For government contractors with cost-reimbursable contracts, an Incurred Cost Submission (ICS) is a mandatory requirement that must be prepared annually and reviewed by the Defense Contract Audit Agency (DCAA). This submission ensures that the government only reimburses allowable, allocable, and reasonable costs as defined by Federal Acquisition Regulation (FAR) Part 31.
However, an inaccurate or incomplete ICS can raise red flags, leading to DCAA audits, disallowed costs, and even contract penalties. Many contractors unknowingly make mistakes that increase audit risks, causing delays, added scrutiny, and potential financial setbacks.
Let’s break down the most common audit triggers in Incurred Cost Submissions, highlight best practices for reducing risk, and explain how contractors can prepare an audit-ready ICS to avoid compliance issues.
Understanding the DCAA Audit Process
The Defense Contract Audit Agency (DCAA) audits ICS submissions to verify compliance with Federal Acquisition Regulation (FAR) Part 31 and Cost Accounting Standards (CAS). Their primary goal is to ensure taxpayer funds are used appropriately and that government contracts are executed fairly and efficiently.
A typical DCAA audit involves notification, document review, interviews with key personnel, and the issuance of audit findings. Auditors focus on three key areas:
- Allowability (are the costs permissible under FAR?)
- Reasonableness (are the costs justifiable?)
- Allocability (are the costs assigned to the correct contracts?)
Audit findings can result in cost disallowances, financial penalties, and the requirement to implement corrective action plans, which can be time-consuming and expensive.
Top Audit Risks in ICS Submissions
Several common mistakes can significantly increase your risk of a DCAA audit finding. Understanding these risks is the first step toward mitigating them:
Risk 1: Unallowable Costs
Including unallowable costs is a major red flag for DCAA auditors. These are expenses specifically prohibited by FAR Part 31, such as entertainment, lobbying (related to government contracts), fines and penalties, alcoholic beverages, bad debts, donations, certain interest and financing costs, personal use of company assets, and certain types of advertising and public relations. Segregating these costs throughout the year is crucial.
Risk 2: Misclassified Costs (Direct vs. Indirect)
Incorrectly classifying costs as either direct or indirect can distort your indirect cost rates and lead to overbilling or underbilling. Direct costs are those that can be directly tied to a specific contract (e.g., materials, direct labor). Indirect costs (e.g., rent, utilities, administrative salaries) benefit multiple contracts and are allocated through indirect cost rates. Clear policies and procedures are essential for accurate classification.
Risk 3: Inaccurate Indirect Cost Rates
Errors in calculating fringe, overhead, and G&A rates can significantly impact the total cost of your contracts, leading to overbilling or underbilling and potentially triggering DCAA scrutiny. Using an unreliable calculation method, failing to document your calculations, or neglecting to update rates based on actual costs are common pitfalls.
Risk 4: Incomplete or Inconsistent Documentation
Missing receipts, inadequate timesheets, or inconsistent record-keeping can make it difficult for auditors to verify your claimed costs, potentially leading to disallowances and penalties. Auditors require substantiation for every expense. This includes receipts for travel and meals, detailed timesheets linking employee time to specific contracts, and supporting documentation for other expenses (e.g., trip reports, consultant contracts).
Risk 5: Mathematical Errors and Inconsistencies
Even small arithmetic mistakes in your calculations or inconsistencies between schedules can raise red flags for DCAA auditors and cast doubt on the overall accuracy of your ICS. Failing to double-check all figures and ensure data consistency across all schedules increases the risk of audit findings.
Risk 6: Lack of Internal Controls
Weak internal controls, such as inadequate segregation of duties or a lack of checks and balances, increase the risk of errors, fraud, and non-compliance, making your ICS more vulnerable to audit challenges.
Risk 7: Late or Incomplete Submissions
Failing to submit your ICS on time or missing required schedules can trigger increased DCAA scrutiny, payment withholdings, and potential penalties. Missing deadlines or submitting incomplete information suggests a lack of organizational control and can raise concerns about your overall compliance.
Strategies for Reducing Audit Risks
Mitigating the risks outlined above requires a proactive and systematic approach. The following strategies will help you prepare an audit-ready ICS:
1. Cost Accounting Best Practices
Unallowable Costs
A multi-layered approach is essential for managing unallowable costs. Begin by ensuring you have a DCAA-compliant accounting system that automatically flags potentially unallowable expenses based on pre-defined rules aligned with FAR Part 31.
Regular training for all staff involved in expense reporting is equally important. These training sessions should cover unallowable cost policies and use real-world examples and case studies to illustrate the concepts.
In addition, conduct regular reviews of expense reports before they are submitted for reimbursement. This added layer of review can catch any errors that the automated system might miss. Finally, document your company's specific policies on unallowable costs in a readily accessible manual, ensuring that everyone has access to the same guidelines.
Cost Classification
Accurate cost classification is crucial for proper cost accounting. Develop clear, comprehensive written policies on cost classification, providing specific examples of direct and indirect costs in various scenarios.
Regular reviews of cost allocations, ideally by someone other than the person who initially classified the costs, can help ensure accuracy. A robust job costing system that allows you to track direct costs accurately by contract is also essential.
Indirect Cost Rates
Accurate rate calculation is essential for proper reimbursement. Use reliable accounting software designed for government contractors to calculate indirect rates. Avoid manual calculations whenever possible, as they are more prone to error.
Update your rates regularly (at least annually, and potentially more frequently) based on actual incurred costs. Meticulously document your calculation methodology, including all supporting data and assumptions.
2. Documentation and Record-Keeping
Robust documentation is your best defense in a DCAA audit. Implement a robust document management system (digital or physical) to store and organize all financial records, including invoices, receipts, timesheets, contracts, and supporting documentation.
You should also train staff on standardized record-keeping procedures, including how to capture receipts, complete timesheets, and maintain organized files. Regular internal audits of your documentation can help ensure completeness and accuracy.
3. Internal Controls and Compliance
Strong Internal Controls
This is essential for preventing errors and fraud. Implement a system of checks and balances, including segregation of duties, approval processes, and regular internal audits. Periodic reviews of your accounting system and internal controls can help identify and address any weaknesses. You can also consider engaging an independent CPA for an annual audit for an extra layer of oversight.
Timely Submissions
Meeting deadlines is essential for avoiding penalties. Begin by creating a detailed timeline, working backward from the submission deadline, and clearly assigning responsibilities for each task. Use project management tools to track progress and conduct regular reviews to identify and address any potential delays.
4. Ongoing Compliance and Support
Staying current with regulations and best practices is crucial. Regularly review FAR Part 31 and CAS for any updates or changes. In addition, engaging with a DCAA consultant can provide expert guidance on compliance requirements and best practices. Finally, maintaining open communication with your DCAA auditor can help proactively address any questions or concerns.
Simplify Your Incurred Cost Submissions and Minimize DCAA Audit Risks with WrkPlan
Preparing a compliant ICS is a critical task for government contractors, and WrkPlan makes it easier than ever. Our purpose-built ERP system automates cost segregation, timekeeping, and reporting, ensuring accuracy and reducing your risk of audit findings. Schedule a WrkPlan demo today and discover how we can help you take control of your incurred costs and confidently navigate the DCAA process.
