What Is the DCAA and How Does it Work?

Written by Richard Fitzpatrick, Content Editor at Cora Systems

The US government spends more than 10% of its federal budget on defense, and in 2021, that figure increased to over $800 billion¹. Back in 1965, they established the Defense Contract Audit Agency, or DCAA, to oversee the extensive projects they commission independent contractors to undertake.

Key Takeaways

• The DCAA audits government contracts to maintain financial accountability and compliance across defense spending in the United States.

• DCAA audit processes focus on four critical areas: chart of accounts, timekeeping, indirect costing, and reporting systems.

• Achieving DCAA compliance requires robust accounting systems that track every hour worked and all associated expenses.

• Government contractors must accurately distinguish between allowable and unallowable costs to successfully pass DCAA audits.

• Modern ERP and PPM software solutions, such as Cora Systems, help contractors maintain DCAA compliance through automated tracking and reporting.

What's the difference between the DCMA and the DCAA?

The Defense Contract Management Agency, or DCMA, oversees the activities of contractors. The DCAA audits their accounts to ensure that their activities are financially above board and beyond reproach.

The DCMA then has two jobs. When you put yourself forward for a contract, it assesses whether or not you can deliver what you say you can, for the price you're proposing. Then, once the contract has been awarded, it verifies that what was promised is being delivered, at the agreed-upon price, and on schedule.

The DCAA, on the other hand, is concerned exclusively with your accounts, ensuring that the costs you've itemized in your proposal are realistic, legal, and presented in a manner compatible with the Department of Defense's system. And, once you've been awarded the contract, whether your accounts subsequently are consistent with what you committed yourself to.

What is DCAA compliance?

In theory, then, the one you need to focus on is the DCMA, as they're the ones that monitor everything you do apart from your accounts. In reality, though, and as ever, it all comes down to finances. If they're not in order, everything grinds to a shuddering halt. So you must be DCAA compliant.

This, though, is a misnomer. Because the DCAA doesn't issue certificates, instead, they give you a general thumbs up or down. So, what being DCAA compliant means is that they're satisfied with the way you've presented your accounts and the numbers they find there. Therefore, the software and system you use for your accounting must be ones that the DoD can recognize and is happy to see you using.

What they use to evaluate that is itemized in detail in the Federal Acquisition Regulation (FAR) and the Cost Accounting Standards (CAS), where you'll find the criteria you need to meet to satisfy their accounting and costing requirements.

The DCAA's four areas of interest

The audit that the DCAA performs will be broken down into four areas:

• Chart of accounts

• Timekeeping/labor accounting

• Indirect costing

• Reporting

The chart of accounts provides details of your cost structures and the accounting system you use. At the same time, your indirect costing and reporting must be done in a manner particular to the needs of the federal government. However, by far the most important thing for the DCAA is your timesheets.

This is both a software thing and a matter of company culture. Because what the DCAA wants to see more than anything else is that you can account for absolutely every hour that every one of your employees has worked, regardless of whether or not they were paid for it. And, crucially, that all and any changes to those individual hours were precisely logged and accounted for. All of which has to be reported on at least a monthly basis.

Therefore, it's vital that the software system you use can centralize and consolidate all your company data in a way that makes it easily accessible and kept up to date in real-time. You need to be able to configure your software to track your direct and indirect costs separately, and it must be fully integrated with your timekeeping system, providing access to any reports that the DCAA may request when needed.

Understanding DCAA Audit Services and Requirements

The DCAA's audit services extend beyond simple financial reviews. These government agencies require contractors to maintain meticulous records that include:

• Direct labor and material costs for each project

• Overhead allocation methodologies

• Identification of unallowable expenses

• Incurred cost submissions from previous years

• Complete audit trails for all transactions

When preparing for DCAA audits, contractors need to understand that the agency examines not just current costs but also incurred cost submissions from previous years. This retrospective analysis helps agencies verify that contractors have properly allocated expenses across multiple projects and maintained audit compliance throughout the contract lifecycle. The risk of failing a DCAA audit extends beyond financial penalties—it can jeopardize future government contracts and damage a contractor's reputation within the defense industry.

Successful contractors often leverage Cora Systems' PPM capabilities to maintain audit-ready documentation and automate compliance workflows. The platform's real-time reporting features allow contractors to identify potential issues before they become audit findings, significantly reducing compliance risk.

Critical Information Systems for Government Contracts

Modern government contractors rely heavily on integrated information systems to manage the complexity of DCAA compliance. These systems must track every aspect of contract performance, from the initial proposal through to the final incurred cost submission. The DCAA's website provides extensive guidance on acceptable accounting systems, but many contractors find that specialized software solutions offer the most reliable path to compliance.

Key information system requirements include:

• Real-time tracking of all project expenses

• Automated segregation of allowable and unallowable costs

• Integration with timekeeping systems

• Capability to generate DCAA-required reports

• Audit trail documentation for all transactions

Cora Systems' PPM platform has become a trusted solution for government contractors because it's designed to meet stringent government contracting requirements. This advanced PPM system automates many compliance tasks, reducing the risk of human error in tracking overhead rates and identifying unallowable costs. However, even with sophisticated software like Cora Systems, contractors must maintain vigilant oversight of their accounting processes to meet DCAA's stringent standards.

Managing Overhead and Unallowable Expenses in DCAA Audits

One of the most challenging aspects of DCAA compliance involves properly categorizing overhead costs and identifying unallowable expenses before they become audit issues. The United States government maintains strict guidelines about which costs can be charged to government contracts.

Every day, unallowable expenses include:

• Entertainment and alcohol purchases

• Lobbying and political contributions

• Fines, penalties, and legal settlements

• Advertising beyond allowable categories

• Personal use of company resources

• Interest on borrowed capital (with limited exceptions)

Contractors must have systems in place to automatically flag and exclude these costs from government contracts. The accounting DCAA review process scrutinizes how contractors handle these expenses, making it critical to establish clear policies and procedures.

Overhead allocation presents another critical challenge. Contractors must develop consistent methodologies for distributing indirect costs across all their projects, not just government contracts. The DCAA closely examines these allocation methods during audits to verify their fairness and accuracy. Any inconsistencies in overhead treatment can trigger extensive reviews and potential cost disallowances.

Services and Support for Achieving DCAA Compliance

Many specialized consulting services have emerged to help contractors navigate DCAA requirements. These services support contractors through:

• Pre-audit assessments and readiness reviews

• Accounting system implementations

• Incurred cost submission preparation

• Mock audits and compliance testing

• Ongoing monitoring and support

Professional services firms also assist with the preparation of incurred cost submissions, helping contractors compile the extensive documentation required for these annual filings. Given the complexity of government contracts and the severe consequences of non-compliance, many contractors view these services as essential investments in risk mitigation.

The right combination of technology and professional services creates a robust compliance framework. Cora Systems provides both the technical platform and the expertise contractors need to successfully manage DCAA requirements, offering implementation support and ongoing guidance to maintain compliance.

Building a Culture of Compliance

Beyond systems and services, successful DCAA compliance requires building a culture that prioritizes accurate timekeeping and cost tracking. This cultural shift involves:

• Training all employees on proper timesheet completion

• Establishing clear policies for expense documentation

• Regular internal audits to identify potential issues

• Management commitment to compliance standards

• Continuous improvement of accounting processes

The accounting system serves as the foundation, but human factors determine success. Contractors who invest in both technology, such as Cora Systems, and employee training consistently achieve better audit outcomes than those who focus solely on one aspect.

Preparing for Your First DCAA Audit

First-time government contractors face unique challenges in preparing for DCAA scrutiny. The audit compliance process begins long before the actual audit, requiring contractors to:

• Implement compliant accounting systems before pursuing contracts

• Document all policies and procedures

• Establish segregation of duties in financial processes

• Create detailed job cost reports for each project

• Maintain contemporaneous timekeeping records

The DCAA audit team will examine years of financial data, making it essential to establish proper procedures from day one. Contractors cannot retroactively fix compliance issues, so proactive preparation is necessary.

Many contractors underestimate the level of detail required in government contracting. Every transaction must be traceable, every hour accounted for, and every cost properly classified. This level of scrutiny requires robust systems and disciplined processes that many commercial companies lack.

ERP or PPM software?

Landing a government contract can be incredibly lucrative and provides a massive boost to your bottom line. Crucially, once you make that initial breakthrough and land that first contract, there's every chance you'll go on to secure any number of subsequent ones.

So it's imperative that the DCAA is happy with the way you handle that first contract. And what you'll be relying on to get that right is your software. You need to know your ERPs from your PPMs

Because, given what's going on in the world at the moment, it doesn't look like the US is going to be cutting back on its military spending any time soon. So, they're going to rely on independent contractors like you to get all that work done.

While ERP systems handle general business operations, PPM software, such as Cora Systems, explicitly addresses the project-based accounting needs that government contractors face. The distinction matters because DCAA audits focus heavily on project cost accumulation and allocation, areas where specialized PPM solutions excel.

Conclusion

DCAA compliance is a critical success factor for any contractor seeking to pursue government work in the United States. While the requirements may seem overwhelming initially, proper preparation and the right systems make compliance achievable. By investing in appropriate accounting systems, such as Cora Systems, maintaining meticulous records, and understanding the distinction between allowable and unallowable costs, contractors position themselves for success in the government contracting arena. As defense spending continues to grow, opportunities abound for well-prepared contractors who can demonstrate their ability to meet DCAA's exacting standards.

Source

1. Countries with the highest military spending worldwide in 2021

About the Author

This blog was written by Richard Fitzpatrick, Content Editor at Cora Systems. Richard is the producer of the long-running Project Management Paradise podcast. He has interviewed global thought leaders on digital transformation, strategy execution, and the evolving role of the PMO.