DCAA Audit Preparation: The Complete Checklist for Government Contractors
Summary of Key Points
- DCAA audit preparation is an ongoing operational process, not a last-minute task, and successful audits depend on maintaining documented, supportable, and consistently applied accounting and compliance systems at all times.
- DCAA audits focus heavily on accounting system adequacy, including the segregation of direct and indirect costs, contract-level cost tracking, identification of unallowable expenses under FAR Part 31, billing reconciliation, and GAAP compliance.
- Timekeeping and labor distribution are among the most scrutinized areas, requiring employees to record time daily, charge hours to specific cost objectives, maintain documented corrections, and follow written, consistently enforced timekeeping policies.
- Government contractors must maintain clearly defined indirect cost pools, supportable provisional billing rates, proper cost allowability practices, and complete documentation for all significant expenses to ensure costs are reasonable, allocable, and compliant.
- Written policies covering accounting, travel, purchasing, subcontracting, compensation, and compliance reviews help contractors remain audit-ready, while disciplined monthly closes, quarterly internal reviews, employee training, and organized documentation reduce audit risk and operational disruption.
The Audit Notification That Changes Everything
The call or letter comes without warning. Either way, DCAA is scheduling an audit, and suddenly the question shifts from “are we compliant?” to “can we prove it?”
For contractors who have been maintaining their systems and documentation all along, a DCAA audit is an inconvenience, not a catastrophe. For those who have been putting off compliance work, assuming they would get to it eventually, the notification triggers weeks of scrambling, reclassifying, and reconstructing records that should have existed from the start.
DCAA audit preparation is not something you do when the auditor calls. You build into how you operate. This article provides a comprehensive checklist covering every major area DCAA examines, so you know exactly what to have in place, whether the audit is next month or next year.
Understanding What DCAA Audits and Why
The Defense Contract Audit Agency provides audit and financial advisory services to the Department of Defense and other federal agencies. Their role is to ensure that government contract costs are reasonable, allowable, and allocable. DCAA does not audit for the sake of auditing. They audit to protect the government’s financial interests.
DCAA conducts several types of audits, each focusing on different aspects of your operations. The most common include accounting system adequacy reviews, incurred cost audits, forward pricing rate audits, floor checks of timekeeping and labor systems, and pre-award surveys. Each audit type has a specific scope, but they all draw from the same underlying financial infrastructure. If that infrastructure is solid, you can handle any of them. If it is not, even a routine floor check can expose problems that cascade into larger findings.
The key principle across every DCAA audit is supportability. Every cost you charge to a government contract must be supported by documentation. Each rate you use must be traceable to your cost pools and allocation bases. The policy you follow must be written, consistently applied, and available for review. The auditor is not looking for perfection. They are looking for a system that works, is documented, and produces reliable results.
Area 1: Accounting System Adequacy
Your accounting system is the foundation on which everything else rests. DCAA evaluates accounting system adequacy using the criteria in SF 1408, the Pre-Award Survey of Prospective Contractor Accounting System. Even if you have already passed an SF 1408 review, your system must continue to meet these standards as your business evolves.
Your system must segregate direct costs from indirect costs. This means your chart of accounts distinguishes between costs charged directly to specific contracts and costs allocated through indirect rate pools.
Your system must accumulate costs by contract. DCAA needs to see what you charged to each government contract, broken out by cost element. Your system should produce this reporting without manual manipulation.
Your system must identify unallowable costs. FAR Part 31 specifies cost categories that cannot be charged to government contracts. Your system must identify and segregate these costs.
Your system must support your billing. The amounts you bill the government must be reconciled with your accounting records. Provisional billing rates, applied to actual costs, should produce billing amounts that tie back to your general ledger.
Your system must comply with Generally Accepted Accounting Principles. GAAP compliance is a baseline expectation. Your accounting methods, revenue recognition, and financial statement presentation should all follow established standards.
Your system must be consistently applied. DCAA looks for consistency in how you treat costs, allocate expenses, and apply policies across contracts and across periods. Changing your methodology without proper disclosure and justification is a red flag.
Area 2: Timekeeping and Labor Distribution
Labor is typically the largest cost element in government contracts, and it is the area DCAA scrutinizes most closely. Your timekeeping system and practices must meet standards that go well beyond simply tracking hours.
Employees must record time daily. DCAA requires contemporaneous timekeeping, meaning time is recorded as it happens, not reconstructed at the end of the week or pay period.
Time must be charged to specific cost objectives. Each hour worked must be charged to a specific contract, project, or indirect cost pool. Employees must understand the charging structure and apply it correctly.
Supervisors must review and approve timesheets. There must be a documented approval process where a supervisor reviews and signs off on each employee’s time. Electronic approvals are acceptable, but the system must maintain an audit trail showing who approved what and when.
Corrections must be documented. When timesheet errors are corrected, the original entry and the correction must both be visible. Capture who made the change, when they made it, and why.
Your timekeeping policy must be written and distributed. DCAA expects a formal timekeeping policy that covers recording requirements, correction procedures, approval workflows, and consequences for noncompliance. This policy must be distributed to all employees and enforced consistently.
Floor checks test real-world compliance. DCAA conducts unannounced floor checks, observing employees at work and comparing their activities to their timesheets. Floor checks also verify that employees are present when their timesheets indicate they are working.
Area 3: Indirect Rate Structure and Cost Pools
Your indirect rates determine how overhead, fringe, and general and administrative costs are allocated to contracts. DCAA audits these rates to verify they are accurately calculated, properly supported, and consistently applied.
Your cost pools must be clearly defined. Most government contractors maintain at least three indirect cost pools: fringe benefits, overhead, and G&A. Each pool should contain only the costs that belong there.
Allocation bases must be appropriate and consistent. The base you use to allocate each indirect cost pool must bear a logical relationship to the costs in the pool.
Provisional billing rates must be supportable. Your provisional rates are the rates you use to bill the government before final rates are established. They should be based on your most recent experience and your forward projections.
Actual rates must reconcile to your financial statements. When DCAA audits your indirect rates, they will trace the costs in each pool back to your general ledger and your financial statements. The numbers must tie.
Unallowable costs must be excluded from rate calculations. Costs that are unallowable under FAR Part 31 must be identified and removed from your indirect cost pools before rates are calculated. This includes entertainment expenses, alcohol, certain lobbying costs, fines and penalties, and other specifically identified categories.
Area 4: Cost Allowability and Allocability
Beyond indirect rates, DCAA examines whether the individual costs you charge to government contracts are allowable under FAR Part 31 and properly allocated.
Every cost must meet the FAR Part 31 tests. To be charged to a government contract, a cost must be allowable (not prohibited by regulation), allocable (it benefits the contract to which it is charged), and reasonable (a prudent business person would incur it under similar circumstances).
Direct costs must benefit specific contracts. A cost charged directly to a contract must provide a direct benefit to that contract. Misclassifying indirect costs as direct charges is one of the most common audit findings and can result in significant cost adjustments.
Your cost accounting practices must be consistent. If you treat a type of cost as direct on one contract, you should treat the same type of cost as direct on all similar contracts. Inconsistent treatment creates allocability problems and raises questions about your cost accounting methodology.
Supporting documentation must exist for every significant cost. Invoices, purchase orders, contracts, travel authorizations, receipts, and approvals should be organized and accessible.
Area 5: Billing and Revenue
DCAA reviews your billing practices to ensure you are invoicing the government correctly and that your billing records align with your accounting records.
Billing amounts must reconcile to your books. The total amounts billed to the government for each contract must tie to the costs accumulated in your accounting system for that contract, adjusted for applicable indirect rates and fees.
Billing rates must match your established provisional rates. You should be billing at the provisional rates approved or established with the contracting officer. Billing at rates that differ from your provisionals without authorization creates an immediate finding.
Progress payments and cost vouchers must be properly supported. Each billing submission to the government should include supporting documentation as required by the contract.
Area 6: Policies and Procedures
DCAA expects written policies and procedures that govern your accounting practices. These documents demonstrate that your system is not ad hoc but is based on established, repeatable processes.
Accounting policies manual. This document should cover your chart of accounts structure, cost accounting methodology, definitions of direct and indirect costs, allocation bases, revenue recognition, and financial reporting practices.
Timekeeping policy. As discussed above, this must cover recording requirements, correction procedures, approval workflows, and enforcement provisions.
Travel policy. If your employees travel on government contracts, you need a written travel policy that aligns with FAR Part 31 and the Federal Travel Regulation. The policy should address per diem rates, airfare class restrictions, lodging limits, and approval requirements.
Purchasing and subcontracting policy. This covers how you select vendors and subcontractors, obtain competitive bids, document sole-source justifications, and ensure flowdown of applicable contract requirements.
Compensation policy. DCAA reviews whether your compensation practices are reasonable. Your compensation policy should document how you set salaries, award bonuses, and administer benefits. Compensation that exceeds market rates or lacks documentation may be deemed unreasonable.
Building Audit Readiness Into Daily Operations
The contractors who handle DCAA audits with the least disruption are the ones who treat compliance as an ongoing practice, not an event.
Close your books monthly with discipline. A consistent month-end close process that includes account reconciliation, cost pool review, and financial statement preparation keeps your data audit-ready at all times.
Conduct internal compliance reviews quarterly. Walk through your own systems using the same criteria DCAA uses.
Train your team. Every employee who records time, approves purchases, or charges costs to contracts is part of your compliance infrastructure. Regular training ensures they understand their responsibilities and the consequences of noncompliance.
Keep your policies current. Review your accounting, timekeeping, travel, and compensation policies annually and update them to match how you operate.
Organize your documentation continuously. A systematic filing structure, whether digital or physical, that organizes documents by contract, by vendor, and by period eliminates the scramble that turns routine audit requests into time-consuming searches.
The Bottom Line
A DCAA audit does not have to be a crisis. It becomes one when contractors treat compliance as something to deal with later and preparation as something to rush through after the notification arrives.
Preparation is not about being perfect. It is about being systematic, consistent, and supportable. That is what DCAA is looking for and is what protects your business.
Need help assessing your audit readiness? Contact Eubanks Accounting & Advisory to schedule a compliance review before the auditor does it for you.
Sources
- DCAA Contract Audit Manual – dcaa.mil
- DCAA Checklists and Tools – dcaa.mil
- SF 1408: Pre-Award Accounting System Survey – dcaa.mil
- FAR Part 31: Contract Cost Principles – acquisition.gov
- FAR Part 15: Contracting by Negotiation – acquisition.gov
- Cost Accounting Standards (CAS) – acquisition.gov
- Federal Travel Regulation – gsa.gov