For many contractors (truly, for any business), any event with the word “Audit” in the name has a scary connotation. And when you add DCAA to that, a contractor’s blood pressure may automatically rise. However, the best way to rock an audit is to understand what it is for and be prepared for it.
In case you are new to Government Contracting, let’s talk about the Defense Contract Audit Agency (DCAA) and their function in the Government Contracting world. DCAA’s primary function is to perform contract and financial audits for agencies that are responsible for acquisition and contract administration for the US Government.
DCAA has a website that is an excellent resource for those new to government contracting as well as those that have been performing government work for some time. For the Pre-Award Accounting System Audit, DCAA has a checklist located on their website under the “Customers” tab (DCAA Checklist and Tools) to assist in the preparation.
A DCAA Pre-Award Audit—officially named the Pre-Award Survey of Prospective Contractor Accounting System is likely to be a contractor’s first in-person encounter with DCAA. But before your knees begin to shake, let’s explain what it really means. This audit does serve a reasonable purpose—to test the design effectiveness of your accounting system, and not necessarily the operating effectiveness. DCAA wants to determine if your system can handle cost-type contracts, and to ensure you have either an accounting structure OR an implementation plan with the appropriate policies, procedures, and internal controls. If your system is not yet fully operational, if you have your plan documented, you may still have an audit and receive an adequate rating. DCAA uses the standard form 1408 (SF 1408)to document all the necessary requirements.
Even if you have purchased a specific software system like Costpoint or Unanet, you are not guaranteed to pass the audit. DCAA doesn’t endorse any particular accounting software system; you need to be sure that the system is set up correctly to pass the audit.
Why (for Subcontractors)
If you are a Subcontractor, DCAA will determine the amount of effort the prime contractor has taken to determine your system’s effectiveness. Like the prime contractor, the subcontractor would have the same type of audit should DCCA decide an audit is appropriate. DCAA will perform these audits at the request of the prime contractor if the Administrative Contracting Officer deems necessary. A prime contractor may also perform their own assessment of a subcontractor’s accounting system via self-certification by requesting that the SF 1408 by completed, signed, and submitted by the subcontractor for the prime contractor’s evaluation.
The "Pre-Award Survey (SF1408)" is conducted prior to award of a cost reimbursable contract. It results in an opinion that the system is "acceptable" for use on the contemplated contract. It can, and often is, done on a system that is not yet implemented based on the software capabilities and pro forma company policies and procedures.
What (is required)
DCAA’s goal is to document the details necessary to allow them to make a decision on your system’s adequacy (or inadequacy). They use the SF 1408 to document all data needed and must have that data available to complete the entire 1408 before making a determination.
Key topics from the SF 1408:
- Is the accounting system in accordance with GAAP?
- Accounting System provides for:
- Proper segregation of direct and indirect costs
- Identification and accumulation of direct costs by contract
- Method for allocation of indirect costs
- Have a written, practiced, and demonstrable timekeeping system or policy in place
- Show distribution of labor costs among accounts and jobs
- Segregation of unallowable costs
- Accumulation of costs under General Ledger Control
- Issue reports periodically and on-demand
- Accounting System provides financial information
- Required by contract clauses concerning limitation of (cost, funds)(FAR 52.232-20 and 22) or limitation of payments (FAR 52.216-16)
- Required to support requests for progress payments
- Is the accounting system designed to have reliable and accurate data?
- Is the accounting system fully operable?
Pay special attention to the limitation of cost, payments, and limitation of payments clauses as many accounting systems cannot support these requirements and they expose your company to substantial financial risk. If you do not notify your contracting officer in a timely manner the government has NO obligation to pay your claim i.e. your invoice.
How to Prepare
Either the Contracting Officer or DCAA will request the following information before arriving for the audit:
- Policies and procedures for both accounting and timekeeping
- A chart of accounts or trial balance (or both)
- The Proposal Adequacy Checklist
- Walkthrough with your employees of how the accounting system operates or will operate
Proposal Adequacy Checklist
Although longer than the 1408 with more detail, this checklist is used to document how the design of your accounting system allows you to meet the Form 1408 criteria. When you scroll down to questions 8-17, the checklist corresponds directly to the 1408. Contractors will have to provide more detail here, with more detailed information necessary on any Yes/No responses.
How to Establish Compliant Policies and Procedures
There are specific details crucial in your Policies and Procedures to help DCAA give you an “Adequate” approval. Be sure to cover:
- Cost accounting for direct, indirect, and unallowable costs
- AP and general ledger reconciliations
- Billing invoice preparation
- Billing of direct costs
- Invoice payments (both subs and vendors)
- Month-end financial closing and reports
- Travel authorization and reimbursement
- And most importantly—timekeeping and labor distribution
TIP: Although the names don’t have to match the checklist description, it is important to avoid anything that sounds “fun” or “less businesslike” in account names. Since direct, indirect, allowable, and unallowable costs are segregated, anything entertainment-sounding needs to be in unallowable costs.
Audit Day Requirements
One way to make the DCAA auditor’s visit less stressful is to be prepared for the day. Although officially two separate activities, the Entrance Conference and Walk-through are often combined. You will walk through your accounting system with the auditors—even if your system is not fully operational, you can still discuss the design and show how it will be effective. DCAA auditors will ask for your written plan and give you the opportunity to discuss or demonstrate how you will calculate actual indirect rates (crucial in cost-reimbursable contracts).
You will be asked to demonstrate who, how, and how often someone on your team will compare actual costs to the contract funding to ensure those costs remain within funding limitations. Auditors will also ask to see transactions if your system is working, so be prepare to show GL transactions, project status reports, reconciliations and timesheets.
Best Practices—Your Ticket yo Success!
You can make the audit and approval process much easier by utilizing these helpful best practices.
- Set up a pre-construction notebook—use Form 1408 as a table of contents
- Provide screenshots, timesheets, print outs, and transaction data for each question on Form 1408
Make Your First Impression a Good One
You cannot prevent an accounting system walk-through, but since DCAA uses Form 1408, you have the ability to complete and answer nearly all of the audit questions before the day the auditors arrive. You only have one chance to make a good impression, and with a little preparation, you can ensure your accounting system is adequate. We can’t over-emphasize the importance of that “Adequate” rating for proposals or obtaining any government work.
Redstone GCI team can help you at any stage of your Pre-Award Audit, whether it be in writing or reviewing your policies and procedures, helping you to choose the best accounting software for your organization, or assisting your team in designing and setting up an accounting system effective in meeting all necessary requirements.