The Ever-Present Challenge of Unallowable Costs and Inadequate Documentation

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Among the most consistent and challenging DCAA compliance issues for government contractors are the proper identification and exclusion of unallowable costs and the pervasive problem of inadequate documentation. These two areas are frequent sources of audit findings and disallowed costs, impacting a contractor’s profitability and reputation. Recent DCAA reports continue to underscore the agency’s vigilance in these critical areas.

Unallowable Costs: A Persistent Hot Button:

FAR Part 31, “Contract Cost Principles and Procedures,” explicitly outlines various costs that are unallowable under government contracts. These include, but are not limited to, entertainment costs, certain lobbying costs, bad debts, charitable contributions, fines and penalties, and certain executive compensation deemed unreasonable. Despite clear guidance, DCAA frequently finds unallowable costs charged to government contracts, either directly or indirectly through overhead pools.

In FY 2023, DCAA identified $5.4 billion in audit exceptions, with a significant portion attributable to questioned costs related to allowability. The sheer volume of these exceptions highlights the ongoing struggle contractors face in consistently identifying and segregating unallowable expenses. A common deficiency is the use of broad percentages to exclude unallowable travel, rather than specific identification, which DCAA views as insufficient.

The Documentation Imperative:

Beyond cost allowability, inadequate documentation is a pervasive problem that can undermine even otherwise compliant practices. DCAA audits require contractors to provide robust evidence supporting all incurred costs. This means:

  • Detailed Records: Every expense, especially direct costs, must be traceable and supported by invoices, receipts, and other relevant documentation.
  • Timekeeping Records: Timekeeping records must be accurate, completed daily, approved by supervisors, and include an audit trail for any corrections. The lack of proper documentation for labor hours is a leading cause of DCAA findings.
  • Approval Authority: Documentation of proper approval authority for expenditures, journal entries, and invoices is crucial.
  • Policies and Procedures: While not direct cost documentation, written policies and procedures that align with actual practices are vital supporting documentation for DCAA’s assessment of a contractor’s overall compliance.
  • Subcontractor Documentation: Evidence of proper subcontract analysis, pricing, and contracting officer approvals is essential.

Consequences of Lapses:

The consequences of failing to properly identify and exclude unallowable costs or maintain adequate documentation are severe. They can lead to:

  • Disallowed Costs: DCAA will question and ultimately recommend disallowing any costs deemed unallowable or unsupported, leading to financial recovery by the government.
  • Payment Withholdings: For significant deficiencies, particularly in business systems, payments can be withheld.
  • Reputational Damage: Repeated audit findings or disallowances can erode trust with government agencies, making it difficult to secure new contracts.
  • Legal and Criminal Penalties: In cases of fraud, misrepresentation, or intentional charging of unallowable costs, contractors can face civil fines, criminal charges, debarment, and even imprisonment.

Best Practices for Mitigation:

To address these challenges, contractors should:

  • Implement Strong Internal Controls: Establish robust internal controls for expense tracking, approval processes, and documentation.
  • Conduct Regular Training: Provide comprehensive training to all employees, particularly those involved in financial reporting and project management, on FAR Part 31 and the importance of detailed documentation.
  • Automate Where Possible: Utilize DCAA-compliant accounting and expense management software that facilitates the identification and segregation of costs and automates documentation processes.
  • Perform Internal Audits: Regularly conduct internal reviews to identify and correct any potential issues related to unallowable costs or documentation deficiencies before a DCAA audit.
  • Consult FAR and DCAA Resources: Refer directly to FAR Part 31 and DCAA’s “Information for Contractors” manual (DCAAM 7641.90) for detailed guidance on cost allowability and documentation requirements.

Conclusion:

The persistent challenge of unallowable costs and inadequate documentation requires continuous vigilance from government contractors. By prioritizing a strong understanding of cost principles, implementing robust internal controls, and fostering a culture of meticulous documentation, contractors can significantly reduce their audit risk and ensure compliance with DCAA standards.

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