Most small contractors fail Defense Contract Audit Agency (DCAA) audits before the auditor walks through the door. The accounting system was never designed for government contracting. Time gets recorded in lump sums at the end of the week. Indirect costs flow wherever they fit at month-end. Nobody flagged these practices as problems until a pre-award survey came back adverse and a $3 million contract award stalled indefinitely.
The pattern repeats constantly. A contractor wins a cost-reimbursable opportunity, celebrates the win, and then discovers the accounting system cannot pass Standard Form 1408 (SF 1408) review. Or the company has been charging executive salaries to overhead on commercial work and suddenly needs to justify the same practice under Federal Acquisition Regulation (FAR) Part 31. The compliance gap was always there. The audit made it visible.
DCAA audit readiness is not a pre-audit scramble. It is a structural condition. The checklist below organizes the specific requirements across accounting, timekeeping, indirect costs, and incurred cost submissions so you can assess where your systems stand today and close the gaps before an auditor measures them.
Pass a DCAA audit by maintaining four systems in continuous compliance: an accounting system that segregates direct and indirect costs per SF 1408, daily timekeeping with employee certification and supervisor approval per DCAA Contract Audit Manual (CAM) 6-500, indirect cost pools with documented allocation methodology per FAR 31.203, and timely incurred cost submissions using the Incurred Cost Electronically (ICE) model per FAR 52.216-7. Floor checks can arrive unannounced.
DCAA Audit Readiness Requirements for Small Contractors
DCAA operates from more than 300 branch offices with thousands of auditors whose primary job is reviewing contractor accounting practices and cost representations. Their authority comes from FAR 42.101, which authorizes DCAA to perform contract audit services for all federal agencies.
Small contractors face four primary audit types, each with distinct triggers and objectives.
| Audit Type | Trigger | What DCAA Examines | Typical Timing |
|---|---|---|---|
| Pre-Award Survey (SF 1408) | New cost-reimbursable contract award | Accounting system adequacy, segregation of costs, timekeeping, billing procedures | Before contract award |
| Floor Check | Random or contract-specific | Employee timekeeping practices, labor charging accuracy, supervisor approval | Any time, often unannounced |
| Incurred Cost Audit | Flexibly-priced contract closeout; annual submission | Actual costs incurred, indirect rate calculations, unallowable cost identification | After incurred cost submission |
| Forward Pricing Audit | Contractor proposal on contracts above Truth in Negotiations Act (TINA) threshold | Proposed rates, cost estimating system, basis of estimate | Pre-negotiation |
Two threshold changes reshape audit exposure for small contractors beginning in FY2026. The Cost Accounting Standards (CAS) per-contract trigger rises from $2.5 million to $35 million under the FY2026 National Defense Authorization Act (NDAA), and full CAS coverage increases from $50 million to $100 million in net cost-reimbursable awards. The Truth in Negotiations Act (TINA) threshold jumps from $2 million to $10 million effective June 30, 2026. These changes reduce compliance obligations for contractors below the new thresholds but do not eliminate FAR Part 31 requirements, which apply to all cost-reimbursable contracts regardless of size. For a full breakdown of how these threshold shifts affect contractor obligations, see the FAR 2.0 overhaul guide.
The most common DCAA finding across all audit types: unallowable costs charged to government contracts. FAR 31.201-6 requires unallowable costs to be identified, segregated, and excluded from any billing or proposal submitted to the government.
Accounting System Compliance: SF 1408 and FAR Part 31
SF 1408 is the pre-award accounting system survey form that DCAA uses to evaluate whether a contractor’s accounting system meets government requirements before awarding a cost-reimbursable contract. An adverse finding on SF 1408 does not slow an award. It can block it entirely.
The SF 1408 evaluation focuses on eighteen specific criteria, organized around five core capabilities. Your accounting system must segregate direct costs from indirect costs. It must identify and exclude unallowable costs before billing. It must accumulate costs by contract. It must produce the reports and billing schedules required by the contract. And it must maintain records that support both billing and audit.
FAR Part 31 defines the allowable cost principles that govern everything an accounting system must track. FAR 31.201-2 establishes the four tests a cost must pass to be allowable: reasonableness, allocability, compliance with CAS or Generally Accepted Accounting Principles (GAAP), and compliance with contract terms. FAR 31.205 lists specific cost categories that are expressly unallowable, including entertainment per FAR 31.205-14, most advertising per FAR 31.205-1, and certain compensation arrangements per FAR 31.205-6. For a detailed walkthrough of every allowability test, see the FAR Part 31 allowable costs guide.
The audit fix. Map your chart of accounts to the SF 1408 criteria line by line before submitting to DCAA. Create a separate general ledger account for unallowable costs. Configure your accounting software to prevent direct cost coding to indirect accounts and vice versa. Document your accounting system policies in a written procedures manual. Run a mock FAR 31.205 sweep quarterly to flag every expense category against the unallowable list before year-end incurred cost submissions.
Timekeeping and Labor Charging
Timekeeping is the single highest-risk area in DCAA audits. Floor checks, which can happen without advance notice under DCAA CAM 5-1100, focus entirely on whether employees are recording time accurately, contemporaneously, and to the correct contract or indirect account. A floor check finding can trigger a broader labor floor audit or an incurred cost audit of the entire year.
The DCAA standard for timekeeping comes from FAR 31.201-2 and DCAA CAM 6-500. Time must be recorded daily or at minimum with sufficient frequency to reconstruct actual hours worked by project or indirect category. Supervisory approval of timecards is required. Employees cannot record time in advance, and supervisors cannot instruct employees on how to charge time to meet budget targets. That practice, known as labor mischarging, is a False Claims Act exposure.
Timekeeping failures rarely appear in isolation. When DCAA finds employees recording time in weekly lump sums or charging project time to overhead to avoid overrunning a contract budget, the finding creates a domino effect. DCAA questions the accuracy of all labor charges for the audit period, which puts every direct labor line on a cost-reimbursable contract under scrutiny. The initial finding is a timekeeping deficiency. The downstream exposure is cost misrepresentation across an entire contract portfolio.
Electronic timekeeping systems reduce audit risk significantly compared to paper or spreadsheet-based recording. The system needs to capture the contract number or indirect account for each labor entry, the date, the employee, and the hours. It needs to require employee certification and supervisor approval before payroll processing. Corrections must create an audit trail showing the original entry, the correction, and the reason.
The audit fix. Implement daily timecard recording. Configure your timekeeping system to require employee certification and supervisor approval on every timecard before payroll runs. Document a written timekeeping policy and distribute it to all employees who charge to government contracts, retaining signed acknowledgment forms. Audit a random sample of timecards quarterly. Train supervisors on the prohibition against directing employee time charging.
Indirect Cost Rate Structure and Pools
Indirect cost rates determine how much overhead, general and administrative expense, and fringe benefits you can recover on government contracts. The structure you build at company formation shapes your profitability on every cost-reimbursable contract you will ever win.
FAR 31.203 defines indirect costs as costs incurred for a common or joint objective that cannot be identified specifically with a particular final cost objective. These costs must be accumulated in pools and allocated to contracts using a base that reasonably reflects the proportion of benefit each contract receives. The three standard pools for small contractors are fringe benefits, overhead, and general and administrative (G&A) expense.
Fringe benefits cover payroll taxes, health insurance, paid time off, and retirement contributions. The fringe rate is calculated by dividing total fringe costs by total direct and indirect labor dollars. Overhead covers costs associated with the performance of work on contracts: facility costs, depreciation on equipment used on projects, and project management support. The overhead rate uses direct labor as its allocation base. G&A covers corporate-level expenses: executive salaries, accounting fees, legal fees, and business development costs. G&A typically allocates on total cost input, which is the sum of all direct and overhead costs.
The audit fix. Document your indirect cost pool structure in a written disclosure statement. For contractors above the modified CAS coverage threshold, a Disclosure Statement on Form CASB DS-1 is required under CAS 401. Review your allocation bases annually. Identify every cost in your G&A pool and cross-reference each category against FAR 31.205. Model your forward pricing rates before proposal submission. Retain all supporting documentation for rate calculations.
Rate structure matters beyond compliance. A contractor with a poorly designed G&A pool recovering 18 percent when the market rate allows 22 percent is leaving margin on the table. Indirect rate design is both a compliance obligation and a profitability lever.
Incurred Cost Submission Preparation
Contractors on flexibly-priced contracts must submit an Incurred Cost Submission (ICS) within six months of fiscal year-end under FAR 52.216-7. The submission reconciles actual indirect rates for the year against the billing rates used on contract invoices during the year.
The ICS uses the Incurred Cost Electronically (ICE) model, a spreadsheet package developed by DCAA that contractors complete with their actual cost data. The ICE model contains fifteen schedules covering direct costs, indirect cost pools, rate calculations, compensation analysis, subcontractor management, and more. DCAA uses the schedules to determine whether the ICS is adequate for audit.
The most common ICS adequacy failures among small contractors are missing schedules, incomplete compensation data, and unreconciled differences between the general ledger and the ICS totals. Every number in the ICS must tie to the general ledger.
The audit fix. Download the current ICE model from DCAA’s website each year before starting your submission. Prepare a trial balance that ties directly to the ICS schedules. Run a compensation reasonableness analysis before submitting, since FAR 31.205-6 requires compensation to be reasonable (evaluated against BLS survey data). Submit on time: contractors with ICS submissions more than two years overdue appear on DCAA’s outstanding submissions list, which contracting officers review before awarding new contracts. Retain the ICS and all supporting documentation for at least three years after final contract closeout.
DCAA Audit Readiness Checklist
| Compliance Area | Requirement | Regulatory Basis |
|---|---|---|
| Accounting System | Segregates direct and indirect costs by contract | SF 1408; FAR 31.201-2 |
| Accounting System | Identifies and excludes unallowable costs from billing | FAR 31.201-6; FAR 31.205 |
| Accounting System | Accumulates costs by contract number | SF 1408, Item 6 |
| Accounting System | Written accounting policies and procedures manual | SF 1408, Item 18 |
| Timekeeping | Employees record time daily to specific contracts or indirect accounts | DCAA CAM 6-500 |
| Timekeeping | Employee certification and supervisor approval on every timecard | FAR 31.201-2; DCAA CAM 6-500 |
| Timekeeping | Timecard corrections create auditable trail with reason codes | DCAA CAM 6-506 |
| Timekeeping | Written timekeeping policy distributed and acknowledged by all employees | DCAA CAM 5-1104 |
| Indirect Rates | Indirect cost pools documented with written allocation methodology | FAR 31.203; CAS 418 |
| Indirect Rates | Unallowable costs segregated before entering indirect pools | FAR 31.201-6 |
| Indirect Rates | Forward pricing rates prepared annually | FAR 42.1701 |
| Incurred Cost | ICE model submission filed within 6 months of fiscal year-end | FAR 52.216-7 |
| Incurred Cost | All ICS schedules complete with general ledger reconciliation | DCAA CAM 6-708 |
| Incurred Cost | Compensation reasonableness analysis using BLS data | FAR 31.205-6(b) |
| Billing | Public vouchers supported by contract cost ledger detail | FAR 52.216-7(d) |
DCAA audit readiness is not a project. It is an operating condition that either exists or does not exist at the moment an auditor requests your records. Small contractors who treat compliance as a pre-award scramble discover the hard way that accounting systems, timekeeping practices, and indirect rate structures cannot be rebuilt in two weeks. The contractors who survive pre-award surveys and incurred cost audits intact built the right infrastructure before they needed it.
Frequently Asked Questions
What triggers a DCAA audit for a small contractor?
Cost-reimbursable contract awards trigger a pre-award survey through SF 1408. After award, DCAA conducts floor checks at any time without advance notice under DCAA CAM 5-1100. Incurred cost audits are triggered by annual submissions required under FAR 52.216-7. Forward pricing audits occur when a contractor submits a proposal above the TINA threshold, which rises to $10 million effective June 30, 2026.
Does QuickBooks pass DCAA’s SF 1408 review?
QuickBooks can satisfy SF 1408 criteria with proper configuration, but it is not purpose-built for government contracting. The chart of accounts must segregate direct and indirect costs, support unallowable cost identification, and produce billing reports from the ledger. Purpose-built platforms like Unanet and Deltek Costpoint carry lower configuration risk.
What are the most common DCAA audit failures?
The four most frequent findings are: failure to segregate direct from indirect costs, failure to identify and exclude unallowable costs before billing, absence of written accounting policies and procedures, and inability to produce reports that tie billing to contract cost ledgers.
How do the CAS threshold changes in FY2026 affect small contractors?
The FY2026 NDAA raises the modified CAS coverage trigger from $2.5 million per contract to $35 million, and full CAS coverage from $50 million to $100 million. Contractors below the new thresholds are exempt from CAS disclosure statements. FAR Part 31 allowable cost principles continue to apply regardless of CAS status.
What is the incurred cost submission deadline?
FAR 52.216-7 requires submission within six months of fiscal year-end. Overdue submissions appear on DCAA’s outstanding list, which contracting officers review before awarding new work. Persistent delays can trigger billing rate reductions.
What does DCAA look for during a floor check?
Floor checks focus on three questions: Are employees present and working on the contracts to which their time is charged? Can employees explain the basis for their time charges? Are timecards completed contemporaneously? DCAA auditors speak directly with employees, not management.
How should unallowable costs be handled?
FAR 31.201-6 requires unallowable costs to be identified and excluded from any billing or proposal. Best practice is a dedicated general ledger account so the exclusion is structural rather than manual. Contractors who rely on judgment at billing time create audit risk because the control is not systematic.
What is the difference between overhead and G&A?
Overhead covers costs associated with contract work performance: facility rent, equipment depreciation, project management. Overhead allocates on direct labor. G&A covers corporate-level costs: executive compensation, accounting fees, legal fees. G&A allocates on total cost input. Misclassifying between pools changes which contracts bear the cost.
Subscribe to The Authority Brief for next week’s analysis.
