As a follow-up to our recent blog post, My CPA Audited My Financial Statements. Does That Mean My Accounting System is Adequate? where we covered some differences between a financial statement audit and an adequate accounting system, we received several great questions from our readers. We thought it might be beneficial to address them via a new blog post for the benefit of all our readers. We welcome discussion on our blogs, though we do so in private via email. In this case, though, these questions are ones we see frequently and impact all companies doing business with the U.S. Government.
My company is a tier 1 subcontractor and DCAA says that they will not audit my accounting system, because we do not have any DoD Prime contracts. What do I do?
Unfortunately, this is an all too common situation and one that is not limited to just being a subcontractor. If you have prime contracts, but they are outside of DoD, DCAA will not typically perform a pre-award accounting system audit to determine the adequacy of your system. This really is a function of budget and the authority of DCAA. DCAA operates at the direction of the DOD contracting officers who request their services. If you don’t have a direct contractual line to a DOD contracting officer your chances of obtaining a DCAA adequacy opinion on your accounting system are low. There are options, though.
- If you are a 1st tier subcontractor, then your Prime could initiate a request through their contracting officer. DCAA audits cost money, though, so the contracting officer may not be receptive unless the risk to the government is justified (you are a major subcontractor in terms of contract dollars). Technically, the management of subcontractors is the responsibility of the Prime, so this is an easy “No” for the contracting officer, but it’s worth discussing if you have a good relationship with your Prime contractor.
- If DOD is not your cognizant agency, then you could request an accounting system audit from your cognizant agency. Many agencies like NASA, DHHS, DOE and others routinely perform accounting system audits, and any agency issuing a cost-type contract is required by FAR 16.301-3(a)(3) to determine a contractor’s accounting system is adequate prior to the award of a cost-type contract.
- As a last resort, you could seek out a third-party opinion on your accounting system. Many agencies are relying on third-party audit firms to perform accounting system audits on their behalf. Redstone GCI routinely performs these types of audits, as well as attest and non-attest services surrounding other contractor business systems. The primary drawback to this approach is that rather than being paid for by the government a third-party audit’s cost will be paid by the contractor.
I only have time-and-material contracts. Do I need an adequate accounting system?
Technically, no. FAR 16.301-3(a)(3) is the only explicit guidance to contracting officers that indicates an accounting system adequacy determination is required for contract award. However, T&M contracts are a hybrid contract type. The T (time) portion is billed at a fixed labor rate, which only requires capture of timekeeping data in a compliant manner. The M (materials) portion of the contract is billed on a cost-reimbursable basis with allocable G&A or material handling applied which must be “trued up.” Since the M-portion is cost-reimbursable, the award of a T&M contract really should trigger an accounting system audit, but it doesn’t always occur in practice. You could remind your contracting officer that FAR 52.232-7(b)(4) indicates that reimbursement of materials is subject to the Allowable Cost and Payment clause (FAR 52.216-7), which also happens to be required for cost-reimbursable contracts. If there is a significant volume of materials (any non-labor cost, e.g. travel, ODCs, materials, et al.) then it is in your interest, as well as your contracting officer’s interest, to make a determination of adequacy prior to contract award.
My accounting system was deemed inadequate. How do I get DCAA to come back out and review my corrective actions?
The short answer, you don’t. Only your contracting officer can request a follow-up visit from DCAA. This situation, unfortunately, occurs all too commonly with many small businesses who don’t understand the importance of passing the pre-award accounting system audit on the first try. 100% of contractors we have worked with for the past 15+ years have passed their pre-award accounting system audit if the necessary corrective actions were made in advance. It is critical to start preparing early. If you know your company plans to pursue cost-reimbursable or T&M work (now or in the future) you should prepare in advance of the proposal. This allows for adequate time to implement any necessary corrective actions and will also help your company to ensure a compliant proposal as well. We have seen multiple situations where a company waited until after DCAA showed up to reach out to our team. We do our absolute best to mitigate findings, but if the audit is underway or rapidly approaching sometimes there’s just not enough time. Once your system is deemed inadequate, the one thing you cannot control is getting DCAA back out to review. An inadequate system can be a significant black mark on a contractor’s record and will likely prevent award of cost-type contracts until it is corrected.
The other situation we see that can lead to an inadequate accounting system is contractors who do not understand the differences between pre and post-award accounting system audits. The pre-award audit answers the question, “Is your system capable of performing a cost-reimbursable contract.” Since, in a pre-award setting you don’t have existing cost-reimbursable work the audit primarily focuses on internal controls, policies, procedures and the accounting system features, not testing of transactions for compliance. The post-award audit covers the same areas of a pre-award, but also includes a substantial amount of transaction testing where the auditor will review source documents like timesheets, vendor invoices and other documentation necessary to support amounts billed under a cost-reimbursable contract. Quite often, contractors assume if they passed their pre-award then they don’t have to worry about the post-award. This is one of the worst assumptions a contractor can make. It’s critical to get an objective review of your accounting system routinely to stay current with regulation and to identify gaps that may not be apparent to your team. Annually we work with contractors all over the world in pre and post-award audit settings and stay current on regulation and audit approaches, so we can help ensure your team and your system are ready for follow-on reviews. We help many contractors annually with all DFARS Business System areas to ensure they remain ready for future audits.
My company uses X-accounting software. Do I need to upgrade to a GovCon-specific accounting software?
Whether you’re using QuickBooks, Xero, IFS, Dynamics, Oracle, SAP or any other accounting system the answer is always: not necessarily. The advantage of using an accounting software designed for government contracting is that you should be able to do everything needed to account for cost and bill within the system, however doing everything within the accounting software is not a requirement for an adequate accounting system. Technically, you could have a system deemed adequate with not much more than a few excel spreadsheets, though I would not recommend it. The decision to use a GovCon specific software is really a question for the business and stems from the administrative effort required to manage the contract. Many commercial companies who are performing a single cost-reimbursable contract can do so on their current accounting system, though it does require a good deal of work outside the system. If you’re in the situation where you are trying to decide whether to upgrade, please let us know. We’d be happy to discuss the pros and cons based on your business situation and since we don’t sell software, you can be assured we’ll provide objective guidance based on your business situation. Over the years, we’ve helped contractors obtain an adequate opinion on just about every accounting software available on the market and routinely encounter new software and we’ve yet to encounter an accounting software that could not be made “adequate” for government contracts. Just because you’re not running one of the usual suspects used in the industry shouldn’t slow you down if you are prepared.