Being the largest purchaser of goods and services in the world, it is no wonder that businesses large and small want to work with the United States Federal Government. With an average of $500 billion spent annually, many view federal contract procurement as a potential revenue stream to grow their business. However, many of these companies do not consider all of the rules, requirements, and oversight that come with that potential revenue. Before jumping headfirst into government contracting, let’s take a look at the types of oversight a company can expect when doing business with the government.
Defense Contract Audit Agency (DCAA)
The Defense Contract Audit Agency is the auditing branch of the federal government. Under control of the Secretary of Defense, the branch’s main purpose is to make sure federally procured funds are being spent accurately and appropriately.
According to DCAA’s Information for Contractors publication, “DCAA performs all necessary contract audits for the Department of Defense and provides accounting and financial advisory services regarding contracts and subcontracts to all DoD Components responsible for procurement and contract administration.”
Essentially, what this means is that their primary goal is to ensure taxpayer dollars are spent on fair and reasonable contract prices. It is DCAA’s responsibility to serve public interest first and foremost.
In order to accomplish this, DCAA has a multitude of audit procedures to ensure that government contractors are kept in line. DCAA is especially concerned with contractors working on cost reimbursable contracts as opposed to those who provide fixed price work. This is because there is more room for error (and even fraud) when billing at cost.
Some of the most common types of DCAA audits for companies providing cost-type work are as follows:
- Accounting System Requirements (Pre & Post Award)
- Real-time Labor Evaluations
- Provisional Billing Rates
- Public Vouchers (Progress Payments)
- Incurred Cost Submissions
We will break down the first 4 of these common audit procedures below.
- Incurred Cost Submissions are too involved to cover in an overview post. This audit type will be covered in a detailed post to follow.
- There are many more types of audits that do take place, such as financial capacity, proposal adequacy, contract briefs, monitoring subcontracts, contract close outs, etc. The above 5 were selected for the accounting heavy folks in your organization!
1. Accounting System Review
Government agencies want to make sure your company is operating using proper accounting policies and procedures before providing funding for any cost type work. To do this, a contracting officer from said agency for said contract will request DCAA perform an accounting system audit on your company, which is broken down into two phases – the pre-award & post-award audits.
The pre-award audit takes place before any cost type contracts are awarded to your company. This is the preliminary check that DCAA will perform to see if you have a proper accounting system in place to be able to handle the proposed contracts.
To start the process, a contacting officer or DCMA (Defense Contract Management Agency) will have you complete standard form 1408, which lists what’s required for your accounting system. Some requirements include segregation of direct costs from indirect costs, identification and accumulation of direct costs by contract, ability to allocate indirect costs consistently across cost objectives, etc. For a full list of what is required, please see our prior blog post How PROCAS Addresses the SF1408.
Once the SF1408 is completed and returned to the contracting officer/DCMA, DCAA will meet with your company to see if you have the capacity to perform on what was completed in the form. This is an upper level review that does not get into the nitty gritty of the system, but ensures you have the proper policies and procedures included with your accounting system. For more on what DCAA will be requiring of your system, please see their related documents here.
The post-award audit takes place after your company has been performing on the awarded contract for some time. Typically, this is not too long after being awarded and is around 3-6 months (but can be earlier or later). The purpose of this phase of the audit is to make sure you are complying with the accounting policies and procedures specified in the pre-award.
During the post-award audit, you can expect the auditors to dig around your system more than the pre-award. This is a total accounting system review, which will include testing of your policies and procedures as well as data entry. Some examples of areas they could test include: segregation of duties, proper levels of access to data, correct revenue and expense recognition, trailing transactions from general ledger to invoicing, accurate labor distribution from timesheets to general ledger, etc.
At the end of the day, DCAA wants a vote of confidence that you are operating as you said you would in the pre-award. Therefore, the auditor will take their time and conscientiously look through your system to make sure it does not have any holes.
2. Real-time Labor Evaluations
Also known as the “Help! DCAA auditors showed up at my door unannounced, and I don’t know what to do!” audit, real-time labor evaluations are checks to see if your people are working when they say they are working. For service-based contractors, labor is the largest piece of what is billed to the government, so it is of major concern to be monitored by the DCAA.
In these time check or “floor check” audits, the auditors are going to randomly select employees of your company and ask them simple questions to see how timesheet procedures are performed. Some of these procedures include completing time entries, determining how charge codes are created/selected, submitting timesheets, correcting/adjusting time entries, the approval process, access to employees’ timesheets, etc. Once these are confirmed, the auditors will meet with the accounting staff to see how timesheets are collected and labor is distributed with cost. They will want to see that specific cost journals in the general ledger match historic timesheets!
Some common deficiencies in timekeeping compliance that can lead to the failure of a real-time labor evaluation include:
- The ability of more than 1 person to access an employee’s timesheet to record time
- Improper selection of charge codes for work being performed (inaccurate use of labor categories, projects, etc.)
- Inconsistent charging of time across contracts
- Failure to track changes to employees’ time by audit trail (without reason)
- Approvers overriding subordinate time without employee consent
- Inconsistent method of applying labor cost to employee timesheets
In this audit, there is no warning for when the auditors are going to stop by. Therefore, it is important that your employees know your company’s policies and procedures at all times. We recommend having supervisors and management review these policies with your staff as frequently as possible. For more information to prepare for this surprise audit, please see click here.
3. Provisional Billing Rates
If specified in the provisions of a cost-type contract, contractors are allowed to be reimbursed for indirect costs via interim payments as opposed to waiting until the end of the contract. FAR 42.704 governs the procedures and guidance for establishing provisional billing rates, which is the effective way to approximate a contractor’s final year-end rates (adjusted for any unallowables). Provisional billing rates pose as an estimation of these final year end rates, which are trued up to actual indirect rates at the end of the contract’s fiscal year. More information on FAR 42.704(b) can be found here.
One major criterion for an adequate accounting system is that it provides for billings that can be reconciled to cost accounts for current and cumulative amounts claimed. The auditor is going to check to make sure your system can handle this process within the Accounting System Review audit. However, once approved, the contractor is still going to have to submit provisional billing rates to its DCAA Office or administrating contracting officer every fiscal year included in the contract.
According to DCAA, provisional billing rates should be:
- Submitted at the beginning of each fiscal year or when established billing rates are no longer accurate in representing final year rates (unforeseen circumstances)
- Representing a 12-month period (contractor’s fiscal year)
- Submitted at least annually and electronically (if possible)
- Provided in an Excel format
According to DCAA, provisional billing rates should contain:
- Proposed billing rate calculations (including rationale)
- Prior fiscal year pool and base
- Current fiscal year to date pool and base
- Current fiscal year budget pool and base (if available)
- Comparative analysis with explanation of significant differences (if applicable)
Penalty: If the above measures are not taken, vouchers and progress payments can be held/returned until appropriate measures are taken to adjust billing rates. This not only hurts your cash flow but can affect all future invoices!
4. Public Vouchers (Progress Payments)
Following the same thought process described above, conrtactors can claim interim payments on work performed throughout their fiscal year. According to DCAA, cost type contracts allow for payments for costs on a Standard Form 1034 public voucher or equivalent. Typically, contracting officers have slight variations on how they would like their invoice to look, however the audit process will look similar for checking how the records of each invoice are maintained. For a look into all of the contractor’s and DCAA’s responsibilities in establishing progress payments, please click here.
Voucher audits are conducted by DCAA to determine the accuracy of costs billed to the government. DCAA auditors will use sample testing to track individual invoices from submitted government invoice in WAWF to the general ledger and job cost report and eventually to the source documents supporting the billed voucher.
Looking at your accounting records, an auditor will check for:
- Compliance between the invoice and contract terms
- Accuracy of billed costs to recorded costs (current and cumulative)
- Consistent application of labor distribution
- Consistent allocation of indirect rates using established provisional billing rates
- Segregation of unallowable costs from allowable costs (unallowables cannot be invoiced)
- Timely payments to vendors and subcontractors
- Appropriate source documentation for billed costs
Penalty: If the above measures are not taken, vouchers and progress payments can be held/returned until appropriate measures are taken to adjust your invoices. This not only hurts your cash flow but can affect all future invoices!
At the end of the day, DCAA wants to make sure the public’s money is being spent appropriately. The above measures can seem very intimidating, so it is important that your company is aware of all the rules and regulations that need to be followed. Remember, you always have the right as a contractor to ask why an auditor needs what they are requesting from you. If anything appears to be unrelated to the measures described in each audit above, you have the right to know why it is required. If any PROCAS clients need help through any of the above audits, feel free to reach out to our consulting team at email@example.com.