DCAA Audits: What Federal Contractors Need to Know

The Defense Contract Audit Agency (DCAA) is the federal government's independent audit arm for defense contracts — and increasingly for other federal agencies as well. If you hold cost-reimbursement contracts, time-and-materials contracts above certain thresholds, or any contract where the government has a right to audit your costs, DCAA may review your books.

Many small contractors fear DCAA audits because they don't know what to expect. This guide demystifies the process and explains what you need to do to be audit-ready.

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What DCAA Is and What It Does

DCAA is a Department of Defense agency that performs contract audits on behalf of DoD contracting officers and, through interagency agreements, for other federal agencies including NASA, DHS, HHS, and others.

DCAA performs several distinct types of audits:

1. Pre-Award Accounting System Audit

Before you can be awarded a cost-reimbursement contract, the government may require DCAA to review your accounting system and issue an "adequacy determination." An adequate accounting system:

• Segregates direct from indirect costs
• Distinguishes between contract costs
• Identifies unallowable costs (per FAR Part 31)
• Provides for timekeeping and labor distribution
• Generates records that support billings

This is a prerequisite for cost-reimbursement contracts. Without an adequate accounting system determination, you cannot be awarded these contract types.

2. Annual Incurred Cost Submission (ICS) Audit

For cost-reimbursement and T&M contractors with cumulative incurred costs exceeding $250 million annually (a high threshold — most small businesses are not audited on this basis unless selected for risk-based sampling), you must submit an Incurred Cost Submission (ICS) within six months of your fiscal year end.

The ICS reconciles your claimed costs for the year. DCAA may then audit the ICS to verify:

• Costs are allocable to government contracts
• Indirect rates are properly calculated
• Unallowable costs are excluded

3. Pre-Award Survey

A field check of your facilities and organization to verify you have the physical and organizational capability to perform a proposed contract. Common for construction and manufacturing contracts.

4. Floorchecks (Labor Verification)

DCAA auditors may conduct unannounced floorchecks at contractor facilities — visiting your offices and asking employees what project they are working on. If an employee says "Project A" but your timesheets show them charging to "Project B," that is a timekeeping problem.

Floorchecks are more common at defense contractors with large cost-reimbursement portfolios.

5. Contractor Business System Audits

DCAA can audit any of the six contractor business systems required by DFARS 252.242-7006:

• Accounting system
• Estimating system
• Purchasing system
• Earned value management system (EVMS)
• Material management and accounting system
• Property management system

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The DCAA-Compliant Accounting System: What You Need

If you plan to pursue cost-reimbursement or T&M contracts above the micro-purchase threshold, you need a DCAA-compliant (or "adequate") accounting system. This does not require DCAA-approved commercial software — it requires that your system be capable of tracking costs in the required manner.

Core Requirements

Cost segregation:

• Direct labor (charged to a specific contract)
• Direct materials and ODCs (charged to a specific contract)
• Indirect costs (fringe, overhead, G&A) — allocated across contracts

Your chart of accounts must distinguish between direct and indirect costs, and within indirect costs, between fringe, overhead, and G&A pools.

Labor charging: Every employee charging to a government contract must submit timesheets for every hour worked. Timesheets must:

• Be completed daily (or at least weekly)
• Identify the specific contract, task, or project for each hour
• Be signed by the employee and approved by a supervisor
• Never be altered retroactively without a documented correction procedure

Labor is the area DCAA focuses on most heavily. Incorrect labor charging — charging hours to the wrong contract, charging hours not worked, not charging at all — is the most common area of disallowed costs.

Unallowable cost identification: FAR 31.205 lists costs that cannot be billed to the government (entertainment, advertising, lobbying, fines, certain compensation costs). Your accounting system must identify and exclude these from any government billings.

Invoice support: Every line item on every cost-reimbursement invoice must be supported by a transaction in your accounting system. DCAA will trace invoiced amounts back to source documents.

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Accounting Software Options

You do not need specialized "government" accounting software. What you need is software configured to support the DCAA requirements above. Commonly used options:

QuickBooks (with govcon configuration): Many small government contractors use QuickBooks Pro or Enterprise with a customized chart of accounts. This works if configured properly — but QuickBooks is not natively configured for DCAA compliance and requires customization by a GovCon accountant.

Unanet: Purpose-built for government contractors. Project-based accounting and time-tracking that supports DCAA requirements natively. Popular among mid-size contractors.

Deltek Costpoint: The dominant enterprise solution for large government contractors. Expensive but comprehensive. Overkill for small businesses under $5M in government revenue.

Jamis Prime: A growing cloud-based alternative designed for small to mid-size government contractors.

GCS Premier: Another purpose-built DCAA-compliant alternative.

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Preparing for a DCAA Audit: A Checklist

If DCAA contacts you for an accounting system review or incurred cost audit, here is how to prepare:

Accounting records:

• Current chart of accounts with clear direct/indirect segregation
• Three years of general ledgers
• Timesheets for all employees (all years under audit)
• Payroll records and labor distribution reports
• Indirect rate calculations and support

Contract documentation:

• Copies of all contracts under review
• All invoices submitted and supporting cost data
• Subcontract agreements and subcontractor invoices

Policies and procedures:

• Written timekeeping policy (how hours are recorded, correction procedures)
• Indirect cost allocation methodology
• Unallowable cost identification procedures
• Purchasing and purchasing approval policies

Management:

• Designate a single point of contact for DCAA interactions
• Retain a GovCon CPA or consultant to accompany auditors (you have this right)
• Never allow auditors unsupervised access to your systems or personnel

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Your Rights During a DCAA Audit

You have rights in a DCAA audit. Key protections:

1. You can have counsel or a CPA present at all interviews and meetings with DCAA.
2. Requests for records must be in writing — verbal requests are informational only; respond formally in writing.
3. If DCAA issues a draft audit report, you have the right to respond with written comments before the final report is issued.
4. You can dispute audit findings through the contracting officer and, if necessary, through the Contract Disputes Act process.
5. Auditors cannot demand documents outside their scope — know what the audit covers and what it does not.

If DCAA makes findings you believe are incorrect, respond clearly and with documentation. Unsupported DCAA findings that are not challenged often become contracting officer unilateral determinations of disallowed costs.

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Common DCAA Audit Findings (and How to Avoid Them)

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Key Takeaways

• DCAA audits accounting systems, incurred costs, and labor — the three areas most critical to cost-reimbursement contract compliance.
• An adequate accounting system is required before receiving cost-reimbursement contracts — segregate direct and indirect costs, track labor by project, and exclude unallowable costs.
• Daily timesheets are a DCAA requirement for any employee charging to government contracts — not weekly estimates.
• You have rights in an audit — have a CPA or attorney present, respond to draft findings, and document your position.
• The most common findings are unallowable costs billed and inadequate timekeeping — both are preventable with proper process design.
• QuickBooks configured by a GovCon accountant can be DCAA-compliant for small businesses — you don't need expensive enterprise software.

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