Rose Report: Issue 18

Pre-Award Audits: A Stamp of Credibility for Contractors

When a government agency is about to award a cost-reimbursable type contract, it must make sure that the contractor’s accounting system is sophisticated enough to handle the necessary work. When preparing a response to an RFP, the contractor may be asked if it has a DCAA approved system. If not, the Contracting Officer (CO) may request that DCAA come out and perform a Pre-Award audit.

In recent years, DCAA has become so busy that it’s been difficult to perform all of these audits in a timely fashion, which can create delays and bottlenecks. In response, a new practice has been established to streamline and speed up the process: The acceptance of a “Letter of Adequacy.”

Performed by independent accounting firms and consultants, “Letters of Adequacy” don’t take the place of DCAA audits, but rather provide the government with a level of assurance up front that the contractor has a system that is capable of handling the work. Since many RFP’s request some sort of approval with the proposal submission, adequacy reviews are typically performed at the proposal phase. Their purpose is to evaluate the prospective contractor’s compliance in the financial, operational, and organizational areas. Whether the contract is for $100 million or $1 million, the contractor is subject to basic requirements.

During the review, the third-party accounting firm will be working off of an evaluation checklist. They’ll be looking not only at the accounting software, but also at the firm’s policies and procedures. If the accounting firm finds that the system meets all of the requirements, they will issue a “Letter of Adequacy” vouching for the contractor’s capabilities.

Here are some examples of the capabilities they will be looking for:

• Does the accounting system provide for proper segregation of direct and indirect costs?

• Is there a logical and consistent method for the allocation of indirect costs?

• Is there a labor distribution system that charges direct and indirect labor to the appropriate cost objectives?

• Is there an interim determination—at least monthly—of costs charged to a contract through routine posting of books of account?

• Is the accounting system designed, and are the records maintained in such a way that accurate, reliable data are developed for use in pricing follow-on acquisitions?

It’s important to note that the review looks at the design of the system, but not necessarily the operation of the system. In other words, the auditor is looking to ensure that the system is capable of handling the work, even if it never has done so before.

“The introduction of the ‘Letter of Adequacy’ is a good thing for the government and for the contractor,” says Rose Financial Services partner Jeanne McMillen. “If the CO has to wait for DCAA to come in, there could be a delay in contract performance. The ‘Letter of Adequacy’ provides a certain level of comfort that when the contract is awarded, the contractor is ready to perform its accounting obligations. The review is also beneficial to the contractor since it provides feedback and time to correct any deficiencies prior to an actual audit.”