DCAA Audit Prep: What Auditors Actually Look For

The Defense Contract Audit Agency does not show up unannounced and start pulling files at random. DCAA audits follow predictable patterns. The contractors who handle them well aren’t the ones with the best lawyers — they’re the ones who understood what was coming and kept their records current.

This is a practical guide to what DCAA auditors actually focus on, where manufacturers consistently fall short, and what you can do now to be in a defensible position when the call comes.

What DCAA Is Actually Doing

DCAA provides contract audit and financial advisory services to the Department of Defense and other federal agencies. Its job is to evaluate whether costs claimed under government contracts are allowable, allocable, and reasonable — the three tests that run through all of FAR Part 31.

A cost is allowable if it complies with FAR Part 31 cost principles and the terms of your contract. A cost is allocable if it can be assigned to the contract based on relative benefits received. A cost is reasonable if it doesn’t exceed what a prudent businessperson would pay under similar circumstances. Every cost you claim needs to clear all three.

DCAA’s scope extends beyond cost review. Auditors evaluate the adequacy of your business systems — accounting, estimating, purchasing, billing, property management, and timekeeping. A deficient system finding isn’t just an audit problem. It can trigger withheld payments and affect future contract awards.

The Types of Audits You’re Most Likely to See

Incurred Cost Audits

If you hold cost-reimbursement-type contracts, you’re required to submit an Incurred Cost Proposal each year, due six months after your fiscal year end under FAR 52.216-7. DCAA then audits that submission to verify the costs you claimed. They’re checking whether the costs were actually incurred, properly allocated between contracts and overhead pools, and free of unallowable items.

A backlog of unaudited incurred-cost years poses a risk. If DCAA finds significant issues in one year, they tend to look harder at the others.

Accounting System Audits

Before you can receive cost-reimbursable contract payments, DCAA typically evaluates whether your accounting system is adequate. They’re checking whether it can segregate direct from indirect costs, identify and exclude unallowable costs, and produce accurate records that support contract billing. An inadequate accounting system finding can hold up contract awards.

Labor Floor Checks

DCAA can conduct labor floor checks — essentially unannounced visits to verify that employees are actually working on the contracts they’re charging to. They compare what employees say they’re working on against what’s in the timekeeping system. Discrepancies are findings. These are part of DCAA’s Mandatory Annual Audit Requirements (MAARs).

Forward Pricing Audits

When you submit a proposal on a cost-type contract that requires certified cost or pricing data under FAR Part 15, DCAA may audit the proposal before award. They’re evaluating whether your estimated costs are supported by historical data, whether your rates are reasonable, and whether your estimating methodology is consistent with your accounting practices.

Business System Audits

For larger contractors, DCAA audits the six business systems specified in DFARS 252.242-7005: accounting, estimating, purchasing, material management, property management, and earned value management. A significant deficiency in any of these can result in payment withholding of 2 to 10 percent until the deficiency is corrected.

What Auditors Focus On: The High-Risk Areas

Unallowable Costs Mixed Into Indirect Pools

FAR 31.205 lists categories of costs that are expressly unallowable — meaning they can never be billed to the government regardless of circumstances. The list includes alcohol, entertainment, charitable contributions, fines and penalties, lobbying, and certain advertising and public relations costs. These aren’t edge cases. They’re common business expenses that contractors routinely incur and must segregate.

The problem DCAA finds most often isn’t that contractors are deliberately claiming unallowable costs. It’s that their accounting systems don’t have adequate controls to identify and exclude them before they flow into indirect cost pools. And under FAR 31.201-6, when an unallowable cost is incurred, its directly associated costs are also unallowable. If your CEO attends an unallowable trade show, the travel costs go with it.

Labor Charging Accuracy

DCAA takes labor charging seriously because it’s the area most susceptible to misallocation — intentional or not. They want to see a timekeeping system that requires employees to record time to specific contracts, that is completed by the employee (not filled in by a supervisor after the fact), and that shows corrections with the original entry still visible.

Backdated timesheets, supervisor-prepared time records, and direct labor charged to indirect pools are all findings. So is a timekeeping policy that exists on paper but isn’t enforced consistently.

Cost Accounting Consistency

Costs need to be treated consistently across contracts and over time. You cannot charge a cost as direct on one contract and indirect on another, unless the nature of the work genuinely differs and that treatment is documented. Changes to cost accounting practices require notification to the government under the Cost Accounting Standards if CAS applies to your contracts.

Subcontract Management

Under FAR Part 44, your purchasing system needs to demonstrate that you’re competing where practical, reviewing subcontractor proposals for reasonableness, and flowing down required contract clauses. DCAA coordinates with the DCMA on purchasing system reviews, and findings in this area can affect your ability to independently consent to subcontracts.

Indirect Rate Structure

DCAA will evaluate whether your indirect cost pools and allocation bases are reasonable and consistently applied. Overhead pools that include unallowable costs, G&A bases that don’t reflect the nature of the business, and fringe benefit pools with unsupported rates are all common targets. If your rate structure has changed from prior years, be ready to explain why.

The Documentation Standard

The core documentation requirement is in FAR 31.201-2(d): a contractor is responsible for maintaining records, including supporting documentation, adequate to demonstrate that costs claimed have been incurred, are allocable to the contract, and comply with applicable cost principles.

In practice, it means every cost in your indirect pools needs supporting records showing it was actually incurred. Allocations need to be supported by a documented methodology that can be explained and defended. Unallowable costs need to be identified and tracked, not just excluded at settlement time. Time records need to reflect actual work performed, with a clear audit trail for any corrections.

The question DCAA is implicitly asking throughout an incurred cost audit is: if I pick any cost on this schedule and ask you to walk me through where it came from, can you do it? If the answer to that question depends on institutional memory rather than documentation, you have a problem.

The Most Common Findings at Manufacturing Contractors

Inadequate segregation of direct and indirect costs. Costs that should be direct are going into overhead pools, or vice versa. Sometimes this is a system limitation. Sometimes it’s a classification habit that hasn’t been examined.

Unallowable costs not excluded before pool accumulation. The exclusion happens at settlement but not in real time. DCAA wants to see the controls in the system, not a year-end cleanup.

Timekeeping system deficiencies. Missing policy, inconsistent enforcement, or a system that doesn’t prevent backdating.

Subcontractor cost support missing. Price or cost analysis documentation for subcontract awards that doesn’t exist or doesn’t meet the standard required by FAR 15.404-3.

Incurred Cost Proposal submitted late or inadequate. Late submissions can result in a unilateral rate determination under FAR 42.703-2. Inadequate submissions — missing required schedules, unsupported rates, incomplete reconciliations — result in formal inadequacy findings and restart the clock.

What Good Audit Preparation Looks Like

The contractors who fare best in DCAA audits are the ones who treat audit readiness as an ongoing operational state, not a sprint that starts when the auditor calls.

Practically, that means keeping indirect cost pool documentation current throughout the year, not just at year-end. Running periodic internal reviews of timekeeping compliance before DCAA does a floor check. Maintaining a running identification of unallowable costs as they’re incurred, not reconstructing it from invoices afterward. Making sure the accounting system can produce the schedules DCAA expects — the ICE model schedules are a useful reference for what an adequate submission looks like. And having documented cost accounting practices that are consistent with what you’re actually doing.

None of this requires a compliance department. It requires systems that capture the right information as work happens, and a process to review it periodically.

Where GovComply Fits

GovComply maintains the audit trail DCAA expects to see. Every clause determination, cost allocation decision, and compliance action is logged with timestamps, the person responsible, and the reasoning behind it. Point-in-time snapshots let you show an auditor exactly what your compliance posture looked like on any given date — including dates from prior years.

For manufacturers managing multiple cost-type contracts, the platform also tracks the applicability of the FAR Part 31 cost principle and flags changes that affect how costs must be treated. When DCAA asks for documentation, you’re not assembling it from scratch.

If you want to see what your current contract compliance posture looks like before an auditor does, the free contract analysis is a good starting point. Book a demo today.