The Cost Corner: Government Contracts Cost And Pricing ' DCAA Audits

• Jurisdiction: United States,Federal
• Law Firm: Sheppard Mullin Richter & Hampton
• Subject Matter: Accounting and Audit, Government, Public Sector, Audit, Accounting Standards, Government Contracts, Procurement & PPP
• Author: Mr Keith Szeliga and Emily Theriault
• Published date: 04 July 2023

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Summer is here and we're back with another edition of the Cost Corner, where we provide practical insight into the complex cost and pricing requirements that apply to Government contractors. We just completed a two-part series on the Truthful Cost or Pricing Data Statute, commonly known as the Truth in Negotiations Act (TINA).¹ We will return to TINA in a few months to address the Defense Contract Audit Agency's (DCAA) playbook for defective pricing audits. But first, we embark on a two-part series regarding DCAA audits generally. Part 1 (this article) provides an overview of DCAA's mission, organization, audit guidance, and audit rights. We also address the types of audits DCAA conducts and recent DCAA audit statistics. Part 2 (our next article) will focus on DCAA's audit guidance, audit procedures, and best practices for contractors dealing with DCAA audits.

DCAA's Mission

Prior to 1965, each military department conducted its own contract audits.² Contractor and government personnel recognized the need for consistency. In May 1962, Secretary of Defense, Robert S. McNamara, instituted "Project 60" to examine the feasibility of centrally managing contract administration and audit functions.³ This study resulted in a decision to create a single contract audit capability within the Department of Defense (DoD).⁴ Secretary McNamara then established DCAA as a separate DoD agency on June 8, 1965.⁵

DCAA's mission is to conduct contract audits and to provide accounting and financial advisory services to all DoD components responsible for procurement and contract administration.⁶ DCAA provides these services for the negotiation, administration, and settlement of DoD contracts and subcontracts to "ensure that taxpayer dollars are spent on fair and reasonable contract prices."⁷ DCAA also provides contract audit services for other Federal agencies through inter-agency agreements.⁸

DCAA interprets its contract audit function broadly. The DCAA Contract Audit Manual, DCAA's primary source of guidance for auditors, describes contract audits as extending to all aspects of a contractor's organization, including not only financial data, but also operations, policies and procedures, internal controls, management decisions, and any other activities that have the potential to impact contract costs:

The purpose of contract auditing is to assist in achieving prudent contracting by providing those responsible for Government procurement with financial information and advice relating to contractual matters and the effectiveness, efficiency, and economy of contractors' operations. Contract audit activities include providing professional advice on accounting and financial matters to assist in the negotiation, award, administration, repricing and settlement of contracts. Audit interest encompasses thetotality of the contractor's operations. Audits are performed to assure the existence of adequate controls which will prevent or avoid wasteful, careless, and inefficient practices by contractors. These audits include the evaluation of a contractor's policies, procedures, controls and actual performance, identifying and evaluating all activities which contribute to, or have an impact on, proposed or incurred costs of Government contracts. Areas of concern to the auditor include the adequacy of contractor's policies, procedures, practices, and internal controls relating to accounting, estimating, and procurement; the evaluation of contractors' management policies and decisions affecting costs; the accuracy and reasonableness of contractors' cost representations; the adequacy and reliability of contractors' records for Government-owned property; the financial capabilities of the contractor; and the appropriateness of contractual provisions having accounting or financial significance. Contract auditors perform evaluations of contractors' statements of costs to be incurred (cost estimates) or statements of cost actually incurred to the extent deemed appropriate by the auditors in the light of their experience with the contractors and relying upon their appraisals of the effectiveness of the contractors' policies, procedures, controls, and practices. Such evaluations may consist of test checks of a limited number of transactions or in-depth examinations at the discretion of the auditor.⁹

DCAA frequently takes aggressive audit positions. Fortunately for contractors, DCAA's role in the procurement process is advisory.¹⁰ DCAA is responsible for advising the contracting officer regarding the acceptability of incurred and estimated costs, reviewing the financial and accounting aspects of the contractor's internal controls, and performing other analyses and reviews that require access to the contractor's financial and accounting records.¹¹ DCAA does not have the authority to make final determinations regarding the allowability of costs, the contractor's compliance with regulatory or contractual requirements, or the acceptability of the contractor's business systems. The contracting officer has the exclusive authority to make those determinations.

Notably, contracting officers do not always adopt DCAA's audit findings.¹² DCAA's FY 2022 Report to Congress indicates that contracting officers sustained less than half the dollar value of DCAA's audit exceptions.¹³ This demonstrates the importance of responding thoroughly to adverse DCAA audit findings in order to present the contractor's best defenses to the contracting officer. Audit responses can be particularly effective when they include a detailed contractual and legal analysis of DCAA's audit position (including citations to applicable contract provisions, regulations, regulatory history, case law, and DCAA audit guidance).

DCAA's Organization

DCAA's...