Changes to DCAA’s Incurred Cost Audit Model: How May It Affect You?

It is no secret that the Defense Contract Audit Agency (DCAA) has been plagued by a significant backlog in processing incurred cost (electronically) proposals (“ICE proposals”). In 2011, there were approximately 31,000 ICE proposals awaiting audit.  While reduced, the current estimate is still a staggering 14,000.  While DCAA has implemented policies to reduce this backlog, including limiting its review to DoD contracts, raising the dollar limit for automatic close-outs (proposals not requiring review) from $150,000 to $500,000, and contracting with AbilityOne to assist with contract closeouts, it has failed to achieve its objective of reducing its backlog to only those ICE proposals submitted for the two prior years.

The inability of DCAA to timely audit ICE proposals can have a significant impact on contractors. Contractors are not able to close out contracts and receive final payments until the audit is completed.  The inability to close out contracts and receive rate agreements, in turn, can impact contractors’ ability to finalize subsequent years’ ICE proposals and, internally, to obtain an accurate financial picture of the firm.  Additionally, logistical problems can arise when DCAA fails to timely audit an ICE proposal as key documentation and personnel may no longer be available and Government funding may be expired, requiring additional hoops and hurdles to completing the close-out process.

Congress has been tracking DCAA’s audit backlog and, in light of recent events, we can conclude it is not pleased. The 2018 NDAA includes multiple mandates to DCAA that signal not only Congress’s conclusion that DCAA is failing to adequately reduce its backlog, but also that Congress has concerns regarding the quality of DCAA’s work. In an effort to eliminate the ICE proposal backlog, Section 803(b) of the 2018 NDAA requires DCAA to contract with private auditors and to delegate review of as many audits as necessary to ensure that, by October 1, 2020, the incurred cost audit backlog is eliminated. The NDAA imposes strict deadlines for DCAA’s compliance – including an October 2018 deadline for a detailed plan on how DCAA intends to comply with the requirement of using private auditors and an April 2019 deadline for entering into contracts with a minimum of two private audit firms.

Addressing not only the current backlog but also looking ahead, this section provides that DCAA must maintain the use of private auditors to ensure that current and future audit needs are met, and requires that all future audits be completed within one year of DCAA’s acceptance of a contractor’s ICE proposal.

In addition to the imposition of private auditors on DCAA, it is interesting to note that the 2018 NDAA requires that DCAA pass a peer review conducted by a commercial auditor for all unqualified audit findings as of October 1, 2022. Based on this requirement, it appears that Congress’s concerns are not limited to the backlog, but also relate to performance.

One frustration contractors often have with the scope of DCAA’s audits relates to materiality.  That is, the potential issues raised by DCAA are trivial in comparison to the claim and/or cannot fairly be classified as reflecting “risk.”  Acknowledging this issue, the 2018 NDAA also requires that DCAA develop a numerical materiality standard, i.e. the dollar amount of misstatements/omissions that would be material to the Government, and further specifies that this standard be consistent with “commercially accepted standards of risk and materiality.”  In our view, this is a critical component of audits – if the amount questioned is not material and/or does not present a risk to the Government, it would appear that the time and expense (both for the Government and contractor) of the audit is outweighed by any benefit to the Government.  The creation of a uniform materiality standard has the potential to streamline DCAA’s work and create more predictability and a more logical system for ensuring that the interests of the Government, as well as of the contractor, are protected.

The next few years will bring significant changes to the incurred cost audit process. There is reason to believe that these changes will benefit contractors by eliminating DCAA’s backlog, ensuring that future years’ ICE proposals are processed in a timely manner, and bringing efficiencies and uniform standards that may not have previously existed. There are, however, some reasonable concerns that have been expressed by contractors:  Will contractors be subject to a learning curve as private auditors step into on what has historically been DCAA’s audit territory?  Will there be a disconnect between private auditors and Government Contractors?  Will Contracting Officers’ decisions on adopting the recommendations of the auditors be affected by whether the auditor is from DCAA or a private firm?  Additionally, and with respect to the one-year requirement for processing future ICE proposals – Will this result in a heightened standard of acceptability, increasing the number of ICE proposals rejected by DCAA and delaying the commencement of the one-year clock?  We hope that these concerns do not materialize and that the result of the requirements imposed by the 2018 NDAA is a more efficient and effective audit process.