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A pre-award accounting system audit is an evaluation of the design of your accounting system for the award of cost-type contracts, including Cost-plus-fixed-fee and Time & Materials (T&M). An adequate accounting system is required pursuant to FAR 16.104:

(i)  Adequacy of the contractor's accounting system. Before agreeing on a contract type other than firm-fixed-price, the contracting officer shall ensure that the contractor’s accounting system will permit timely development of all necessary cost data in the form required by the proposed contract type.

What is SF 1408?

DCAA, and prime contractors alike, us the Standard Form SF-1408 to evaluate if a contractor’s accounting system is adequate for the award of these types of contracts. Without an adequate accounting system that passes the criteria in the SF-1408, a contractor will not be able to compliantly perform under cost-type contracts so it’s critical that a contractor understand the criteria, and how to demonstrate compliance with the criteria.

The Standard Form 1408 (SF1408), otherwise known as the Pre-Award Accounting System Survey, or Pre-Award Accounting System Adequacy Checklist, is a checklist used by Defense Contract Audit Agency (DCAA) auditors in the performance of a “pre-award audit”. The “pre-award audit” is technically a review and not a true audit because it does not look at any actual costs, rather it determines whether the design of a contractor’s accounting system is “adequate”

The SF1408 is usually a self-certification that documents the contractor’s accounting system adequacy and is used by DCAA during its Accounting S

ystem Review, but in some cases, it can be utilized by a third-party CPA to issue a determination of acceptability. It should be noted, however, that acceptance of a third-party CPA’s determination by the Federal customer is usually stated explicitly within the solicitation.

 

SF1408 Criteria

The SF1408 criteria requires that a contractor be able to demonstrate the following:

SF1408

What if a Contractor Does Not Meet the SF1408 Criteria?

If a contractor cannot demonstrate it maintains an “adequate accounting system”, it may be denied the award or required to correct the deficient elements prior to reconsideration. If a contractor has been awarded a Federal contract and cannot pass an Accounting System Audit, DCAA can suspend the contract until the deficiencies are resolved.

As such, it is always in a contractor’s best interest to proactively conduct and submit an SF1408 if it plans to bid on a cost-reimbursable award, or show proof of a previous determination of an “acceptable accounting system”. If gaps within the accounting system have been identified during the process, the contractor should include a detailed plan with implementation date for bringing its system into compliance.

What is the Difference Between a Pre-Award Accounting System Audit and a Post Award Accounting System Audit?

A lot! A pre-award accounting system audit evaluates the design of the accounting system, namely that it can collect costs at the project level and has sufficient cost accounting set-up with policies to demonstrate it is capable of properly invoicing under cost-type awards. A post award accounting system audit tests the operating effectiveness of the system, specifically evaluating transactions that run through the accounting system. They are entirely different audit programs:

Pre-Award Accounting System Audit Program: 17740 Preaward Survey of Prospective Contractor Accounting System AP (dcaa.mil)

Post-Award Accounting System Audit Program: 11070 Compliance with DFARS 252.242-7006 Accounting System Administration Requirements Audit AP (dcaa.mil)

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Navigating a DCAA audit can be a complex and challenging process, and ensuring that your accounting system is audit-ready is crucial for success. Whether you're seeking assistance with supporting an ongoing DCAA audit or evaluating the preparedness of your accounting system for an upcoming audit, our expert team is here to guide you. We specialize in providing comprehensive support, from assessing compliance with DCAA requirements to implementing necessary adjustments in your accounting practices.

 

Cost Accounting Standard (CAS) 403 is one of the most consistently misunderstood standards within CAS.  Why?  Usually because it involves more than just the segment you reside in.  It requires cooperation and communication between parent entities and their  segments, government and commercial segments both.  The purpose of CAS 403 is simple,  “to establish criteria for allocation of home office expenses to the segments of the organization on the basis of a beneficial or causal relationship.”

Key Definitions for CAS 403

To understand CAS 403, it is fundamental to know how CAS defines a home office, an intermediate home office, and a segment.

A home office is an office responsible for directing or managing two or more segments of an organization. For example, a corporate headquarters. A home office usually performs management, administrative, and other back-office functions the benefit one or more segments.

An organization can also have intermediate home offices for each group within the organization that report to one common home office. For example, a company may have an ultimate parent organization that directs strategy of the business with core executive functions and similar.  And intermediate home offices may be back office support organizations that sit beneath the ultimate parent but still perform functions on behalf of multiple segments.

In order to properly comply with CAS 403, a complete cost accounting illustration is necessary to understand the big picture of who supports who and where they sit within the organizational and operating structure of the business.  Just getting this part right at the on-set is a significant advantage to complying with CAS 403, but also to understanding the best way to optimize cost allocations within your business.

A segment is “one of two or more divisions, product departments, plants, or other subdivisions of an organization reporting directly to a home office, usually identified with responsibility for profit and/or producing a product or service.”

CAS 403 focuses on how home office expenses must be allocated to segments, and/or intermediate home offices, as applicable.

Allocation Pool and Base Requirements

CAS 403 requires that home office expenses are allocated on the basis of beneficial or causal relationships.  The allocation methodology is hierarchial in nature, with direct allocations of home/intermediate home office costs being required to the maximum extent practicable. The concept of ‘direct allocation’ is not to be confused with the concept of ‘direct costs’.  Directly allocated simply means a cost is being assigned directly to the benefiting segment.

For example, if a home office is performing legal work on behalf of an individual segment, however it has responsibility for four (4) segments, the time spent on the matter can be directly identified, and hence directly allocated to the benefitting segment.  When direct allocation is not practical, home office expenses must be grouped into homogeneous expense pools and allocated subsequently.

Homogenous Expense Pools Prescribed by CAS 403

The following are the types of homogenous expense pools prescribed by CAS 403 that can be used:

  1. Centralized service functions
  2. Staff management of certain specific activities of segments
  3. Line management of particular segments or groups of segments
  4. Central payments or accruals
  5. Independent research and development (IR&D) costs and bid and proposal costs (B&P)
  6. Residual expenses

These are referred to as “functional allocations”.  The number of functional allocations an organization has usually depends on the variety and significance of service and management functions performed by the home office. But to avoid having too many groupings, as long as the pooled expenses can be allocated using the same allocation base (e.g., employee headcount), they can be included in the same home office expense pool.

CAS 403 Examples

CAS 403 provides illustrated examples of typical home office allocation pools and bases. For items one through five above, following are some additional examples.

Home Office Expense or Function Illustrative Allocation Bases
Human Resources Employee headcount, labor hours, payroll, number of hires
Information Technology Employee headcount, computer equipment nodes
Centralized warehousing Square footage, value of material, volume
Finance and accounting Operating revenue
Security Employee headcount, square footage

 

Lastly, if the home office costs cannot be allocated either directly or functionally then CAS provides for the remainder of costs to be treated as “residual expenses”.  Residual expenses are typically those that are not identifiable with specific activities of segments and cannot be more equitably allocated based on a functional allocation.

While it may be compliant to allocate residual expenses in different ways, the most common approach is the Three Factor Formula which is calculated by taking the arithmetical average of the following three percentages for the same period:

  1. Percentage of segment payroll dollars to total payroll dollars of all segments
  2. Percentage of segment operating revenue to total operating revenue of all segments
  3. Percentage of average NBV of the sum of segment tangible capital assets plus inventories to the total average NBV of such assets of all segments

Note that at certain size thresholds contractors are required to use the 3 Factor Formula.  Other contractors sometimes use sales as a simple residual allocation method when not required by CAS to use 3 Factor Formula.  Others still may find that a 2 Factor formula is most equitable given the nature of their business.  For example, it is not uncommon for some businesses to have highly variable fixed assets across their segments which may be distortive to the allocation method.

Best Practice Strategies

CAS 403 Challenges

The most common CAS 403 challenges we find working with contractors include:

While CAS 403 is a U.S. Government contract requirement, it’s allocation methodologies are highly leverageable by companies that understand them.  CAS 403 has its own dedicated audit program (DCAA > Customers > Guidance > Directory of Audit Programs)  that DCAA uses when auditing and findings within CAS 403 are some of the most common CAS audit findings.  While they can be a challenge, they can also be a way to ensure alignment between home office parents and their segments.  We have found the contractors with the most success with CAS 403 are those that have strong communication and alignment with their parent organizations.

Lastly, Home Office allocations require a Home Office Disclosure Statement.  For more information on preparing compliant Disclosure Statements, please visit:  DS Done -- CAS DS-1 Form completion application (rkiaccounting.com)

Cost Accounting Standards (CAS), promulgated by Part 30 of the Federal Acquisition Regulation (https://www.acquisition.gov/far/part-30#FAR_30_101), maintains specific requirements for a US Government Contractor when they apply to a US Federal Government Contract.

A CAS Covered Contract is one that meets specific qualifications that trigger CAS Coverage. The qualifications, exceptions, and other conditions that determine CAS Applicability, Coverage Type, and Disclosure Requirements can be confusing. Our blog post: What Are CAS Covered Contracts?  lists these qualifications and additional detail on the matter. To provide added clarity for the visual learner, we’ve put it all into one clean illustration:

Download the CAS Flowchart Here: CAS Applicability Flowchart.

 

Cost Accounting Standards (CAS) 401 and 402 are all about a U.S. Government contractor’s consistency in its cost accounting practices. While CAS 401 dictates the requirements for contractors to “bid, book, and bill” consistently, CAS 402 focuses on how a contractor ensures that contracts are not inequitably charged for similar costs incurred in like circumstances..

Cost Accounting Standards 401 – Consistency in Estimating, Accumulating and Reporting Costs.

The purpose of CAS 401 as stated: “is to ensure that each contractor’s practices used in estimating costs for a proposal are consistent with cost accounting practices used by [the contractor] in accumulating and reporting costs.”

In its simplest sense the federal government wants to ensure that a contractor can prove that the costs it estimates can, in some meaningful way, be tied to the actual costs they incur. Without this consistency, there is risk a contractor may estimate costs one way without any capability to evidence that their estimated costs were reasonable. An example follows:

Example: A contractor estimates engineering labor hours for five (5) separate engineering labor categories. However, the contractor does not separately track engineering labor hours for its employees in any of its books and records. In such a scenario, a contractor cannot demonstrate the actual number of hours incurred for the labor categories that they estimated.

The key question a contractor should ask themselves is “can I reproduce this cost estimate with actuals once the contract begins?”. Of significance in answering this question is the CAS definition for “accumulating costs”, as follows:

“Accumulating costs means the collecting of cost data in an organized manner, such as through a system of accounts.” (48 CFR 9905.501-30)

Cost Accounting Standards 401 Practice:

Please note that the definition provides for collecting cost data in an “organized manner”. That does not mean that you can’t have supplemental records that corroborate your cost estimates. Extending our example above for cost accounting standard 401, it’s possible the contractor does not differentiate its engineering labor in its General Ledger (G/L). However, it may well have work orders or project accounting records that provides such visibility.

There are even instances where a contractor may maintain the records outside its accounting software. Hence, the CASB DS-1 section 1.5.0 “Identification of Differences Between Contract Cost Accounting and Financial Accounting Records.” The federal government requirements understand that financial accounting and federal cost accounting are not one and the same.

The key is that they be equitable and reconcilable with the ability to reproduce actuals consistent with how you estimated. Best practice is certainly to have your financial accounting and federal cost accounting match one-to-one, but that’s not always practical. Understanding CAS 401 is key to how you establish your cost accounting and cost estimating practices. 

Cost Accounting Standards 402 – Consistency in Allocating Costs Incurred for the Same Purpose

The purpose of CAS 402 as stated: “is to require that each type of cost is allocated once and on only one basis to any contract or other cost objective.” Certain types of costs, such as project management, equipment, project accounting personnel, etc., are prone to inconsistent cost accounting practices where a federal contract may be charged twice for the same, or similar cost, without any additional benefit received.

They key words in Cost accounting standards 402 are that “All costs incurred for the same purpose, in like circumstances, are either direct costs only or indirect costs only with respect to final cost objectives.” This can be tricky given the innumerable circumstances in which a cost may be incurred (e.g., on-site, remote, etc.). An example follows:

Example: A contractor has a procurement department that supports all purchasing efforts, direct and indirect of the business. The department’s costs are included entirely in G&A. However, it has a new contract award that it bids procurement personnel as direct labor for.

This example is a classic CAS 402 example. The obvious conclusion is that this is a CAS 402 non-compliance because a federal contract would be incurring cost directly for the direct labor of the new procurement individual, as well as the G&A (which includes procurement personnel) resulting in double charging (bad words in government contracting!). Are there examples by which this may be compliant? Beauty is in the eye of the beholder.

Some contractors may be able to demonstrate that the nature of the procurement is different. Perhaps its local procurement overseas whereby they’re purchasing small dollar items for contract-specific needs. This may not in and of itself make it ‘unlike’, but it might. There are many variables to properly defining each cost as direct or indirect.

The question we most often ask a way of translating this is “Is the contract benefitting from both the direct activity and the indirect activity?” This might not answer the question completely, but it’s a start. CAS 402 is one of the most common, if not the most common CAS non-compliance during CAS audits.

Benefits of CAS 401 and CAS 402 Compliance

Complying with CAS 401 and CAS 402 have benefits to contractors that can significantly impact their bottom lines. CAS compliance can lead to:

A CASB Disclosure Statement is a form whereby a US Government Contractor discloses its cost accounting practices, for which it is required to demonstrate CAS compliance for the life of its active CAS (Cost Accounting Standards) covered awards. The CASB Disclosure Statement, otherwise known as DS-1, has a very rigid format with eight different parts:

Each part has numerous sections called items which vary in applicability to the contractor, depending on the contractor’s cost accounting practices. While each item is generally constituted by selection boxes and multiple-choice questions, certain responses require the contractor to detail information in longer narrative form, on “continuation sheets”.

When is a CASB Disclosure Statement Required?

The requirement to submit a CASB Disclosure Statement depends on the CAS covered contracts a contractor maintains. In a nutshell, CAS is applicable to individual contracts and the applicability of CAS is triggered based on dollar thresholds. Whether or not CAS is applicable to a given contract is determined by the contract type, the size of the business receiving the contract, and the amount awarded. A CASB Disclosure Statement is required if Full-CAS coverage applies to a contractor. [Click here] to learn more about types of CAS coverage and CAS applicability.

Any CAS-covered contract of $50 million or more requires a Disclosure Statement prior to the contract award. CASB DS-1 should not be submitted prior to Full-CAS coverage applicability. The solicitation usually provides clarification on when exactly the Disclosure is required. Typically, if the requirement is in the solicitation, and it is the Contractor’s first Disclosure, then submission is due at the time of the proposal.

If a CAS-covered contract under $50 million is awarded, and the Contractor received net CAS-covered awards in the prior accounting period totaling more than $50 million, then the Contractor is required to file a Disclosure Statement prior to the contract award. However, if the award is within the first 90 days of the proceeding accounting period, then the contractor is not required to file until the end of the 90 days.

If a contractor anticipates future Full-CAS coverage, it is prudent to have the Disclosure Statement prepared and ready (i.e., not submitted to the Government).

CASB Disclosure Statement Adequacy and Compliance

When a CASB Disclosure Statement is required, it must be submitted to the Contracting Officer (CO) and the Cognizant Federal Agency Official (CFAO). All Disclosure Statements will be reviewed and audited based on two major factors (1) adequacy, and (2) compliance.

CASB Disclosure Statement Adequacy

The adequacy of a CASB Disclosure Statement is determined by how the DS-1 is formatted and filled out based on the applicability of the 19 Cost Accounting Standards to the contractor. For example, if a contractor accumulates Home Office expenses and allocates such expenses to various business segments, but it does not complete Part VIII of the Disclosure Statement, the Disclosure Statement would be deemed inadequate.CAS Disclosure statement

Ensuring adequacy on a CASB Disclosure Statement is not easy, and it can be a grueling process to pass adequacy with DCAA. DCAA’s adequacy checklist evaluates the DS-1 for completeness and proper formatting, oftentimes resulting in many rounds of back and forth before a Disclosure Statement is accepted for audit.  This erodes auditor confidence and burns costly time on behalf of the Government and the contractor.

Our experience suggests that at least 50% of inadequacies can be avoided simply by filling the DS-1 out with all the required information in proper format.  As a result, we designed a proprietary software – CASB DS-Done – to facilitate an adequate Disclosure Statement.  The software is built with control integrity to hit on all the required fields and continuation sheets with user-friendly prompts avoiding the countless hours of formatting and inadequacy rejections.  [Click here to learn more about DS-Done].

Contractor Compliance With Disclosed Accounting Practices and Procedures

The Defense Contract Audit Agency (DCAA) maintains eight types of noncompliance based on CASB rules, regulations, and standards, and FAR Part 31:

  1. Disclosed practices not compliant with CAS;
  2. Disclosed practices not compliant with FAR;
  3. Actual practices of estimating costs not compliant with CAS;
  4. Actual practices of estimating costs not compliant with FAR;
  5. Actual practices for estimating costs not compliant with the practices disclosed in the Disclosure Statement;
  6. Actual practices for accumulating or reporting costs not compliant with CAS rules and regulations;
  7. Actual practices for accumulating or reporting costs not compliant with FAR; and
  8. Actual practices for accumulating or reporting costs not compliant with the practices disclosed in the Disclosure Statement.

What Are the Penalties of CASB Disclosure Statement Inadequacies or Noncompliance?

Inadequate formatting of CASB DS-1 greatly hampers the progress of a contractor’s Government Contracts program from an operational, accounting, and billing standpoint. To ensure all contract estimates, procurements, and billings are conducted properly under CAS rules, regulations, and standards, and FAR part 31, the accounting practices of Full-CAS covered contracts or companies/business segments are audited via initial Disclosure Statement audit.

Such audits will only be initiated once the CFAO has deemed the CASB DS-1 to be adequate. Delays in Disclosure Statement adequacy translate to delays in Disclosure Statement audits, and delays in Disclosure Statement audits degrade both contractor and Government confidence in the contractor’s cost accounting reliance.  It can also result in delayed contract award, in addition to unnecessary resource consumption on both parties to resolve inadequacies that can be avoided with upfront diligence.

Penalties for Noncompliance

Depending on the nature of the non-compliance there can be a variety of penalties for noncompliance. In its simplest sense, the U.S. Government will be entitled to repayment of any material non-compliance if it resulted in increased cost to the Government. If the CFAO determines that noncompliance is material, the contractor is required to submit a description of any accounting practice change needed to bring the practices into compliance, which the auditor will review for adequacy and compliance. If the proposed change is both adequate and compliant, the contractor must submit a cost impact detailing the effect the non-compliance had on all effected CAS covered awards.

The CFAO will evaluate the cost impact and if the result was increased cost to the Government, the CFAO will administer contract and/or billing adjustments, plus applicable fines and interest to repay the amounts due as a result of the noncompliance. Noncompliant cost impacts take time to develop, negotiate, and are a significant burden and expense to both the contractor and the Government to administer. It can require going back years into your historical contract and accounting records to obtain the necessary information to perform a cost impact analysis.

Adding to the risk of CAS non-compliances is the risk of perceived, or actual, False Claim Act (FCA) allegations from the customer.  In many instances, the U.S. Government customer may assert that the contractor was aware, or should have been aware, of the non-compliance and, as such, the Government is entitled to False Claim damages up to treble damages.  In short, CAS non-compliances only come in 2 varieties:  bad and worse.

“CAS noncompliance” is among the short list of bad words you never want associated with your organization; right along with false claims and defective pricing – words that often get attached to CAS noncompliance if the Government feels the noncompliance was purposeful.  Be diligent upfront and ensure you can demonstrate compliance with CAS.

 

Defining CAS Coverage and What Constitutes a CAS Covered Contract

In its simplest sense, a CAS covered contract is any U.S. Government contract that does not meet an exemption from the Cost Accounting Standards (CAS) and includes the CAS clause (FAR 52-230-2 Cost Accounting Standards). While that sounds simple, what is not is navigating whether a contract meets CAS exemptions, and if it does not, knowing which CAS coverage is applicable to the contract; modified CAS or full CAS.

CAS applicability is one of the most common challenges faced by a growing U.S. Government contractor. Once a contractor has triggered CAS through the award of a CAS covered contract, its compliance profile changes significantly with increased cost accounting requirements and audit interest from the Defense Contract Audit Agency (DCAA).

Compliance with CAS can be complex and confusing to many Contractors, so it is crucial for Contractors to understand CAS applicability and determine whether they have any CAS Covered Contracts. It is also crucial, based on the type of CAS Coverage, to understand CAS implications in their organization. Many contractors lack the formal procedures and internal controls to effectively track their US Government Contract awards against CAS Coverage. This can result in major compliance challenges downstream that are expensive to untangle.

CAS Applicability & Exemptions

CAS is applicable to negotiated contracts greater than $2M, unless the contract meets one of the following CAS exemptions:

The trigger contract often results in contractors amassing multiple CAS covered contracts. Losing track of which contracts are subject to CAS and which are not is significant, as the U.S. Government has certain rights under CAS covered contracts that it does not under non-CAS covered contracts. This includes retroactive price adjustments should a contractor not comply with CAS.

CAS Coverage – Modified vs. Full CAS Coverage

Modified CAS Coverage is triggered when a contractor receives a CAS Covered Contract greater than $7.5M but less than $50M in its current cost accounting period. Modified CAS Coverage requires the contractor to comply with four of the 19 standards (CAS 401, 402, 405, and 406).

Full CAS Coverage, which requires compliance with all 19 standards, is triggered when either:

A.     A contractor receives a CAS covered award over $50M in the current cost accounting period; OR

B.     A contractor received an accumulation of CAS covered awards in the previous cost accounting period that total $50 or more.

As required by cost accounting standards, a CASB disclosure statement is required if full CAS coverage applies (and in some cases, modified coverage). Disclosure Statements are a form whereby a contractor discloses its cost accounting practices, for which it is required to demonstrate compliance throughout the life of its active CAS covered awards.

CAS Exemptions Flowchart

A CAS coverage flowchart that illustrates applicability, coverage, exemptions, and disclosure statement requirements can be found here.

A common misconception held by many contractors is that a contractor is either CAS-covered or not CAS-covered. While a simple way to think of it, it is important to recognize that CAS applies at a contract level, not at a contractor level. Every U.S. Government contract should be evaluated on its date of award to determine if and how CAS applies.

How Long Does CAS Coverage Last?

The CAS applicability on the date of the contract award is the applicability for the life of the contract. Hence, some contractors can have a combination of exempt, modified CAS, and full CAS covered contracts.

The CAS status of a contract or subcontract remains the same throughout its life. For example, if a contractor holds a contract subject to Modified CAS Coverage, and then receives a contract subject to Full CAS Coverage, the initial contract does not become subject to Full CAS, and remains subject to Modified CAS.

Making Cost Accounting Practice Changes Under CAS

Once CAS is triggered, contractors must monitor its cost accounting practices for any changes as they require disclosure to the U.S. Government pursuant to FAR 52.230-3 Disclosure and Consistency of Cost Accounting Practices. Contractors that fail to realize this significant requirement, applicable under both modified and full CAS covered contracts, may make a change that results in increased cost to the U.S. Government for which it will not pay.

Generally, the U.S. Government will not pay increased costs due to changes in a contractor’s cost accounting practices. One of the easiest, and expensive, ways to get in trouble with CAS covered contracts is to make changes to cost accounting practices that seem benign but change the way the U.S. Government participates in cost. Examples of common changes in cost accounting practice that are natural for a contractor but impact cost allocation include:

Impact on CAS Covered Contracts

All changes to cost accounting practice are likely to result in some cost impact to CAS covered contracts. Changes to cost accounting practice require disclosure prior to adopting them. In most instances the U.S. Government will require a contractor to submit a cost impact proposal, either through a Detailed Cost Impact (DCI) or General Dollar Magnitude (GDM).

Not realizing this requirement can result in significant cost impacts to the U.S. Government whereby a contractor may have to pay large sums of money back to the U.S. Government for years of undisclosed changes in cost accounting practice. This is a massive difference from commercial and non-CAS covered contracts. In its simplest sense, once a contractor is CAS covered, it really needs cooperation in order to change its cost accounting practices.

Monitor Your Contracts and Protect Your Organization!

If you are a contractor, it is important to evaluate every award for CAS applicability and maintain a CAS tracker so that you know the CAS applicability at the contract level. And it is something every executive team, not just accounting and contracts, needs to be familiar with. Changes in organizations bring changes to cost accounting; and those changes need to be considered prior to making the change. If the entire organization is not aware of these risks, it can easily result in changes that cost the contractor money.

Need Help Becoming CAS Compliant?

Ready to navigate the complexities of CAS coverage with confidence? At RKI, we specialize in providing comprehensive guidance and support for all your CAS-related needs. From understanding the nuances of modified and full CAS coverage to ensuring full compliance with cost accounting standards, our team is here to help. Don't let the intricacies of CAS applicability overwhelm you. Contact RKI today for expert assistance and protect your organization from costly compliance pitfalls. Get in touch now and take the first step towards seamless CAS management.

If a contractor has received a contract containing the Allowable Cost and Payment clause (FAR 52.216-7), the clause requires preparation of an Indirect Cost Rate Proposal (ICRP).  The clause is applicable to all cost-type contracts.  The proposal also goes by the following industry names “Incurred Cost Proposal” (ICP) and “Incurred Cost Submission” (ICS).  The proposal is prepared using the Defense Contract Audit Agency (DCAA) Incurred Cost Electronic (ICE) Model (DCAA > Customers > Checklists & Tools > ICE Model) and is due  six months after the contractor’s fiscal year end.

Under cost-type contracts, contractors utilize a provisional billing rate throughout the year.  The intention of the Incurred Cost Proposal is to true-up a contractor’s provisional billing rate to actual under its cost-type contracts. The actual rate is compared to what was billed and the calculated over/underbill is either credited back to the government or invoiced, respectively.

The proposal includes a series of Schedules from Schedule A through O, including Supplemental Schedules.  Some of the more impactful Schedules Include Schedule A Summary of Indirect Rates, Schedule H Summary of Direct Contract Costs, and Schedule I Cumulative Costs Claimed & Billed.

Upon completion, the Incurred Cost Proposal is submitted to DCAA and your Administrative Contracting Officer (ACO) for audit.  DCAA uses an Incurred Cost Submission Adequacy Checklist (DCAA > Customers > Checklists & Tools > Incurred Cost Submission Adequacy Checklist) to determine if the submission is adequate for audit.  Upon acceptance, DCAA may audit the submission for compliance including accuracy of rate calculations and applications.  This is the most frequent audit performed by DCAA year over year.  Their findings routinely center on unallowable costs pursuant to FAR 31 and exceptions to exceptions to cost accounting practices used by contractors.

The Defense Contract Audit Agency (DCAA) maintains multiple audit programs to monitor and verify government contractor compliance.  DCAA audit programs may occur before, after, or during contract performance through Preaward Audits, Postaward Audits, and Contractor Business System Audits. DCAA is chartered with identifying and evaluating all activities that contribute to or impact proposed or incurred costs of Government contracts.

DCAA’s major areas of emphasis include: DFARS Business Systems such as Accounting Systems, Estimating Systems, and Purchasing Systems; management policies and procedures; accuracy of contractor forward pricing and incurred cost representations; adequacy and reliability of records and accounting systems; and contract compliance with contractual provisions having accounting or financial significance such as the FAR Cost Principles (FAR Part 31), the Cost Accounting Standards (CAS), and clauses pertaining to the Truth in Negotiations Act (TINA).

The timing of DCAA’s audit will depend on the risk profile of your organization and its contracts.  DCAA uses a variety of risk assessment tools to determine which areas of regulatory risk warrant audit attention.  In addition, Contracting Officers have very broad discretion as to where audit resources should be deployed.

For an introduction to incurred cost proposals, please read What is an Incurred Cost Proposal?

There are six main steps to an incurred cost proposal:

  1. Gather input data from contractor accounting system, and project files
  2. Input data into the rate model
  3. Ensure reconciliation of the model to cost data
  4. Analyze resulting over/under billings by contract
  5. Prepare Incurred Cost Proposal Checklist to ensure adequacy
  6. Prepare and submit the Incurred Cost Submission

1. Gathering Input Data

There are many pieces of data needed to complete an incurred cost proposal. The main source of information is the contractor’s cost accounting data. For indirect costs, the right level of detail to identify the contractor’s cost pool accumulation is needed. Some organizations have separate accounts for each cost pool, while others may utilize cost centers to differentiate between overhead pools, for example. For direct costs, a project ledger that reports costs at the level specified within each given contract (usually at the Contract Line-Item Number, or CLIN, level), along with B&P and IR&D costs is needed.

There are a handful of other data sources and reports required for completion of the incurred cost proposal. These are also identified by schedule, in the next section:

2. Inputting Data into the Incurred Cost Proposal

The first objective of the Incurred Cost Proposal is to calculate the actual indirect rates expended during the cost accounting period. Calculation of the indirect rates using the standard ICE model (Incurred Cost Electronically), is most accepted by the Defense Contract Audit Agency (DCAA). The ICE model is an excel workbook with separate Schedules for each rate pool, and subsequent calculations. The following table illustrates each schedule and its purpose within the Incurred Cost Proposal.

Incurred Cost Submission Template

Schedule Title Description Inputs

(as applicable)

A Rate Summary Summary of all calculated final and intermediate rates showing pool and base values, and resulting rate. Schedules B-E
B General & Administrative (G&A) Pool Includes account balances for all trial balance accounts containing G&A labor and non-labor expenses, related fringe, intermediate allocations (if applicable), Bid & Proposal (B&P), and Independent Research & Development (IR&D) costs. Unallowable G&A costs within displayed accounts are illustrated and removed using the adjustment column. Trial Balance, Schedules D(x), Fringe, H and E
C(x) Overhead Pool(s) The contractor can include as many Overhead (OH) pools as needed labeling the fist as C(1), the second C(2), and so on. Each schedule C should include accounts balances for all trial balance accounts containing OH labor and non-labor expenses, related fringe, and intermediate allocations. Unallowable OH costs within displayed accounts are illustrated and moved to the G&A base. Trial Balance, Schedules D(x), and Fringe
D(x) Intermediate Pool(s)

(as applicable)

Includes account balances for all trial balance accounts containing intermediate expenses (e.g., facilities, IT, etc.), and related fringe. Each of these schedules must also show the allocation base and the resulting intermediate allocations to the G&A and OH pools Trial Balance, and Fringe
Fringe Fringe

(as applicable)

Accumulates all fringe expenses for subsequent allocation to G&A, OH, and/or intermediate pools, unless fringe expenses are included within those pools. Trial Balance, and

Schedule E

E Claimed Allocation Bases Calculates all allocation bases for each final rate (e.g., G&A, OH) by element of cost used to distribute indirect costs. For example, an Overhead base might include contract labor, IR&D labor, and/or B&P labor. Schedule E will also detail whether the G&A base is total cost input or value-added depending on inclusion or subtraction of direct material and subcontracts from the base calculation. All direct costs come from Schedule H. All overhead costs are included in the G&A base, and IR&D and B&P removed for subsequent inclusion in the pool in Schedule B. Schedules B, C(x), and H
F FCCOM Rate

(as applicable)

If the contractor maintains Facilities Capital Cost of Money (FCCOM) Rates, Schedule F is included in the Incurred Cost Proposal. This schedule lists all facilities capital costs and related accumulation and distribution of Net Book Value of assets. Schedule F-1
F-1 Calculation of NBV

(as applicable)

Lists all assets by asset class and related distributions. Only applicable if the contractor maintains FCCOM rates. General Ledger Accounts
G Direct Cost Reconciliation Reconciles direct costs by major cost element in Schedule H to the contractor’s General Ledger Schedule H
G-1 Direct Cost Recon 2 Reconciles direct costs by major cost element in the contractor’s general ledger to its job cost ledger Schedule G
Summary H Summary of Schedule H Summarizes direct costs in Schedule H by direct cost element, and details B&P and IR&D costs and applied indirect burdens Schedules H and E
H Direct Costs by Contract/

Subcontract

Lists all direct costs by contract type (i.e., cost type, other flexibly priced, T&M, fixed price, commercial work), by major cost element (i.e., labor, travel, material, ODC, subcontracts. Schedule H also applies the final rates calculated from Schedule A to calculate total actual cost expenditure by contract by Contract Line Item Number (CLIN). Contractor Project Ledger
H (cont.) Gov’t Participation in Direct Cost Bases Lists percentages of each total indirect cost base by contract type. Effectively illustrates percentage of government vs. commercial direct cost by final cost basis. Schedule H
I Cumulative Government Costs Claimed and Billed The “true-up” schedule. Schedule I is perhaps the most important schedule of the ICE model in that it informs both the contractor and government whether the contractor has an overbill or underbill position on each contract. This schedule lists the cumulative costs incurred per contract based on current and historic project accounting bookings, as well as the cumulative costs billed per contract based on historic bill files. The two amounts are compared, and the resulting variance indicates whether the contractor owes the government based on an overbill, or whether the government owes the contractor based on an underbill. This schedule effectively tells all parties (a) whether the contractor’s provisional billing rates are a stable estimate of the contractor’s actual costs incurred, and (b) which contracts are physically complete. Schedules H, K, and Contractor Gov’t Invoices
J Subcontract Information Lists all subcontracts issued under government contracts, including information such as subcontractor name, DUNS number, value, performance period, etc. Must reconcile to direct subcontract cost amounts listed on Schedule H Contractor Subcontract Logs
K Time & Material Contract Details Lists all hours and rates by labor category by Time & Materials contract, and any material and travel costs. Must reconcile to direct cost amounts listed on Schedule H Contractor Labor Distributions
L Payroll Reconciliation Reconciles all labor costs (direct and indirect) included in the ICE model to the contractors IRS Form 941s, payroll accruals and adjustments. Schedules B, C(x), D(x), and H
M Decisions/

Agreements

Lists any decisions/agreements, or approvals affecting the direct/indirect cost structures, and descriptions of accounting or organization changes. Contractor Accounting Changes
N Certificate of Final Indirect Costs Certification by signature of the contractor’s designated officer, to establish the final indirect cost rates, and state that all unallowable costs have been removed to the best of their knowledge. Contractor Signature
O Contract Closing Information Lists all contracts listed as “physically complete” on Schedule I, and includes period of performance, contract ceiling, fee, and level of effort if applicable. Schedule I
Supplementals Various The ICE model contains several supplemental schedules, which are not required for completion, but may be requested by the Contracting Officer or DCAA auditor. Historic Rate Data, and Contract/ Subcontract Briefings

3. Reconciliation of the Incurred Cost Proposal to Cost Data

In addition to the schedules described above, it is very useful to include a separate worksheet that lists all the expense accounts, which rate pools/bases they map to, and subsequent reconciliation to the rate schedules. Contractors may also want to consider including a “Total Cost Reconciliation”, which shows that all contractors books of accounts reconcile to costs used in the rate model. Effectively, the contractor’s expense Trial Balance, plus or minus certain adjustments and unallowables should equal the total costs in the model.

Expert Tip: any adjustments to rate pools should be accompanied with a footnote explaining the reasonings behind them. The most common adjustments are FAR 31 unallowable costs and other common DCAA questioned costs. The footnote may even be a reference to a separate calculation schedule (e.g., Cost of Ownership). This best practice demonstrates understanding of FAR cost accounting.

4. The Annual “True-up”

The main objective of the Incurred Cost Proposals is to calculate the over or underbill positions the contractor is in for each contract, to understand what it owes or is owed by the government or its prime contractors. As described above, this amount is calculated in Schedule I.

Once the incurred cost proposal has been filled out and reconciled, it is important for the contractor to return to Schedule I and review its position on all contracts and subcontracts to ensure that there are no surprisingly over or underbilled contracts, and develop informed billing strategies going forward. For example, if a given contract has a large unanticipated overbill, it might be prudent to double check the data input source for the correct information, or perhaps to stop claiming indirect costs on future bills.

Expert Tip: In addition to Schedule I, it is best practice to compare the current calculated rates to the latest provisional billing rates and previous final rates. This will inform the contractor not only how the rates changed, but provide an understanding of which accounts or direct cost elements and contracts are the main drivers of change. Having this information in your back pocket will allow you to answer auditors with confidence when they ask why certain rates changed materially.

5. Prepare Incurred Cost Proposal Checklist to Ensure Adequacy

Prior to submission of the Incurred Cost Proposal or ICE model, the contractor should fill out a DCAA ICS Adequacy Checklist as a final internal review, and include it with the submission. Before the actual Incurred Cost Audit, the auditor will perform this preliminary adequacy check of the Incurred Cost Proposal that is submitted to ensure the model is adequate for review.

While the auditor will complete this checklist themselves, performing this exercise prior to submission is not only a tool for quality control, but may demonstrate to DCAA that the contractor has an understanding of the review process.

6. Final Preparation and Submission

Once the schedules have been completed and reconciled, and Schedule I has been reviewed for accuracy, the contractor is ready to begin the submission process. The Incurred Cost Proposal is typically included as an attachment to an email addressed to the assigned DCAA auditor. It is prudent to request confirmation of receipt of the submission from the government to remove liability of delinquency in the timing of your submission.

If your Incurred Cost Audit results in no findings, DCAA will issue a formal letter addressed to the certifier in Schedule N, with the final rates.

We understand that preparation and submission of Incurred Cost Proposals is challenging. Please contact us here if you have any general questions, are in need of indirect rate services, or need Incurred Cost Audit support.

If you have a US Government contract containing the Allowable Cost and Payment clause (FAR 52.216-7) you are required to submit an annual Incurred Cost Proposal. This clause applies mostly to cost-reimbursable contracts, such as Cost Plus Fixed Fee (CPFF) and Time and Material (T&M). An Incurred Cost Proposal, also known as an Incurred Cost Submission (ICS), or Indirect Cost Rate Proposal (ICRP), takes all the cost accounting data from a contractor’s expense accounts to calculate the actual indirect rates for the cost accounting period (the fiscal year).

Under cost-type contracts, contractors utilize a provisional billing rate throughout the year.  The intention of the Incurred Cost Proposal (ICP) is to true-up a contractor’s provisional billing rate to actual under its cost-type contracts. The actual rate is compared to what was billed and the calculated over/underbill is either credited back to the government or invoiced, respectively.

When Must ICPs be Submitted?

As required by the Federal Acquisition Regulation (FAR), Incurred Cost Submissions must be submitted within 6-months of the contractor’s fiscal year end. For example, a contractor who’s fiscal year is the calendar year, must submit its ICP by June 30th of the following year. While it is not recommended, contractors may request an extension for submission of their rates, which may or may not be honored by DCAA.

Incurred Cost Submission Schedules

The proposal includes a series of Schedules from Schedule A through O, including Supplemental Schedules.  Some of the more impactful Schedules Include Schedule A Summary of Indirect Rates, Schedule H Summary of Direct Contract Costs, and Schedule I Cumulative Costs Claimed & Billed. Please read How to Prepare and Submit an Incurred Cost Proposal for more details on the preparation and submission process.

Upon completion, the Incurred Cost Proposal is submitted to DCAA and your Administrative Contracting Officer (ACO) for audit.  DCAA uses an Incurred Cost Submission Adequacy Checklist (DCAA > Customers > Checklists & Tools > Incurred Cost Submission Adequacy Checklist) to determine if the submission is adequate for audit.  Upon acceptance, DCAA may audit the submission for compliance including accuracy of rate calculations and applications.  This is the most frequent audit performed by DCAA year over year.  Their findings routinely center on unallowable costs pursuant to FAR 31 and exceptions to exceptions to cost accounting practices used by contractors. It is therefore crucial to spend extra time reviewing accounting for FAR allowability, FAR 31 expressly unallowable costs, and other common DCAA questioned costs.

Upon resolution of any findings, DCAA will issue a formal letter establishing the final rates for that year. Based on the results of the Incurred Cost Proposal, final bills or vouchers to the government may be prepared to close out physically complete contracts listed in the ICP.

Need Help with your Incurred Cost Proposal?

Understanding, preparing, and submitting ICPs can be challenging. Please contact us here if you have any questions, or need help on your indirect rates, and we will be happy to assist you.

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