Where to Start with DCAA's New Accounting System Audits

By Joseph McCaffrey and Delaney Gordon, Baker Tilly

In recent years, the Defense Contract Audit Agency (DCAA) has focused on clearing its incurred cost audit backlog. With this backlog becoming more manageable, the DCAA has devoted increased resources to contractor business system oversight, including contractor’s accounting systems. After more than a year of development, the DCAA published a new accounting system audit program in October 2018 and has kicked off numerous audits. This sparks the following question: what should you expect if your company has been notified you are going to be audited, and more importantly, what should you do to prepare?

What is an Accounting System?

Let’s first understand what the government considers to be an accounting system. The Defense Federal Acquisition Regulations Supplement (DFARS) defines an accounting system as:

“the Contractor's system or systems for accounting methods, procedures, and controls established to gather, record, classify, analyze, summarize, interpret, and present accurate and timely financial data for reporting in compliance with applicable laws, regulations, and management decisions, and may include subsystems for specific areas such as indirect and other direct costs, compensation, billing, labor, and general information technology.”

What does that actually mean? An accounting system is more than just a software application; it’s the entire financial reporting ecosystem, which includes your people, processes and technology. In other words, it’s the internal controls and processes that dictate how you use your accounting software. In an effort to define how a contractor should design an “acceptable” system, DFARS 252.242-7005 establishes 18 specific criteria that form the basis of an acceptable accounting system for contract accounting. Contractors must meet these criteria when implementing or updating their accounting system.

When Can the Government Audit My Accounting System?

There are a few situations where the government may audit a contractor’s accounting system. Most commonly, the government will conduct a pre-award audit, or SF-1408. These audits focus on whether an accounting system has been adequately designed and typically take place before a company is awarded a cost reimbursement contract. The DCAA is still conducting these pre-award audits, but they are increasingly dedicating resources to post-award audits. A post-award audit goes beyond an SF-1408: the DCAA examines both how the accounting system is designed and if it is operating effectively. This translates into actually testing the established internal controls to determine if they are working as designed.

The DCAA has two audit programs for post award audits: one for major contractors and non-major contractors with “complex” systems, and another for non-major contractors, which are essentially smaller contractors with streamlined systems. Both of these audit programs utilize the DFARS 252.242-7006 Accounting System Administration criteria as the backbone of the audit. For the purposes of this post, we’ll only be focusing on the major contractor audit program.

What to Expect During an Audit

While in the audit preparation and planning phase, you should expect extensive documentation requests and follow-up questions, along with requests to perform walkthroughs and demonstrations of how your processes and system are designed and operate. The DCAA has developed templates and request lists that ask contractors to identify major policies, processes and associated controls across a number of areas, which form the basis of the walkthroughs. Frustratingly, this is largely unaddressed in the published audit program, and it can take a significant amount of time and effort to compile and present this information to the DCAA.

After the planning phase, you will be asked to provide documentation allowing the auditors to select a sample to test the effectiveness of the identified internal controls. There are eight areas, outlined in the audit program and aligned to the 18 DFARS accounting system criteria, on which the testing will focus. These areas range from the contractor’s control environment and ethics program, to billing practices, and are selected to provide the DCAA with insight into all aspects of the accounting system to determine its acceptability.

Once the audit fieldwork has wrapped up, the DCAA will prepare a draft audit report and present it to you for comment and feedback. This is the last chance with the DCAA to correct any misunderstandings of your system and documentation before the report is finalized (but you were doing that all along, right?).

How Do I Prepare for an Audit?

How should a contractor prepare for an audit? The number one recommendation: Don’t be caught unprepared. Know and understand your accounting system. This is one time where copying from your friend is truly not advisable! If you had a pre-award/SF-1408 audit, that may be a good place to start. But ensure your policies and procedures are up to date, reflect your actual business practices, and are actually followed by your employees. Take time to organize your policies and procedures, including the related internal controls, around your major business cycles and have a logical description of how your system is operated. Taking these steps up front should help set the stage at audit kick-off and will pay off through the course of the audit.

More on New DCAA Accounting System Oversight Updates

Set aside time to discover additional resources, understand common accounting system deficiencies, and learn proactive steps to take before the auditors show up at the door during the webinar Back to the Future! What to Expect from DCAA’s New Accounting System Audits.