Coping With
(Or, Hopefully Avoiding)
DCAA
John Edward ("Ed") Murphy
CPA CFE CGFM CPCM
FINANCIAL MANAGEMENT INSTITUTE
http://www.fmi.cc
2334 Oak Street
Falls Church VA 22046 – 2326
Telephone: 703-532-9106/9107
FAX: 703-532-4295
E Mail: ed@fmi.cc
You Will Learn

What prompts a Defense Contract Audit Agency
(DCAA) audit and how to avoid a visit from DCAA

Contractor rights and obligations

What a contractor can expect during a "systems"
review or audit, the consequence of "flunking," and
how to pass with flying colors

What a contractor can expect during a DCAA audit
and how to prepare for one

How to expedite any audit

Consequence of an adverse audit finding
2
Target Contracts for DCAA Interest
“Flexibly priced” contract types that require you to report the
actual cost incurred in order to:
1. Claim compensation for cost incurred (e.g. cost reimbursement
contracts);
2. Demonstrate your entitlement to incentive fees (e.g., fixed price
incentive contracts);
3. Redetermine contract compensation (e.g., fixed price
redetermination contracts); or
4. Prove your compliance with the Truth In Negotiations Act (TINA),
PL 87-653.
3
Audits and Reviews by DCAA

Audits of Proposed or Incurred Costs

Pre-award Survey of Prospective Contractor Financial
Capability, (SF 1407)

Pre-award Survey of Prospective Contractor -Accounting
System, (SF 1408)

Timekeeping and Labor Charging (Floor Checks)

Cost Accounting Standards

Estimating System

Purchasing System

Indirect Cost

Truth in Negotiation Act (PL 87-653) Enforcement
4
Learn About DCAA

Tonight’s attendance is a good start.

Don’t Wait Until DCAA Contacts You --- Learn About DCAA Now!

DCAA’s website (http://www.dcaa.mil/) with downloadable useful publications
and electronic files.

Information for Contractors (DCAAP 7640.90) will tell you a lot about DCAA
and what a contractor can expect during a DCAA visit.

DCAA auditor’s bible, Contract Audit Manual (phonetically referred to as the
“CAM”). Review the sections of the CAM that correspond to the contents of
Information for Contractors. Chapter 10 of the CAM showing examples of the
different DCAA audit reports is particularly informative.

If a you know how DCAA works and what to expect from them, you can
expedite the audit visit and avoid spending more time with them than
necessary. Conversely, if you are not prepared, the audit time frame may be
unnecessarily extended.
5
Avoiding DCAA
•
“Avoiding” DCAA ≠ “Bashing” DCAA
•
“Avoiding” DCAA ≠ Contempt or Disrespect
•
If you cannot avoid a visit from DCAA, then welcome DCAA as a
respected representative of your valued customer, “Uncle Sam.”
6
Avoiding DCAA Guiding Principle
All submissions to your Contracting Officer should made in a manner
that conveys the following messages
- We know the FAR and what is expected of us.
- An audit or review by DCAA is unnecessary; and probably a ‘waste of time.’
- If you insist on an audit or review, we will cooperate to expedite it.
Accordingly all submissions should be
- In sufficient detail and with explanations to preclude follow up.
- Accompanied by assurances of compliance with the FAR --- particularly
FAR 31.
- Free of costs deemed unallowable per FAR 31, or contract terms.
- In accordance with prescribed instructions.
- Free of mathematical errors.
- Cosmetically appealing.
- On time
7
Avoiding DCAA Guiding Principle
(continued)
Assurances
M&M’s annual Cost Allocations Plans for fiscal years ended 31
December 20X6 (actual), 20X7 (actual), 20X8 (actual), and 20X9
(budget) are summarized in the attached Excel electronic working
paper. This plan has been or will be submitted pursuant to the
Allowable Cost and Payments Clause (FAR 52.216-7). Major
features of this electronic working paper shows —
(continued on next slide)
8
Assurances
1. A reconciliation of the cost allocation plan with the results of operations as
presented in M&M’s audited (Clean Opinion from PriceWaterhouseCoopers)
financial statements.
2. The constituent general ledger account balances for each Direct Costs
Element.
3. The constituent general ledger account balances for each of the five final
indirect costs pools.
4. The proper accounting for applicable credits pursuant to FAR 31.201-5.
5. The proper accounting for unallowable costs pursuant to FAR 31.201-6.
(M&M’s chart of accounts identifies costs expressly unallowable pursuant to
FAR 31. M&M accounting practices adhere to FAR 31.201 6 (a), (b),
Accounting for unallowable costs; and CAS 405. Unallowable costs are
identified and excluded from any billing, claim, or proposal applicable to a
Government contract. But, pursuant to FAR 31.203 (d), unallowable costs
are included in any base used to allocate a subsequent indirect cost).
9
Contractor Rights and Obligations
Allow access to your books, records, and facilities only when required.
Know your rights.
Read the "access to records" clauses in your contracts, and the Federal
Acquisition Regulation (FAR) or the Defense FAR Supplement
(DFARS).
DCAA does not have unlimited authority to review your operations.
Don't ask them to defend their right to access.
Instead, question their right to access using arguments based on
law, regulation, and contract provisions, not on emotion, ideology
or inconvenience to your firm.
10
Contractor Rights and Obligations
(continued)
Virtually all DCAA audit requests are initiated as a result of a sound
determination of DCAA rights. DCAA will not (except by an
embarrassing mistake) ask to review a proposed price submitted in
response to Sealed Bidding (a response to an Invitation for Bid).
Nor will they ask to review costs proposed in response to a Request
for Proposal (RFP) unless instructed to do so by the contracting officer.
DCAA's rights to access to your accounting records
are identified by regulations or contract.
11
Contractor Rights and Obligations
(continued)
If DCAA's access to records is based on a specific contract clause, you
have very little foundation for denial. As a practical matter, don't waste
time entertaining such foolish fantasies.
Under a “flexibly priced” contract, they have a contractual right, for
example, to review your accounting records to verify the actual cost
incurred, so that you can get paid.
Do all you can to facilitate this cost incurred audit, and
get paid as soon as possible!
12
Contractor Rights and Obligations
(continued)
You may have some basis for denial when DCAA asks to
review the data supporting the price proposed in response
to a Request for Proposal (RFP).
The best way to deny DCAA access to the data supporting
your cost estimate is to avoid submitting Cost and Pricing Data.
Instead prepare a claim for exception. While your exception request is
being considered, do not release any cost and pricing data to DCAA (or
any other government agent).
Don't disclose any cost or pricing data unless and until
the Contracting Officer denies your exception request.
13
About DCAA (continued)
Contracting officers initiate an audit or review --- not
the auditors.
Contracting officers --- not the auditors ---have the
ultimate responsibility of determining if a contractor’s
proposed or actual compensation is fair and reasonable.
But in many instances contracting officers will rely on others
government agents, particularly the contract auditors.
14
About DCAA (continued)
If most of a your work is with the DOD, DHS, NASA and DOE there is
a good probability that a contractor will encounter auditors from
DCAA.
If your workload is primarily with other civilian agencies, a contractor
may still encounter DCAA.
Almost all Federal agencies rely on DCAA under various interagency
agreements. DCAA is the dominant Federal agency performing
contract audit work for the entire government.
If you never encounter DCAA or any other contract auditor, don’t feel
slighted!
And if you do encounter DCAA or any other contract auditor, treat
them as a representative of a valued customer!
15
Avoiding DCAA - Best Practice

Market-Based Prices rather than Cost-Based Prices

Propose and negotiate a "bottom line" selling prices,
without disclosing any information on the composition of
your prices (material cost, labor cost, indirect cost, and
profit)
16
Establish a General Policy “Bottom
Line" Selling Prices

A contractor’s general policy should be to propose and negotiate "bottom line"
selling prices, without disclosing any information on the composition of our
prices (material cost, labor cost, indirect cost, and profit). For the purpose of
this policy statement, a bottom line selling price may be expressed as a unit
price; an hourly billing rate; or a lump sum price for a project, program, or other
endeavor.

The FAR encourages — indeed supports --- this general policy. The FAR
forbids obtaining anything but the bottom line selling price in Acquisition of
Commercial Items (Part 12), Simplified Acquisition (Part 13), Sealed Bidding
(FAR 14).

Information other than a bottom line selling price is usually in the form of a cost
and price breakdown and shows each element of cost and the proposed profit.
Only in Acquisition by Negotiation (Part 15) does the FAR permit information
other than a bottom line selling price. But even in Acquisition by Negotiation,
the buying activity (a Federal activity or a prime contractor) is cautioned to avoid
asking for more that a bottom line selling price. Furthermore the buying activity
is proscribed in the method of requesting information other than a bottom line
selling price.
17
Market-based Prices

Competitive offers

Catalog prices

Established market prices

Prices established by law or regulation
18
Avoiding DCAA - Best Practices
(continued)

Cost-Based Prices often trigger the inclusion of a
(intrusive) Defective Pricing clause in contract
19
Cost-based Prices

Seller's Cost and price breakdown is presumably the seller's best estimate
of what they feel it will cost to produce the goods and services called for in
the solicitation, and the requested profit margin.

Seller is forced to disclose data which can be challenged by the buyer.
Buyer can perform cost analysis to detect ineconomies, inefficiencies, and
ineffectiveness inherent in seller's proposal.

Buyer can also perform cost realism analysis by analyzing such data as
labor hours and labor mix, to determine if the seller's proposed effort is
responsive to the buyer's solicitation.

Buyer challenges the seller's will cost position with its own should cost
position. Buyer may also challenge seller's proposed profit.

Differences between buyer and seller positions are worked out through
negotiation before contract award.

Fair and reasonable price determined through full disclosure, negotiation,
and mutuality of agreement.
20
METAPHYSICAL DEVICE
COST AND PRICE BREAKDOWN
Materials costs 1/
$ 200,000
Materials handling overhead 3/
5,000
Direct labor costs 2/
500,000
Production overhead 3/
1,000,000
Total production costs
$1,705,000
General and administrative (G&A) expenses 3/
295,000
Total costs
$2,000,000
Profit
100,000
Selling price
$2,100,000
__________________
1/Based on a "priced out" bill of materials.
2/Based on a work breakdown structure (wbs) and estimated labor
rates.
3/Based on indirect cost allocation plan derived from the
enterprise's financial statements and cost accounting system
produced in conformity with generally accepted accounting
procedures.
21
Avoiding DCAA - Best Practices
(continued)

A careful reading of FAR 15.402, Pricing policy
demonstrates that Uncle Sam's policy is to avoid making
contractors submit Cost or Pricing Data; and that Cost or
Pricing Data should be requested only when other means of
determining a fair and reasonable price are unavailable.

FAR 15.403-5 shows that Contracting Officer, as part of the
solicitation, shall give the offeror an opportunity to avoid
the submission of Cost or Pricing Data.
22
Avoiding DCAA - Best Practices
(continued)
“By submitting this proposal, we grant the Contracting Officer
and authorized representative(s) the right to examine, at any
time before award, those records, which include books,
documents, accounting procedures and practices, and other
data, regardless of type and form or whether such supporting
information is specifically referenced or included in the
proposal as the basis for pricing, that will permit an adequate
evaluation of the proposed price.”
Contracting officers usually use this as the basis for
requesting contract audit support.
23
Pre-award Survey of Prospective Contractor
Financial Capability, (SF 1407)

Gather financial statements from the past three or four fiscal years.
Summarize the information for these three or four years on a spread
sheet, so that comparison between years is apparent. Provide a
copy of this comparative trend report, together with several
interpretive ratios. The most common ratios are the current ratio,
"acid test" ratio, receivable turnover, inventory turnover, debt to
equity, and earnings per share. Provide this information on an
electronic spread sheet. Also assemble filings with regulatory
agencies (e.g., SEC, SBA, etc.); cash forecasts, budgets, and other
future projections; credit history and ratings; and any other
documents you feel a government auditor would need to complete a
pre-award survey.
24
Preaward Survey of Prospective Contractor
Financial Capability, (SF 1407) (continued)

Summarize all the information assembled. Have two or more
employees independently complete the Preaward Survey of
Prospective Contractor Financial Capability, Standard Form 1407
acting like impartial government auditors. An employee unable to
recommend "complete award" should be instructed to either get
additional information or to prepare a narrative for a best case
situation. This "devil's advocate" review should enable you to
prepare a convincing case (or at least your best case) for a review.
If you feel comfortable about your financial capability, there's a good
chance the government auditor will feel comfortable.
25
Pre-award Survey of Prospective
Contractor – Accounting System, (SF 1408)

Big Myth --- DCAA must approve our accounting system
before we are eligible to receive a “flexibly priced” contract.

True contracting officers will often commission a survey of a
contractor’s accounting system using the standards
articulated in SF 1408), a survey often performed by an
audit activity such as DCAA.

FAR 16.301 3 (a) provides that a cost reimbursement
contract may be used only when, “The contractor's
accounting system is adequate for determining costs
applicable to the contract.” But this is a determination is
the responsibility of the contracting officer.

Contracting officer can and do make this determination of
accounting system adequacy, BUT …
26

You will have to convince the contracting officer --- and yourself --that your accounting system meets the FAR 16.301 3 (a) standards.
27
Murphy’s Recommendation
Do your own assessment using the SF 1408 standards.
Knowing what a government representative (e.g., a DCAA auditor is
looking for will enable you to:

Improve your current system;

Identify and correct any deficiencies in your current system;

Assert, in a response to any solicitation for a cost
reimbursement or other flexibly priced contract that your
accounting system meets the requirement of FAR 16.301 3 (a);
and

Be confidently prepared for any pre-award review of your cost
accounting system.
28
SF 1408 Standards
1. Except as stated in Section I Narrative, is the accounting
system in accord with generally accepted accounting principles
as applicable in the circumstances?
2. Accounting System Provides For:
a. Proper segregation of direct costs from indirect costs.
b. Identification and accumulation of direct costs by contract.
c. A logical and consistent method for the allocation of indirect costs to
intermediate and final cost objectives.
d. Accumulation of costs under general ledger control.
e. A timekeeping system that identifies employees’ labor by
intermediate or final cost objectives.
29
SF 1408 Standards (continued)
2. Accounting System Provides For (continuted):
e. A labor distribution system that charges direct and indirect labor to
the appropriate cost objectives.
g. Interim (at least monthly) determination of costs charged to a
contract through routine posting to books of account.
h. Exclusion from costs charged to Government contracts of amounts
that are not allowable pursuant to FAR Part 31, Contract Cost
Principles and Procedures, or other contract provisions.
i.
Identification of costs by contract line item and units (as if each unit
or line item were a separate contract) if required by the proposed
contract.
j. Segregation of preproduction costs from production costs.
30
SF 1408 Standards (continued)
3. Accounting System Provides Financial Information:
a. Required by contract clauses concerning limitation of cost (FAR
52.232.20 and 21 or limitations on payments (FAR 52.216-16).
b.
Required to support requests for progress payments.
4. Is the Accounting System designed, and are the records
maintained in such a manner that adequate reliable data are
developed for use in pricing follow-on acquisitions?
5. Is the Accounting System currently in full operation?
If not, describe in Section I Narrative which portions are (1) in operation,
(2) set up. but not yet in operation, (3) anticipated, or nonexistent.
31
SF 1408 Standards With Convincing
Response
2.
Accounting System Provides For:
d.
Accumulation of costs under general ledger control.
M&M's job order cost accounting system, is NOT and extra
territorial “cuff records” system. On the contrary M&M’s is fully
integrated into the general ledger accounting system which produces
the fundamental accounting reports (See 1.).
32
SF 1408 Standards With Convincing
Response (continued)
2. Accounting System Provides For:
e. A timekeeping system that identifies employees’ labor by
intermediate or final cost objectives.
f. A labor distribution system that charges direct and indirect
labor to the appropriate cost objectives.
M&M’s timekeeping and labor distribution is accomplished through
Time Collection web-based software.
Using a numeric coding system, employees must contemporaneously
— at least daily — record the time worked on different work
assignments. The numeric coding system identifies the labor hours
with a job (final cost objective) or with a multiple cost objective
(indirect cost subject to allocation or division).
33
SF 1408 Standards With
Convincing Response (continued)
2. Accounting System Provides For:
e. A timekeeping system that identifies employees’ labor by
intermediate or final cost objectives.
f. A labor distribution system that charges direct and indirect
labor to the appropriate cost objectives.
ANSWERS CONTINUED…
Each employee reports their time online. The electronic timesheet
proceeds electronically through two levels of supervisory approval.
Untimely, corrected, retrospectively prepared, or other notcontemporaneously prepared timesheets require two levels of
supervisory review.
34
Consequence of an Unacceptable
Cost Accounting System
• An unacceptable system is not in your best interests.
• An unacceptable cost accounting system may not preclude you
from getting government business.
• But it will severely restrict the type of contracts and financing
options open to you.
• The government auditor will tell you and the procurement official if
your system is acceptable or not.
• Do all you can to correct any deficiencies.
35
Audits of
Proposed or Incurred Costs
• Auditors do not disallow costs.
• Only the contracting officer can disallow costs.
• But the audit report may identify some proposed or incurred costs as
“questioned,” "unsupported," or “unresolved.”
36
Audits of Proposed or Incurred
Costs (continued)
• Questioned costs are costs proposed or incurred which, in the
auditor’s opinion, are unallowable, unreasonable, or not properly
allocable to Government contract.
• Questioned costs are de facto recommendations by the auditor to
the contracting officer to disallow these costs.
37
Audits of Proposed or Incurred Costs
(continued)
• Unresolved costs are cost proposed that the auditor is unable to
render an opinion as to their reasonableness, allowability, or
allocability.
• Unlike unsupported costs, however, the contractor has presumable
prepared the proper support.
• Unresolved costs require additional audit work usually being
performed simultaneously by another audit team at another location
(e.g., a sub-contractor's facility).
• Costs identified as "unresolved" signal the contracting officer to
expect more factual data (usually in the form of an assist audit
report) before accepting the contractor’s proposed or incurred costs.
38
Audits of Proposed or Incurred Costs
(continued)
• Unsupported costs are costs proposed or incurred that the auditor is
unable to render an opinion as to their reasonableness, allowability, or
allocability.
• Costs identified as "unsupported“ signal the contracting officer to
demand more factual data before accepting the contractors proposed
or incurred costs, or to even disallow these costs in the event that the
contractor fails to provide better support.
39
During the Audit or Review













Be prepared. DCAA seldom makes unannounced visits.
Allow access to your books, records, and facilities only when required.
Demonstrate the integrity and reliability of your accounting and internal
control systems
Treat each audit or review by DCAA as a separate engagement.
Host meetings.
Control and monitor access.
Provide appropriate workspace near accounting and estimating personnel.
Instruct employees to limit socializing.
Provide copies of past reviews that could reduce the current audit effort.
Respond quickly.
Prepare a special file showing all significant non-routine transactions
recorded during the fiscal year.
Prepare a special file to explaining recurring special issues.
Be businesslike, but courteous and respectful.
Debrief the auditors.
40
QUESTIONS?
41