The Taxpayer Times

All About DCAA Audits – Part 2

This article is part of an ongoing series on DCAA audits for government contractors.

In Part 1, DCAA Audit 101, I covered the foundation – what a DCAA audit is, when it applies, and why it matters. If you have not read that article yet, I recommend starting there first, because it provides the context that makes this series easier to follow.

Part 1 link: http://www.taxsimplified.blog/2025/12/08/dcaa-audit-101/

In the articles that follow, I’ll walk through the major areas DCAA evaluates, including accounting system requirements, timekeeping practices, cost classification, internal controls, and pre-award and post-award audits. Each topic will be addressed step by step, with an emphasis on clarity and practical understanding for small and growing contractors.

With that context in mind, this article focuses on one core question contractors often ask after learning about DCAA audits:

What does DCAA actually review during an audit?

This is Part 2 of the DCAA Audit Series, and the focus shifts from what DCAA audits are to what DCAA evaluates once a contractor is subject to review.

DCAA Is Evaluating Systems, Not Just Numbers

One of the most common misunderstandings about DCAA audits is the assumption that the government is reviewing a contractor’s profitability, business decisions, or overall success.

That’s not the purpose.

DCAA evaluates whether a contractor’s accounting system and cost-tracking processes produce accurate, consistent, and supportable cost information in accordance with government requirements. The emphasis is not on perfection, but on reliability.

In practical terms, the review often comes down to questions like these:

• Can the contractor identify where costs came from?
• Are costs recorded consistently?
• Can transactions be traced from source documents to the accounting records?
• Do written policies match actual practices?

Understanding this mindset helps contractors view DCAA audits less as an inspection of outcomes and more as a review of structure.

And this is where many small contractors feel surprised: the concepts are simple, but the implementation must hold up under review, even when the business is busy, and processes are informal.

While these concepts are straightforward on paper, they become more challenging in practice, especially when systems must operate consistently over time, across contracts, and under real-world business pressure. Most DCAA issues arise not from misunderstanding the rules, but from gaps between what a contractor believes is happening and what the records actually show.

The Core Areas DCAA Reviews

Rather than focusing on individual transactions in isolation, DCAA evaluates several interconnected areas. Each supports the government’s need to rely on a contractor’s cost data.

At a high level, DCAA evaluates the following:

Accounting System

The accounting system must be capable of:

• Separating direct and indirect costs
• Accumulating costs by contractor or job
• Recording costs in a consistent manner

This does not require sophisticated software, but it does require intentional setup. Many problems start when a contractor assumes the accounting system will “work itself out later.”

Timekeeping Practices

Labor costs are often the largest component of government contracts, which makes timekeeping a central focus.

DCAA evaluates whether:

• Time is recorded accurately and timely
• Hours are charged to the correct cost objectives
• Practices are consistent across employees

The key issue is not how many hours are worked, but whether labor costs can be supported and traced. In practice, timekeeping is often where a contactor realizes that “we’re small” is not the same as “we can be informal.”

Timekeeping problems rarely stem from a lack of knowledge; they arise when policies are not enforced consistently, corrections are informal, or practices drift as workloads increase.

Direct and Indirect Cost Treatment

Costs must be classified properly and consistently.

DCAA looks at:

• How direct costs are identified and charged
• How indirect costs are grouped and allocated
• Whether similar costs are treated the same way across contracts

Inconsistency, more than the type of cost itself, often creates issues, especially when processes change depending on who is entering transactions or which contract feels urgent that week.

Internal Controls

Internal controls are not limited to large organizations.

For small contractors, DCAA focuses on whether:

• There is appropriate oversight of financial activity
• Key processes are documented, even if simply
• Management is involved in reviewing and approving costs

The expectation is reasonableness, not complexity. A small business may not have layers of staff, but it still needs a system that demonstrates accountability.

Policies and Procedures

Written polices help demonstrate that practices are intentional rather than informal or reactive.

DCAA reviews whether policies exist for areas such as:

• Timekeeping
• Expense reimbursement
• Cost allocation
• Accounting practices

Policies should reflect what the business actually does, not what it hopes to do in the future. A short policy that matches reality is stronger than a long policy that no one follows.

Writing a policy is often the easiest part. Keeping daily practices aligned with that policy, especially as staff, contracts, or priorities change, is where most compliance gaps appear.

Supporting Documentation

Every system relies on documentation.

DCAA evaluates whether costs can be supported by records such as:

• Timesheets
• Invoices
• Receipts
• Payroll records
• Accounting reports

The focus is on traceability from original records to financial reports. If the documentation is missing or inconsistent, even honest work can become difficult to support.

Why These Areas Matter Together

None of these areas stands alone.

Timekeeping affects labor costs. Labor costs affect indirect rates. Indirect rates affect contract pricing and billings. All of it flows through the accounting system.

This is why contractors sometimes feel caught off guard, even if one area seems minor day to day, it may affect everything downstream once costs must be supported and explained.

What This Means for Contractors

Many DCAA audit issues do not arise because contractors misunderstand the requirements. They arise because systems that seemed adequate early on were never stress-tested under audit conditions, growth, or time pressure. What works informally in day-to-day operations often breaks down when costs must be explained months or years later.

Contractors often begin government work using processes that worked well for commercial clients. Over time, those processes may no longer be sufficient.

Recognizing what DCAA evaluates allows contractors to address gaps early, before audits, deadlines, or contract pressure create urgency. And if the goal is to grow in government contracting, building the right structure early usually saves time and cost later.

Understanding the Rules Is Not the Same as Being Ready

Learning how DCAA evaluates contractors is an important first step. Readiness, however, depends on whether systems are consistently followed, monitored, and documented over time. That distinction often becomes clear only when an audit is already underway.

Author’s Note

Clarity should not be mistaken for simplicity. While DCAA requirements can be explained clearly, meeting them consistently, across contracts, personnel, and reporting periods, requires structure, oversight, and sustained attention. Most challenges arise not from misunderstanding expectations, but from the cumulative effect of small gaps left unaddressed.

Looking Ahead in the Series

In upcoming articles, this series will explore these areas in more detail, including:

• Accounting system requirements
• Timekeeping expectations
• Cost classification under government rules
• Internal controls for small businesses
• Pre-award and post-award DCAA reviews

Each topic will be addressed step by step, with clarity and practical context.

If You Missed Part 1

If you are new to DCAA audits, you may find it helpful to start with Part 1: DCAA Audit 101, which explains the background and timing of DCAA audits before diving into what is reviewed.

If you are preparing for government contracting growth or expect increased scrutiny, it helps to review these areas proactively because fixing systems under time pressure is always harder than setting them up intentionally.