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GovCon Expert Kim Koster on How Government Contractors Can Prepare for an Incurred Cost Audit

By Kim Koster, VP of Industry Marketing at Unanet

Preparing for an incurred cost submission audit can seem like quite a major challenge for any government contractor. The Defense Contract Audit Agency conducts these audits and can make even the most seasoned contractors feel overwhelmed.

However, this process can be streamlined with the right preparation and tools. This can turn a daunting task into a manageable one. Let’s walk through the process, what you’ll need to do to prepare and comply and the tools you’ll want to have in place to make it much easier.

Understanding the incurred cost audit

At its core, an incurred cost audit scrutinizes the financial representation of both direct and indirect costs incurred by a contractor during a fiscal period. Its primary aim is to ensure that the claimed actual costs align with billed costs, adhering to the strict regulations outlined in Federal Acquisition Regulation 52.216-7 – Allowable Cost and Payment.

This clause not only mandates interim reimbursement of costs but also determines final indirect rates and billing rates, ensuring transparency and accountability in government contracting.

What are the objectives of the DCAA during an incurred cost audit?

DCAA’s main goal is to verify that costs are reasonable and in compliance with the FAR and Generally Accepted Accounting Principles, or GAAP. Having adequate documentation supporting the costs recorded in your accounting system is non-negotiable. Being able to produce this documentation proves to the government that your recorded costs are accurate.

Additionally, the agency has specific procedures and tests designed to evaluate your internal controls and assess their effectiveness. Having a well-documented system of policies and procedures in place can significantly expedite this process.

Who needs to prepare?

The table below outlines which kinds of contracts are required to submit to an ICS audit.

Time and materialsYes (if it contains the Allowable Cost and Payment clause)

Which contracts are required to submit ICS?

Essentially, if your contract has cost reimbursable provisions, preparing for an incurred cost audit should be on your radar.

The challenge some GovCons experience is that their less than stellar documentation practices and tools leave them scrambling when they undergo an audit. The strongest move is to have a software solution that enables you to store all relevant documentation – and easily produce it when the time is right.

An enterprise resource planning, or ERP, system can be instrumental in meeting DCAA’s requirements, providing comprehensive reports and facilitating the necessary support for the audit process.

The importance of centralized financial documentation

One of the most critical steps in preparing for an incurred cost audit is the centralization of your financial documentation. A disjointed financial system can lead to inaccuracies, misreporting and ultimately, non-compliance.

By integrating your company’s documentation in one digital location, you create a single source of truth for your organization. This consolidation enables easier access to vital records, streamlines the reporting process and significantly reduces the risk of errors.

Again, this is where having a comprehensive ERP plays a pivotal role in achieving this level of organization, offering tools and features designed to keep your financial documentation accurate and accessible.

The role of policies and procedures

Clear, concise policies and procedures that document your cost accounting practices act as the backbone of a smooth ICS audit. These documents should encompass various aspects, including billing, travel, bonus allocations, segregation of direct and indirect costs and the structure and allocation bases of all indirect pools.

More importantly, it’s imperative that your actual practices mirror what is outlined in these policies and procedures, ensuring consistency and compliance.

Steps to prepare for the incurred cost audit

Entering the preparation phase for an incurred cost audit requires meticulous planning and an understanding of the various components that will be examined. Follow these steps to streamline the audit process, minimize disruptions and ensure compliance with relevant regulations.

  1. Gather the appropriate documentation. Start by compiling all pertinent documentation, including financial statements, organizational charts and audit plans.
  1. Review the audit plan. Familiarize yourself with the DCAA Contract Audit Manual and review the audit plan provided by DCAA. Understanding the scope and focus areas of the audit can help you prepare more effectively.
  1. Ensure accuracy and completeness. All schedules and reports should tie together, supported by adequate backup information. Discrepancies or gaps in documentation can lead to unnecessary delays and complications.
  1. Use your ERP. Finally, use the resources that are available to you. Leveraging an ERP system can significantly simplify the preparation process. By storing all of your financial documentation in one easy-to-use place, you can ensure that all your data is accurate, up-to-date and easily accessible.

Completing the audit and next steps

Once the audit is complete, you’ll want to submit billing adjustments based on the final indirect rates determined by the audit. These rates are effective for the entire fiscal period covered by the ICS. Completed contracts should be promptly noted in your accounting system, and closeout procedures should begin without delay.

While the best practices outlined above will go a long way towards keeping you compliant, keep in mind that the incurred cost audit is an iterative process and should be seen as an opportunity to review and enhance your organization’s practices.

If your auditors give you any feedback, view that as a chance to improve. Take note of any recommendations from the auditors and make necessary adjustments to ensure compliance going forward.

The path to a smooth audit experience

An incurred cost audit doesn’t have to be an overwhelming challenge. With the right preparation and tools, specifically a robust ERP system, you can transform this process into a streamlined, efficient operation.

These systems function as a single source of truth for your organization, centralizing your financial documentation and ensuring compliance with government regulations. Remember, preparation is key.

By embracing the right tools and knowledge, you’re doing more than preparing for an audit. You’re setting the stage for your GovCon’s regulatory compliance, leaving you to focus on the important things – like delivering successful project outcomes and winning new business.

Want to dive deeper into the incurred cost audit process? Download “The Basics of Incurred Cost Audits” to prepare your business for compliance success here.

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