. Key items for DCAA approval 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.

Floorcheck Review

Condition: The contractor has a cost reimbursable contract or contracts with a substantial number of employees.

Purpose: To evaluate the accuracy of contractor employees (salaried and/or hourly) 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 whether the government chooses to continue your current costs reimbursable contracts.

Preparation: The contractor should design and maintain and effective timekeeping and labor distribution system for DCAA approval. Design and develop effective written timekeeping policies and procedures. There should be a system of self-monitoring, control, and correction in place.

Incurred Cost Audit

Condition: The contractor is performing on cost reimbursable contracts and is required to submit an annual incurred cost submission.

Purpose: To evaluate the accuracy of the incurred cost submission; ultimately determining whether you have under-billed or over-billed the government. The auditor will conduct transaction testing of your general ledger and the support documents available to support the transactions to determine the total costs per contract with indirect costs applied. An important aspect is the determination of allowability, allocability, and reasonableness of costs. Note: retaining source documents is of vital importance in these engagements. This will determine whether you owe money to the government or the government owes you.

Preparation: The contractor should prepare invoices to the government based on information provided by its accounting system. Thus, the invoices will be reconciled to the contractor’s 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 for DCAA approval.

KDuncan & Company LLC (KDC) is a Licensed Certified Public Accounting and Financial Services firm that provides support to agencies of the federal government and government contractors. KDuncan has more than 30 years of experience with DCAA approval and has a 98% success rate in getting clients’ accounting systems approved by DCAA. Learn more about our services.

KDuncan & Company is dedicated to providing knowledge and support for small government contractors about concerns regarding government contracting. For questions on areas such as as cost proposals, accounting systems, DCAA compliance, and incurred cost audits, reach out to KDuncan & Company.

Records Retention for Government Contracts

When one of our clients goes through an incurred cost audit with DCAA, I find that many times records retention is the most problematic area. FAR 31.201-2 Determining allowability, states:

A contractor is responsible for accounting for costs appropriately and for maintaining records, including supporting documentation, adequate to demonstrate that costs claimed have been incurred, are allocable to the contract, and comply with applicable cost principles in this subpart and agency supplements. The contracting officer may disallow all or part of a claimed cost that is inadequately supported.

The pending question is: For how long must the contractor maintain these records? FAR 4.705 provides the answer.

  • Contractors are required to retain financial and accounting records and acquisition and supply records for four years.
  • However, the specified retention period for time cards and evidence of payment for services rendered by employees is two years.
  • Whereas the retention period is four years for payroll sheets, registers of salaries and wages paid to individual employees, and tax withholding statements.

Why the difference? In the case: JANA, Inc. vs. U.S., “The court reasoned that reading the two retention periods “together suggests the logic between them: While a shorter retention period is imposed on voluminous records, like individual employee time cards, a longer period is required for records of a more summary nature, e.g., the labor recap sheets.”

In general, the retention periods are calculated from the end of the contractor’s fiscal year in which an entry is made charging or allocating a cost to a government contract or subcontract. Of course there are notable exceptions to the retention periods; where the periods can be longer:

  • A retention period longer than that cited in 703(a) is specified in any contract clause; or
  • The contractor, for its own purposes, retains the foregoing records and supporting evidence for a longer period. Under this circumstance, the retention period shall be the period of the contractor’s retention or 3 years after final payment, whichever period expires first; or
  • The contractor does not meet the original due date for submission of final indirect cost rate proposals specified in paragraph (d)(2) of the clause at 216-7, Allowable Cost and Payment. Under these circumstances, the retention periods in 4.705 shall be automatically extended one day for each day the proposal is not submitted after the original due date.
  • If a record contains a series of entries, the retention period is calculated from the end of the fiscal year in which the final entry was made.
  • If the contractor relies on records generated during one contract as certified cost or pricing data in negotiating another contract, the retention period runs from the date of the latter contract.
  • If two or more of the record categories described in FAR 4.705 are interfiled and it is impractical to screen the records for disposal, the entire record series must be retained for the longest period prescribed for any of the categories.

Also note that “supporting documentation” may be more extensive than you may imagine. Each time a client goes through an incurred cost audit, I am reminded of this. In general, supporting documentation encompasses the entire audit trail; from the time that you are considering buying something or hiring somebody through to termination of the agreement. This would include, but not limited to:

  1. Memoranda of negotiations
  2. Purchase agreements (signed by both parties)
  3. Hiring agreements (signed by both parties)
  4. Consulting and subcontract agreements (signed by both parties)
  5. Timesheets, payroll records
  6. Employee evaluations
  7. Modifications to subcontract and/or consulting agreements
  8. Notices of termination
  9. Employee benefits policy
  10. Bonus policy

In any of the documents are not fully executed, costs may be disallowed. If the contractor’s practice is not consistent with the agreement and/or policy, cost may be disallowed.

Takeaways

  • Be diligent, methodical, about the agreements relative to expenditures of costs under Government Contracts.
  • Be diligent, methodical, about retention of records within the parameters of FAR 4.7.
  • Do not maintain records for periods longer that you are required to under FAR 4.7.
  • If you have a requirement to submit an incurred cost submission under FAR 52.216-7, do so on time. If you don’t, your records retention requirement extends indefinitely.
  • If DCAA conducts an incurred cost audit after the specified retention periods have expired, the contractor’s costs cannot be disallowed based solely on the failure to retain adequate supporting documentation when the contractor is in accordance with FAR 31.201-2(d). At the very least, contractors may rely on alternative evidence.

Be sure to also check out this excellent article on the subject and contact us today for help with your records retention.

KDuncan & Company is dedicated to providing knowledge and support for small government contractors about concerns regarding government contracting. For questions on areas such as as cost proposals, accounting systems, DCAA compliance, and incurred cost audits, reach out to KDuncan & Company.

DCAA Audit Process: When Can You Expect A DCAA Audit

In our last blog post, we provided the background for what to expect from a DCAA audit. In this post, I’ll give share my experience concerning the “when” as part of the DCAA audit process.

As mentioned before, it is the Contracting Officer’s responsibility to request an audit.

A DCAA audit is an evaluation of a condition within your company against particular government standards and/or regulations. The various audits are:

  • Preaward Pricing Proposal Review
  • Preaward Accounting System Review
  • Financial Capability Review
  • Floorcheck Review
  • Incurred Cost Audit
  • Postaward Defective Pricing Audit

When to expect an audit is greatly determined by the type of audit, which is greatly determined by the type (s) of contracts. The basic types of contracts are:

  • Cost Plus
  • Time & Material (T&M)
  • Firm Fixed Price (FFP)

Cost Plus

Your probability of having DCAA audits is increased exponentially with cost plus contracts.

  • Preaward Accounting System Review: 90%

First, per FAR 9.104-1(e), to be determined responsible, the contractor must have the necessary accounting and operational controls in place. This usually is interpreted as in order for a contractor to be awarded a cost plus contract, they must have an adequate accounting system. Thus, there must be a review/audit of a contractor’s accounting system to determine adequacy. Thus, if awarded a cost plus contract, the probability of audit is 90% in my experience.

  • Incurred Cost Audits: DOD, USAID, NASA: 75%, CMS: 40% Other Civilian Agencies: 15%

When awarded a cost plus contract, the contractor is required to submit an annual incurred cost submission to its cognizant agency or DCAA. Typically, there is an initial review of the submission by an auditor to determine the adequacy of the submission. Later, the government will determine whether they will audit the submission for the year or years. The determination is based on risk. I don’t know the formula, so I can’t share that with you. However, sometimes, I cannot make sense of the decision. Recently, a client was required to do an incurred cost submission for an $8,500. Luckily, DCAA decided not to audit and accept the indirect rates proposed. We have had clients go through incurred cost audits even though the submission shows that they are grossly under-billed and the government will have no recovery.

  • Floorcheck: 10%

Mostly happens to larger contractors.

  • Preaward Pricing: 25%

Occurs more for DOE and NASA procurements in my experience. There was a directive from DCMA a few years ago saying that DCAA would not review cost plus proposals for amounts less than $100 million.

For more information and for help preparing for your audit or in the DCAA audit process, contact us.

KDuncan & Company is dedicated to providing knowledge and support for small government contractors about concerns regarding government contracting. For questions on areas such as as cost proposals, accounting systems, DCAA compliance, and incurred cost audits, reach out to KDuncan & Company.

What is a DCAA Audit?

As a government contractor, audits, sometimes DCAA, are a regular part of the business. It is the Contracting Officer’s responsibility to request an audit. Here are six important questions that arise:

  1. What is a DCAA audit?
  2. How important is it to my business?
  3. When can I expect it?
  4. How do I prepare for it?
  5. How do I survive it?
  6. What does it buy my company?

This blog post will address the first two questions. A DCAA audit is an evaluation of a condition within your company against particular government standards and/or regulations. I will list the various audits in order of the life cycle of a typical contractor.

1. Pre-award Pricing Proposal Review

You have submitted a cost proposal on a FAR 15, Negotiated Contract, procurement. The auditor’s job is to determine if the pricing proposed is fair and reasonable. In government contracting, pricing is considered fair and reasonable if there is adequate competition or if pricing is based on projected costs incurred, then the reasonableness, allocability, and allowability of the projected direct and indirect costs. Ultimately, the auditor will produce information for the government to project the real price of your cost proposal. This could determine win versus loss of this procurement.

2. Pre-award Accounting System Review

The auditor’s job is to evaluate the design of Accounting System to determine if it is acceptable for prospective contract. Per FAR 9.104-1(e), to be determined responsible, the contractor must have the necessary accounting and operational controls in place. The auditor uses the SF1408 from FAR 53 as a guideline. The form is a checklist of criteria. The auditor must check “Yes” to all applicable criteria or you and your system fail the review. When you pass, you will move forward to the next step of the procurement process.

3. Financial Capability Review

The auditor’s job is to determine if the potential contractor can stay in business long enough to complete existing and potential contract work.  The auditor will request financial statements to conduct a financial analysis on them. The auditor will focus on 8 key financial ratios. Unless a review of the certified statements uncovers something obviously erroneous and of a material nature, the analyst can only assume that the statements are accurate.  The contractor’s or its CPA’s certification is required. This could determine win versus loss of this procurement.

4. Floorcheck Review

The auditor’s job is to evaluate the accuracy of contractor employees (salaried and/or hourly) labor hour charges to contracts, indirect accounts, or other cost objectives. When properly tailored and approved by the supervisory auditor, this program can be used to perform labor floor checks and interviews to help satisfy the mandatory annual audit requirement relating to labor floor checks and/or interviews. Typically, this review is done without prior notification. This could determine the level of scrutiny the government uses in reviewing you billings or whether the government choosing to continue your current costs reimbursable contracts.

5. Incurred Cost Audit

You have been operating and billing a cost reimbursable contract, cost plus or T&M. You have provided an incurred cost submission to the government. The auditor’s job is to evaluate the accuracy of the incurred cost submission; ultimately determining whether you have under-billed or over-billed the government. The auditor will conduct transaction testing of your general ledger and the support documents available to support the transactions to determine the total costs per contract with indirect costs applied. An important aspect is the determination of allowability, allocability, and reasonableness of costs. Note: retaining source documents is of vital importance in these engagements. This will determine whether you owe money to the government or the government owes you.

6. Postaward Defective Pricing Audit

The government thinks that you have violated the Truth In Negotiations Act. You have inflated the costs projections used as the basis of your costs proposal in order to raise the price of an Fixed Priced or T&M contract. The auditor’s job is to determine if a negotiated contract price was increased by a significant amount because the contractor did not submit or disclose accurate, complete, and current cost or pricing data.

In our next blog post, we’ll address what you can expect in a DCAA audit. Have questions? Contact us.

KDuncan & Company is dedicated to providing knowledge and support for small government contractors about concerns regarding government contracting. For questions on areas such as as cost proposals, accounting systems, DCAA compliance, and incurred cost audits, reach out to KDuncan & Company.

Timekeeping Systems Done Right

As we work to assist clients in getting their accounting systems approved by DCAA, we are discovering that the largest hurdle seems to be contractors’ timekeeping systems.  The problems have been in a number of areas:

  • The period of the timesheets do not match the pay periods of the company.
  • The timesheets have not been signed by the employees and approved by a supervisor.
  • The contractor is using the timesheets of a prime contractor rather than having their own.
  • The timesheets do not identify the contract and tasks.
  • The timesheets do not identify the labor categories that are billed on T&M contracts.
  • The hours on the timesheets do not match payroll records or the invoice because of data entry errors – a clear internal control deficiency.

As the first five problems are policy issues that are structural in nature, these are easily remedied.  The final problem can be corrected by implementing an electronic timekeeping system that integrates electronically with your accounting system or by implementing a data entry review and editing process in your payroll procedures.

While electronic (web based) timekeeping systems are usually an improvement, the improvement is gained accomplished when the proper controls are established.  These essential controls are:

  • The timekeeping system integrates electronically with your accounting software; if using Quickbooks, ensure that the timekeeping software will populate the fields: Customer, Job, Service Item, and Payroll Item.
  • Requires employee submittal for approval at the end of each pay period.
  • Requires the supervisor’s approval.
  • Requires a unique user id’s for the employees and supervisors.
  • Allows the tracking of hours by contract, tasks, labor categories, and indirect labor charges.
  • Includes an audit trail function for tracking changes to time entries.

Also, an additional and important attribute of electronic systems is that the administrator can set them to limit the available charges for each employee. Thus, an employee who that should not charge to G&A labor will never see it as an available charge; greatly reducing charging errors.

Please be aware that your accounting system will not be approved when the timekeeping system has deficiencies. It is considered by auditors the most important part of your accounting system.

The staff at KDC will be happy to answer any questions that you may have. You can contact us here.

KDuncan & Company is dedicated to providing knowledge and support for small government contractors about concerns regarding government contracting. For questions on areas such as as cost proposals, accounting systems, DCAA compliance, and incurred cost audits, reach out to KDuncan & Company.