DCAA Audit Survival Guide for Northern Virginia Government Contractors

Northern Virginia is home to one of the largest concentrations of federal government contractors in the world, with thousands of companies holding cost-type contracts with the Department of Defense, intelligence agencies, and civilian agencies. For these contractors, the Defense Contract Audit Agency (DCAA) is a constant presence -- auditing incurred costs, evaluating forward pricing rate proposals, assessing accounting system adequacy, and monitoring compliance with Cost Accounting Standards (CAS). Understanding what DCAA does and how to prepare is not optional for any contractor holding cost-reimbursable contracts.

What DCAA Audits

DCAA performs several distinct types of audits, each with different triggers, scope, and consequences. The most common is the Incurred Cost Audit (ICA), which reviews the costs your company billed to the government on cost-type contracts during a prior fiscal year. DCAA also performs Forward Pricing Rate Audits to evaluate the indirect rates you are proposing to use in future contract bids. Pre-Award Surveys assess whether your accounting system is adequate before you are awarded a cost-type contract. Accounting System Reviews examine whether your system can accurately segregate direct and indirect costs, accumulate costs by contract, and produce the reports required by government contracts. CAS compliance audits review adherence to Cost Accounting Standards for covered contracts.

Who Triggers a DCAA Audit

The primary trigger for DCAA audit activity is holding a cost-type contract: Cost Plus Fixed Fee (CPFF), Cost Plus Incentive Fee (CPIF), Cost Plus Award Fee (CPAF), or Time and Materials (T&M) contracts. Fixed-price contracts generally do not require DCAA audits because the government's cost risk is limited -- the contractor bears the risk if costs exceed the fixed price. Contractors with CPFF or T&M contracts are the most frequent DCAA audit targets. The dollar value of your cost-type contracts also matters: DCAA prioritizes audit resources on contractors with large cost-type contract portfolios, but smaller contractors are by no means immune, particularly if they are new to government contracting or have had prior audit findings.

The Incurred Cost Submission: FAR 52.216-7

If you hold cost-reimbursement contracts, FAR Clause 52.216-7 (Allowable Cost and Payment) requires you to submit an annual Incurred Cost Proposal (ICP) -- also called the Incurred Cost Submission or ICS -- within six months after your fiscal year ends. For calendar-year companies, the ICS is due June 30. This submission documents all indirect costs you incurred during the year, organized by indirect cost pool, and reconciles them to your financial statements and contract charges. DCAA uses this submission as the basis for its Incurred Cost Audit, which determines whether the government overpaid or underpaid you based on your actual indirect rates versus the provisional billing rates you used throughout the year.

Common DCAA Audit Findings

Experienced government contract CPAs see the same findings repeatedly across DCAA audits. Unallowable costs billed to the government are the most serious: under FAR Part 31, certain costs are expressly unallowable regardless of whether they are reasonable or necessary to your business (entertainment, alcohol, lobbying, certain advertising, fines, and penalties). Unallowable costs must be segregated in your accounting system and excluded from indirect cost pools -- billing them inadvertently can trigger penalties and repayment obligations. Improper cost allocation occurs when costs that benefit specific contracts are treated as indirect costs spread across all contracts, or vice versa. Intercompany and related-party transactions receive heavy scrutiny: costs transferred between affiliated companies must be at fair market value or actual cost, and markups above cost are generally unallowable. Inadequate timekeeping -- particularly when employees cannot demonstrate they charged hours to the correct contracts -- is consistently cited as a finding.

What Makes an Accounting System "Adequate"

Before awarding a significant cost-type contract, your contracting officer will typically request a DCAA accounting system review. DCAA evaluates your system against 18 criteria established by DFARS 252.242-7006. Key requirements include: the ability to segregate direct costs from indirect costs; the ability to accumulate and report costs by contract; timekeeping controls that capture labor by contract and type of effort (direct vs. indirect); controls over unallowable costs to prevent them from being billed; and the ability to reconcile your indirect rates to your general ledger. Many small Northern Virginia contractors are surprised to learn that QuickBooks, while excellent for general small business accounting, often requires customization or supplementation to meet DCAA adequacy standards. Job costing modules must be configured to require contract-level cost coding on every transaction.

How to Prepare Your Accounting System for DCAA

Preparing for DCAA does not have to mean overhauling your entire accounting operation, but it does require systematic attention to several areas. First, implement a timekeeping system that requires employees to record hours daily by contract number, distinguishing between direct and indirect time. The system must have a supervisor approval workflow and retain records of changes. Second, configure your chart of accounts to separate direct contract costs from indirect pools (fringe benefits, overhead, G&A), and within G&A, segregate unallowable costs into dedicated accounts. Third, document your accounting policies in a written procedures manual that addresses cost accumulation, timekeeping, expense reporting, and indirect rate calculation. DCAA will ask for this manual. Fourth, maintain a running calculation of your indirect rates throughout the year so you can identify significant deviations from your billing rates before year-end.

Forward Pricing Rate Agreements

For contractors that regularly bid on cost-type contracts, negotiating a Forward Pricing Rate Agreement (FPRA) or Forward Pricing Rate Recommendation (FPRR) with DCAA and your contracting officer provides stability in the bidding process. Rather than supporting your indirect rates from scratch in every proposal, an FPRA establishes agreed rates for a future period that both parties accept for proposal purposes. Obtaining an FPRA requires submitting a Forward Pricing Rate Proposal to DCAA, which will audit the proposal before recommending rates for agreement. The process takes three to six months for a first-time FPRA, but once established, it streamlines future proposal preparation significantly.

Responding to DCAA Findings

If DCAA issues a finding in an audit report, your contracting officer will typically issue a Contracting Officer Final Decision (COFD) demanding repayment of questioned costs or requiring corrective action. You have the right to disagree and appeal through the Armed Services Board of Contract Appeals (ASBCA) or the United States Court of Federal Claims. However, many findings are the result of documentation gaps rather than actual noncompliance -- a skilled government contracts CPA can often work with DCAA to resolve questioned costs through documentation provided during the audit resolution process. Engaging legal counsel and a government contracts CPA at the outset of a significant DCAA audit finding is strongly recommended.