If you’re a government contractor, small business, or startup working with federal agencies, DCAA audits are a reality you can’t afford to overlook. The Defense Contract Audit Agency (DCAA) ensures that companies receiving federal funds are properly accounting for costs and complying with government regulations.
Whether you’re navigating a new government contract or facing an upcoming audit, understanding DCAA requirements is crucial to protecting your business. In this article, we’ll break down what DCAA audits are, highlight the most common compliance pitfalls, and share practical steps to keep your business audit-ready — all while showing how CPA and Virtual CFO services can help you stay compliant and competitive.
What is a DCAA Audit and Why It Matters for Government Contractors
A DCAA audit is a detailed review of your accounting and business systems to ensure you’re managing and documenting government contract costs correctly. These audits are designed to confirm that your company’s billing practices, timekeeping, cost segregation, and internal controls meet the rigorous standards set by the Federal Acquisition Regulation (FAR) and other guidelines.
There are several types of DCAA audits, including:
- Pre-award audits — to evaluate your accounting system’s readiness before awarding a contract.
- Incurred cost audits — to review costs you’ve billed under cost-reimbursable contracts.
- Timekeeping audits — to ensure proper labor charging and accurate time records.
- Provisional billing rate audits — to verify interim indirect rates used for billing.
For any contractor working with the federal government, DCAA compliance is essential not only to win contracts but also to maintain them without costly disputes.
Top Compliance Mistakes That Trigger DCAA Audit Issues
Now that we’ve covered what DCAA audits are, let’s take a closer look at where companies typically go wrong — and how to avoid these costly mistakes.
1. Weak or Non-Compliant Timekeeping Systems
One of the first areas DCAA auditors scrutinize is timekeeping. If your system doesn’t meet DCAA standards, you risk having labor costs questioned or disallowed.
Here’s what you can do to avoid this mistake:
- Implement a DCAA-compliant timekeeping system (manual spreadsheets are not sufficient).
- Train employees to record time daily and accurately — including direct and indirect hours.
- Ensure supervisors review and approve timesheets regularly.
Example: We’ve worked with clients who didn’t realize that retroactively adjusting time entries without proper approval can be a major violation — and easily flagged by DCAA.
2. Improper Segregation of Direct and Indirect Costs
Failing to properly classify direct and indirect costs is a frequent issue. DCAA expects a clear separation — with accurate allocation bases.
To stay compliant:
- Set up your accounting system to track direct and indirect costs separately.
- Review cost allocations periodically to catch errors early.
- Work with a CPA to review your cost pools and allocation methods for accuracy.
3. Charging Unallowable Costs to the Government
Under FAR Part 31, certain costs are unallowable under federal contracts — including entertainment, alcohol, and certain travel expenses. These cannot be billed to the government, even if they are legitimate business expenses.
To avoid this pitfall:
- Educate your team on what’s allowable vs. unallowable.
- Implement internal reviews to flag unallowable costs before billing.
- Regularly consult with a CPA familiar with government contract accounting to review questionable expenses.
4. Poor Recordkeeping and Documentation Practices
Inadequate documentation can sink your audit. If you can’t provide backup for every expense, DCAA may disallow the cost.
Protect yourself by:
- Maintaining detailed records of every transaction (receipts, contracts, invoices, timecards).
- Using accounting software that maintains audit trails.
- Regularly auditing your own files to ensure completeness and accuracy.
5. Incorrect Indirect Rate Calculations
Indirect rates (e.g., overhead and G&A) must be calculated accurately and updated regularly. Miscalculations can lead to contract disputes, audit findings, and financial losses.
Here’s how to avoid mistakes:
- Review and update your provisional billing rates annually.
- Work with a CPA to calculate final indirect rates and prepare required submissions.
- Keep detailed workpapers to support your rate calculations.
6. Missing or Outdated Policies and Procedures
DCAA expects contractors to have formal, documented policies and procedures — and to actually follow them. Without these, your internal controls may be deemed insufficient.
To stay compliant:
- Develop, document, and update internal policies for accounting, timekeeping, and billing.
- Conduct regular employee training on these policies.
- Perform periodic internal reviews to ensure policies are applied in practice.
How CPA and Virtual CFO Services Help You Prepare for DCAA Audits
Navigating DCAA compliance on your own can be overwhelming. That’s where working with an experienced CPA — especially one who understands government contracts — can make all the difference.
At Peter Witts CPA, we help clients:
- Set up DCAA-compliant accounting and timekeeping systems.
- Review and segregate direct and indirect costs properly.
- Identify and remove unallowable costs before submission.
- Calculate and monitor indirect rates.
- Draft and implement internal policies and training programs.
- Represent and support you during the audit process itself.
Our Virtual CFO services also provide ongoing support to ensure compliance is maintained — not just during audits, but year-round.
Recap: Key Takeaways to Stay DCAA Compliant
- Implement robust timekeeping practices and use compliant systems.
- Separate direct and indirect costs accurately.
- Exclude unallowable costs in accordance with FAR Part 31.
- Maintain thorough documentation and audit trails.
- Accurately calculate and update indirect rates.
- Establish and enforce internal compliance policies with regular staff training.
How We Can Help: Get Audit-Ready Today
If you’re a government contractor or small business concerned about DCAA audits, don’t wait until an audit is underway to address these issues. At Peter Witts CPA, we specialize in DCAA audit readiness, government contract accounting, and Virtual CFO services to help you stay compliant, competitive, and financially sound.
Contact us today to schedule a DCAA compliance assessment or learn how we can support your accounting and tax needs as a government contractor.
Frequently Asked Questions (FAQs)
Q1: What happens if I fail a DCAA audit?
A failed audit can lead to withheld payments, disallowed costs, contract termination, or suspension from future contracts. Proactive preparation is key.
Q2: Can a CPA help before a DCAA audit begins?
Absolutely. A CPA can review your systems, processes, and costs to ensure compliance and identify risks before an auditor arrives.
Q3: How often are DCAA audits conducted?
It depends on contract size and type, but contractors with cost-reimbursable contracts are more frequently audited.
Q4: Are Virtual CFO services useful for DCAA compliance?
Yes — Virtual CFOs help maintain compliant systems, monitor costs, and prepare necessary reports, keeping you audit-ready at all times.