The minute you sign a contract with an agency of the federal government, one thing becomes certain: you will be audited. In fact, depending on your contract, you may undergo several types of contract, proposal, or business system reviews or audits.
A wide body of continually changing federal regulations affect how the government ensures that contractors provide goods and services as promised. Some checks and balances fall under the guise of contract management, while others involve formal audits.
Your ability to withstand contract review or audit has a direct bearing on your future as a government contractor. Pass, and your invoices are paid. Fail, and your invoices may be suspended or disallowed. You even could be barred from bidding on future contracts!
With so much at stake, it is important that you begin preparing today to defend your costs, product quality, accounting systems and business practices during an audit. Preparation begins with understanding some of the agencies involved.
Which Agencies Oversee Contracts?
Individual awarding agencies, especially civilian agencies such as Health and Human Services, the Department of Energy and Department of Veterans Affairs, perform many of their own reviews and audits. Each agency follows its own protocols.
For the Department of Defense, NASA and affiliated agencies, two federal agencies hold primary responsibility for ensuring the integrity of the purchasing process. The Defense Contract Management Agency administers contracts, while the Defense Contract Audit Agency provides financial and accounting services, including audits.
The Defense Contract Management Agency provides a broad range of procurement and contract management services to the Department of Defense and other federal agencies. DCMA makes sure that DoD and affiliated federal agencies get the highest quality goods and services, the best value for their dollar and on-time delivery.
The agency employs more than 10,000 professionals around the globe who are involved in every aspect of making sure needed equipment makes it from raw material to finished product. DCMA employees witness testing and accept products on behalf of the government. The agency also staffs six pricing centers around the U.S. to help contracting officers with price analysis and commercial item determinations.
DCMA provides assistance with technical review of proposals and maintains the Commercial Item Determination registry. It maintains a secure web-based system for electronic Invoicing, Receipt, Acceptance, and Property Transfer (iRAPT, formerly known as Wide Area Work Flow/WAWF). It also performs contractor surveillance and product inspections.
Before contract award, DCMA provides advice and information to help construct effective solicitations, identify potential risks, select the most capable contractors, and write contracts that meet the needs of DoD, federal and allied government agencies. After contract award, DCMA monitors contractors’ performance and management systems to ensure that cost, product performance, and delivery schedules comply with the terms and conditions of the contracts.
The Defense Contract Audit Agency performs most formal audits at the request of agency or DCMA contracting officers. The DCAA’s mission is to ensure that government agencies get what they need at fair and reasonable prices. Standards for allowable, reasonable and allocable prices are set forth in Part 31 of the Federal Acquisition Regulation.
Established in 1965, the DCAA provides audit and financial advisory services to Department of Defense and other federal entities responsible for acquisition and contract administration. Other federal government agencies may hire commercial auditors. Pending language in H.R. 2511, introduced in May 2017, would allow the Defense Contract Management Agency or a military service contract officer to pick “a qualified private auditor to perform an incurred cost audit.” All audits must follow the DCAA Contract Audit Manual (DCAAM 7640.1), often abbreviated as the CAM. Chapter 10 of the CAM, which includes examples of different DCAA audit reports, can be particularly helpful for new contractors.
What Types of Audits Does DCAA Perform?
DCAA performs more than 50 specific audits to ensure that contractors have systems in place to support accurate and transparent pricing for the goods and services they provide to government agencies.
Pre-award audits take place before you sign a contract. Common types of pre-award audits include accounting system surveys, proposal pricing and forward pricing rates.
Post-award audits can occur at any time after you sign a contract. Per the DCAA contract audit manual (14-102), the objective of a post-award audit is to determine if the negotiated contract price increased by a significant amount because the contractor did not submit or disclose accurate, complete and current cost or pricing data. Common types of post-award audits include:
- Accounting System Audit
- Cost Accounting Standards (CAS)
- Provisional Billing Rates
- Incurred Costs/Annual Overhead Rates
- Voucher/Progress Payment Reviews
- Floor Checks
- Material Existence
- Contract Closing
- Truth in Negotiation Act Compliance
Contractor business system audits examine internal controls and processes. The FAR and Defense Federal Acquisition Regulation Supplement clauses incorporated into many government contracts list detailed criteria associated with business systems for:
- Material management and accounting
- Earned value management
As explained in CAM Chapter 5, federal contractors are responsible for establishing and maintaining adequate internal controls that support reliability of financial reporting, effectiveness and efficiency of operations, and compliance with applicable laws and regulations. During an audit, you must provide detailed walkthroughs and demonstrations of the processes that make up each system.
Accounting System Audits
Your accounting system is key to proving that your costs are reasonable, allowable and allocable to your contract. The Federal Acquisition Regulation 16.301(3) requires contractors to maintain an adequate accounting system.. Those with flexibly priced contracts must employ an accounting system that meets DCAA standards for tracking costs.
In addition, federal contracts that exceed the $750,000 Truthful Cost or Pricing Data (formerly TINA) threshold require DCAA-compliant accounting systems and operations.
Before awarding a contract, the Contracting Officer (CO) or Administrative Contracting Officer must determine if the contractor has an adequate accounting system. DCAA often serves as the technical advisor in making this decision. It performs a Pre-Award Accounting System Review or Post Award Review at the request of the CO or ACO.
The Pre-Award Accounting System review requires the contractor to show that its accounting system meets requirements outlined in the Standard Form 1408, Pre-Award Survey of a Prospective Contractors Accounting System. The Post Award accounting system review also includes detailed testing of transactions through the contractor’s accounting system to ensure the system actually meets the SF 1408 requirements.
What Types of Audits Does DCMA Perform?
Whereas DCAA performs accounting and financial audits, DCMA audits government property systems, physical assets and shipments, including Item Unique Identification (IUID) methods and reporting obligations. Through IUID, DCMA auditors verify that every asset is uniquely identified, labeled, and tracked in accordance with two important standards: MIL-STD 129 (Shipment Identification) and MIL-STD 130 (Asset Identification). The IUID Registry is managed through iRAPT. Effective October 1, 2017, the Financial Improvement and Audit Readiness (FIAR) initiative dictates that all accountable assets must be audit ready. .
Failure to comply can result in rejected payments, shipments that are rejected upon receipt, costly corrective actions and documentation of your deficiencies in an official government report.
DCMA also performs Contractor Purchasing System Reviews, which are designed to evaluate the efficiency and effectiveness with which a contractor spends government funds and whether it complies with government policy when subcontracting. A CPSR is conducted when a contractor’s annual sales to the government are expected to exceed $50 million in a 12 month period.
Begin Preparing Now to Save Time, Money and Headaches Later
Preparing for audits at the start of your contract – or at least before you receive a notice of audit – is the best way to reduce costs and stress associated with the audit process.
Designing your accounting systems and business operations to comply with contract requirements and audit standards from the beginning helps to prevent costly system redesigns, staff retraining, and the headaches associated with audit findings.
One of the easiest ways to begin audit preparation is to assess your accounting systems using SF 1408. Knowing what a government representative is looking for will help to:
- Improve your existing accounting system
- Identify and correct any defects in your system
- Be prepared for any pre-award review of your cost accounting system.
Having effective internal controls, policies and procedures for your business will help you organize your business and prepare for a potential audit. At minimum, you should have a written policy and procedures manual that covers:
- Accounting system (control environment)
- Budget and Planning
- Information Technology
- Labor, Compensation and Benefits
- Material Management
- Standards of Ethical Operation
Setting up and maintaining the right records is another prudent step in preparing for audits. FAR Part 4.7 outlines records retention requirements for contractors.
Remember, if you know how the DCAA and DCMA work and what to expect from them, you can expedite the audit visit and avoid spending more time with them than necessary. The converse is true for the unprepared.
So, what should you do once the DCAA audit letter arrives? Check out our next blog post: Received a DCAA Audit Letter? Don’t Panic!
Questions about DCAA and DCMA audits and your business? We’re here to help! Call or email Robert E. Jones at (614) 556-4415 or Robert@LeftBrainPro.com.