Revised Audit Guidance on Auditing Subcontract Costs

The Defense Contract Audit Agency (DCAA) has moved to resolve an inconsistency in its coverage of incurred costs by issuing new guidance on when subcontract audit coverage is necessary.

Until now, once a subcontract has been identified for audit, the resultant request for audit stays in effect for the duration of the subcontract. Under the new guidance, the need for a subcontract audit is to be determined each year, based on a variety of risk factors.

Say for example, Contractor with a $50 million contract awards a $20 million subcontract to Subcontractor. The auditor at the prime notifies the auditor of the subcontractor and requests audit coverage of the $20 million subcontract over the life of the subcontract - which may extend several years. In the meantime, the Contractor is placed in the low-risk pool which means its chances of being audited, barring some newly discovered risk factor, is reduced to nil. Meanwhile, the auditors at the subcontractor continue performing their incurred cost procedures of Subcontractor as if nothing changed. And even if there are audit findings at the subcontractor, the Government cannot recover because the incurred costs and rates at the prime contract have already been settled.

The prime contract auditor will no longer request assist audits for the life of the subcontract based on the total expected subcontract value at the time of award. Rather, the prime auditor, in coordination with the subcontractor auditor, will assess the risk and need for assist audit effort based on subcontract costs included in the prime contractor's annual incurred cost proposal.

Under the new contract audit guidance, auditors at both the prime and subcontractor have coordination requirements. The auditor at the prime contractor takes the lead.

• Prime auditor: prior to issuing a request for an assis audit, the prime auditor should communicate with subcontract auditors about audit history, prior issues, eligibility for the low risk sampling pool, reliability of the indirect rates/budgets, and other issues that affect audit risk.
• Subcontract auditor: whenever subcontract auditors become aware of significant subcontractor risks, they should initiate a discussion prior to hearing from the prime auditor.

Here's some advice for subcontractors. When a contract auditor tells you that he/she is initiating an incurred cost audit of one or more of your subcontracts, request the coordination documentation with the auditors at the prime contractor. You are entitled to know what risk factors have been identified and considered as justification for an audit.

The new audit guidance can be found here.