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Is Your Documentation Enough to Pass a DCAA Incurred Cost Audit?

Is your documentation adequate to pass a Defense Contract Audit Agency (DCAA) incurred cost audit? Flexibly priced contracts contain audit and post-incurrence audit and acceptance requirements for some or all costs. Many contractors have been surprised to find out that the documentation they have on hand to support incurred costs is not considered adequate to support either the classification between direct and indirect costs, between allowable or unallowable costs — or both.  When in doubt, the auditor will throw the cost out.

Several Federal Acquisition Regulation (FAR) contract clauses included in your flexibly priced contracts incorporate a number of documentation related requirements:

  • FAR 52.215-2, entitled Audits and Records — Negotiation, is in your flexibly priced contracts including cost-reimbursement, incentive, time-and-materials, labor-hour, or price redeterminable contracts or any combination of these. This clause requires that you maintain, for U.S. government examination and audit, all records and other evidence sufficient to reflect properly all costs claimed to have been incurred or anticipated to be incurred directly or indirectly in performance of the contract.
  • FAR 52.216-7 Allowable Cost and Payment, is a contract clause included in cost reimbursable and time and materials contracts. This clause requires that costs reimbursable under the contract must be allowable as determined in accordance with Federal Acquisition Regulation (FAR) Subpart 31.2.
  • FAR 31.201-2 Determining Allowability, indicates that you are responsible for accounting for costs appropriately and for maintaining records. This includes keeping supporting documentation that is adequate to demonstrate that costs claimed:

    1.
     Have been incurred,

    2. Are allocable to the contract, and 
    3. Comply with applicable cost principles in FAR Subpart 31.2. You must also be able to demonstrate with documentation that you are consistently using compliant practices for classification of costs as direct or indirect and properly classifying costs as either allowable or unallowable. The U.S. government contracting officer may disallow all or part of a claimed cost that is inadequately supported.
  • U.S. government auditors follow Generally Accepted Government Auditing Standards (GAGAS). GAGAS 6.04b requires that auditors must obtain sufficient evidence to provide a reasonable basis for their conclusions. This means they will perform sufficient procedures when testing your assertions to obtain reasonable assurance to identify unallowable costs and other noncompliances with applicable government laws and regulations, including improper cost classification as direct or indirect.

Auditors will perform adequate risk assessment and appropriate substantive procedures, including detailed transaction testing. An auditor will examine evidential matter, which in contract auditing is all or any part of the body of evidence (records, data, observations or any other information) that underlie or support your cost representations or that may be useful in evaluating the representation.

Certain types of evidence have more significance and are more reliable than others. To determine the quantity of evidence required, the auditor must evaluate the quality of the evidence available. The review of documents is an important step in developing audit evidence.

In evaluating a document as evidence, the auditor will consider the source of the document and the controls used in its preparation and processing. Evidence obtained from an independent source is more reliable than that secured from you. Conversely, the poorest quality evidence is your written statement explaining why a cost should be classified as a direct or indirect cost or why the cost is allowable. The reason is simply because it is testimonial and generated by you. Nevertheless, it may be the sole evidence available to support cost classification.

Travel Costs

For example, FAR 31.205-46(a)(7) states that your travel costs are allowable only if you maintain specific documentation to support them. The documentation requirements are similar to the long-standing requirements imposed by Section 274 of the Internal Revenue Code (IRC). For claimed costs to be allowable, you must document the following information:

  1. The date and place (city, town or other similar designation) of the expenses;
  2. The purpose of the trip; and
  3. The name of the person on the trip and his or her title or relationship to your company.

This information must be maintained in a book, diary, account book or similar records. Documentation such as cancelled checks, credit card receipts and hotel bills are to be maintained as corroboration for expenses, but without a diary or similar records, they may not be sufficient support for deductibility. The purpose of the trip must provide sufficient detail to support the classification of the travel costs. Statements of purpose such as “to work on Contract A” or “to meet with Contract A program manager” are not sufficient to support a direct charge or the allowability of the travel costs. The purpose should be related to directly chargeable efforts such as the scope of work, the function performed and/or the activity or event involved.

Meetings and Conferences

In another example, FAR 31.205-43, Trade, Business, Technical and Professional Activity Costs states that the cost of technical or professional meetings and conferences are allowable when:

  • The primary purpose of the meeting is the dissemination of trade, business, technical or professional information or the stimulation of production or improved productivity.
  • The costs meet the other requirements controlling cost allowability. 

Entertainment Costs and Business Meals

Determinations as to whether or not expenses associated with a particular meeting or conference represent allowable business expense under FAR 31.205-43(c) provisions or unallowable social activity under FAR 31.205-14, Entertainment Costs, are made on a case-by-case basis, based on all pertinent facts. This cost principle is used to evaluate allowability of business meals.

Merely providing documentation that the costs of a business meal have been incurred is not sufficient to support cost classification. Determination of allowability requires you to provide sufficient information concerning the purpose and nature of activity at the meeting or conference. You are expected to maintain adequate records supplying the following information on properly prepared travel vouchers or expense records supported by copies of paid invoices, receipts, charge slips, etc.:

  1. The date and location of the meeting including the name of the establishment.
  2. The names of employees and guests in attendance.
  3. The purpose of the meeting.
  4. The cost of the meeting, by item.

The above guidelines closely parallel the current recordkeeping requirements in Section 274 of the Internal Revenue Code for entertainment costs as a tax deductible expense.

If satisfactory support assuring the claimed costs are allowable conference expenses is not furnished, the claimed costs will be questioned. Statements such as “discussed business with John Doe” or “lunch for attendees of business meeting” are not sufficient to support cost classification.

For individuals on official travel, auditors look for assurance that the meal expense is not included in both the claimed travel costs and subsistence costs included as part of organizing the meeting. For individuals not on official travel, auditors examine whether any meal expense is an integral part of the meeting as described in FAR 31.205-43(c). Were the costs necessary for the continuation of official business during the meal period or were they a social function?

Your purpose statements should include details of the trade, business, technical or professional information disseminated and/or the activities, events or presentations that were held to stimulate production or improve productivity. In addition, meeting agendas must indicate that meals were served during the meeting (in other words, there was no meal break) to support cost classification as allowable.

Tips:

  • Ensure your policies and procedures require detailed explanations or descriptions that support cost classifications. This is particularly important for areas of cost considered sensitive by your cognizant auditors.
  • Provide an appropriate space and location within your hard and soft copy documents to capture these narratives.
  • Add steps in your cost and expense approval process to include approver assessment of the adequacy of the explanations or descriptions that support cost classifications.

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