How to Avoid a Denial Letter from DCAA

Recent changes from the Defense Contract Audit Agency are causing more companies to receive denial, or deficiency, letters. So, what do you do when you receive a letter, and how can you prevent one in the future?

If your company contracts with the federal government, you may dread the thought of receiving a denial letter. Receiving a denial, or deficiency, letter presents a challenge for your company, but you can take actions to prevent these letters in the future. But first, you may be wondering why you got a denial letter in the first place.

More contractors are receiving denial letters

Back in late 2008, the DCAA issued MRD 08-PAS-043 (R) to address deficiencies and material weaknesses on contractor systems of internal controls. Furthermore, the auditors ceased the practice of suggesting a potential fix when deficiencies and material weaknesses were present.

Instead, DCAA audit reports on internal controls can only state that a contractor's system is either adequate or inadequate. This lack of specificity of what constitutes a deficiency is causing more contractors to have their systems deemed inadequate. Before the revision, these same systems would have been determined to be inadequate in part, and otherwise adequate.

Contractors must have an adequate accounting system before they can receive a cost reimbursable contract, so the change has negatively affected small businesses that frequently operate from billing to billing. In fact, if a small firm is denied a contract as a result of an inadequate accounting system, that firm is at risk of being run out of business.

You received a denial letter -- now what?

When you receive a denial letter initiated by DCAA either through your prime contractor or through your contracting officer (FOIA request), the best course of action is to hire a professional to help you untangle the contents. This advisor will help you to understand the applicability of the findings and to determine the best course of action and guide you through the corrective actions you will need to take, and they will estimate the time it will take to implement such actions.

While a trusted advisor can help you navigate the challenge of receiving a denial letter, your best bet is never to receive a letter in the first place. This solution may seem to be easier said than done, but what you really need to avoid the dreaded letter is an adequate accounting system.

Avoid a denial letter in the first place

An effective, government-compliant accounting system has the following key elements:

• Segregation of direct and indirect costs
• Direct costs are identified and accumulated by contract under a job order cost system. Subsidiary cost records for each contract are available, and direct costs are identified by contract line item.
• Final or intermediate cost objective is identified in the form of a job, project, or task
• A logical method exists for the allocation of indirect costs to intermediate and final cost objectives.
• Costs are accumulated under general ledger control.
• The timekeeping system identifies employee labor by final or intermediate cost objectives and is maintained daily within the system.
• The system must identify or accumulate unallowable costs according to FAR Part 31.

Adhering to the above criteria will help you prevent a denial letter in the first place. How does your accounting system stack up? Use each of these key elements to give your current system a mock audit. If your system fails to meet any or all of these requirements, it may be time to find a better solution.