You filed your incurred cost submission (ICS) before the six-month deadline. The schedules balance. The indirect rates are calculated. The certification is signed. Now you wait. The waiting is where the incurred cost audit is won or lost, and most of what happens next runs on a clock set by statute rather than by DCAA.
The period between filing your ICS and receiving your final rate determination is not dead time. DCAA follows a defined process: adequacy review, audit selection, fieldwork (if selected), rate negotiation, and final rate agreement. Understanding this process gives you a concrete edge. Preparing for each phase produces faster rate finalization and fewer questioned costs. Treating the submission as the finish line produces surprises.
What happens after your incurred cost submission leaves your desk, what DCAA is looking for at each stage, and how to position your company for the best possible outcome.
Phase 1: The Adequacy Review
DCAA’s first step is not an audit. It is a checklist. The adequacy review confirms your submission contains all required schedules, the numbers reconcile, and the package is complete enough to audit if selected.
DCAA uses a standardized Adequacy Checklist with specific items including:
- All required schedules present. FAR 52.216-7(d)(2)(iii) lists them as items (A) through (O), fifteen in all, and the certification is not extra: Schedule N is the Certificate of Final Indirect Costs
- Schedule G reconciles your books of account to claimed direct costs by major cost element, and Schedule H sets out direct costs by contract and subcontract
- Schedule A summarizes every claimed indirect expense rate with its pool and base, and Schedule E sets out the claimed allocation bases
- Unallowable costs identified and excluded from indirect rate pools
- Contractor certification signed by an authorized official
- Cumulative allowable cost worksheet ties to contract billings
For Department of Defense work this phase has a deadline in statute. 10 U.S.C. 3842(g)(2) requires the Secretary of Defense to tell a contractor within 60 days of receiving an incurred cost submission whether it is a qualified submission.
Notice who the statute names, because it is not who emails you. The duty sits with the Secretary of Defense. The message arrives from DCAA. That hand-off is written down.
The delegation runs through DoD Directive 5105.36, effective 1 December 2021. It was issued under “the authority vested in the Secretary of Defense by Sections 113 and 191 of Title 10, United States Code,” and it establishes DCAA as a Defense Agency whose mission is to “perform all necessary contract audits for the DoD.” Paragraph 2.d(2) puts the allowability of incurred costs inside that mission, which is exactly what your submission sets off. The Secretary keeps the statutory duty. DCAA does the work.
The statute expects the same arrangement. Section 3842 defines a qualified submission as one “qualified by the Department of Defense,” not by the Secretary personally, and names the Defense Contract Audit Agency thirteen times, including a passage about a submission “submitted to the Defense Contract Audit Agency.”
The FAR closes the loop on who actually handles your file. FAR 52.216-7(d)(2)(i) tells you to submit to the contracting officer, or the cognizant federal agency official, and to the auditor. FAR 42.705-2(a)(1) then makes the cognizant government auditor the one who establishes final indirect cost rates for business units not covered by 42.705-1(a), which is where most small contractors sit.
The practical version: the obligation is the Secretary’s, the work is DCAA’s, and the letter that decides your rates is signed by an auditor. If the 60 days pass in silence, the office to chase is the DCAA field audit office holding your submission, not the Pentagon. Two outcomes:
| Determination | What It Means | What Happens Next |
|---|---|---|
| Adequate as filed | Your submission meets completeness requirements and is ready for audit consideration | Enters the audit selection pool |
| Inadequate as filed | Missing schedules, reconciliation errors, or incomplete data. DCAA specifies the deficiencies. | You must correct and resubmit. The clock restarts on the audit timeline. |
An inadequacy determination is not a finding. It means DCAA cannot audit your submission in its current form. The fix is mechanical: provide the missing data, correct the math, resubmit. But each resubmission delays your rate finalization by weeks or months.
Run through DCAA’s checklist before you submit rather than after. That is what passing adequacy on the first attempt takes. If you prepared your ICS using our preparation checklist, your submission is built around the adequacy criteria from the start.
Phase 2: Audit Selection
Not every adequate ICS gets a full audit. DCAA uses a risk-based selection process to determine which submissions receive detailed fieldwork and which receive expedited processing.
Full Audit
DCAA selects submissions for full audit based on risk factors including: dollar value of flexibly-priced contracts, prior audit findings, changes in indirect rate structure, high-risk cost categories, and time since the last incurred cost audit. Larger contractors with cost-reimbursable contracts and prior deficiencies are selected more frequently.
If selected, DCAA assigns an auditor who will conduct detailed testing of your costs, indirect rate calculations, and supporting documentation. The audit typically begins within months of the adequacy determination.
The one-year figure you hear quoted is not an internal aspiration. 10 U.S.C. 3842(g)(3) requires audit findings to be issued not later than one year after the date a qualified incurred cost submission is received. Paragraph (g)(4) supplies the consequence: if findings are not issued in that year, the audit “shall be considered to be complete and no additional audit work shall be conducted.” Know the exception before relying on it.
Under (g)(5) the Under Secretary of Defense (Comptroller) may waive that on a case-by-case basis at the written request of the DCAA Director, and each waiver must be reported.
Read who that official is before you rely on the deadline. DoD Directive 5105.36 places the Director of DCAA “under the authority, direction, and control of the Under Secretary of Defense (Comptroller)” [10 U.S.C. 192]. The person who signs off on excusing a missed audit deadline is the same person DCAA reports to. The relief in (g)(4) is real, and it is not adjudicated by a stranger to the agency that missed the date.
Low-Risk Memo
Contractors not selected for full audit receive a low-risk memorandum. This memo acknowledges your submission and provides an auditor-determined final indirect rates letter for your signature. The rates in the letter are based on your proposed rates from the ICS. You sign the letter, the contracting officer issues a rate agreement, and your rates for that fiscal year are finalized.
A low-risk memo is a good outcome. It means DCAA assessed your submission as low risk based on their screening criteria. It does not mean your costs are approved. DCAA reserves the right to audit previously settled fiscal years if new information surfaces, though this is uncommon for low-risk contractors.
Phase 3: The Incurred Cost Audit (If Selected)
A full incurred cost audit examines whether the costs you claimed on flexibly-priced contracts are allowable, allocable, and reasonable under FAR Part 31. The audit also verifies your indirect rate calculations and tests your cost allocation methodology.
What DCAA Tests
| Audit Area | What DCAA Reviews | Common Findings |
|---|---|---|
| Direct costs | Labor charges by contract, material costs, travel expenses, subcontractor costs | Labor charged to wrong contract, missing travel receipts, unallowable materials in direct costs |
| Indirect rate pools | Composition of fringe, overhead, and G&A pools | Unallowable costs in pools (entertainment, alcohol, lobbying per FAR 31.205), misclassified costs between pools |
| Allocation bases | Consistency and accuracy of the base used to allocate each pool | Inconsistent allocation bases between fiscal years, mathematical errors in rate calculations |
| Unallowable costs | Whether FAR 31.205 categories are identified and excluded | Unallowable costs remaining in indirect pools, inadequate screening procedures |
| Billing reconciliation | Whether total billed amounts reconcile to claimed costs | Overbillings from provisional rate adjustments, unreconciled differences |
The Fieldwork Process
The DCAA auditor will request access to your general ledger, trial balance, supporting journals, invoices, timesheets, purchase orders, travel vouchers, and contract documents. Expect multiple rounds of information requests over weeks or months.
The auditor tests transactions by sampling. They pull a statistically valid sample of expenses from each cost category and verify the supporting documentation. A missing receipt for a $200 expense is not catastrophic. A pattern of missing documentation across multiple categories signals a systemic problem.
Three practices reduce audit friction and improve outcomes:
- Organize your records before the auditor asks. A shared drive or organized filing system with invoices, receipts, and contracts filed by period and category saves weeks of back-and-forth.
- Respond to information requests within 48 hours. Slow responses extend audit timelines and create a negative impression. An auditor waiting three weeks for a response to a straightforward question assigns more risk to that area.
- Have your CPA available for methodology questions. When the auditor asks why you allocated facilities costs to overhead instead of G&A, the answer needs to reference your disclosed accounting practice and the applicable CAS standard. A CPA provides this explanation with professional credibility. A bookkeeper provides the number without the regulatory justification.
Phase 4: The Audit Report and Rate Negotiation
After fieldwork, DCAA issues an audit report to the Administrative Contracting Officer (ACO). The report includes the auditor’s opinion on the allowability of claimed costs and any questioned costs or rate adjustments.
Questioned Costs
Questioned costs are expenses the auditor believes are unallowable, unallocable, or unreasonable under FAR Part 31. The audit report specifies each questioned cost, the dollar amount, and the FAR citation supporting the determination.
Questioned costs are not automatically disallowed. The ACO reviews the audit report and makes the final determination. You have the right to respond to questioned costs with additional documentation, alternative interpretations of FAR provisions, or evidence the auditor did not consider. This negotiation phase is where CPA involvement pays for itself. A CPA who knows FAR Part 31 argues the regulatory basis for your position. A bookkeeper says “we thought it was allowable.”
Rate Adjustments
If the audit identifies costs that should not have been in your indirect rate pools, your actual indirect rates change. The auditor recalculates rates excluding the questioned costs and compares them to the rates you billed at during the performance period.
- If your actual rates are lower than your provisional rates: You overbilled the government. The difference becomes a refund liability. The ACO will negotiate a repayment schedule.
- If your actual rates are higher than your provisional rates: You underbilled the government. You are owed additional payment. The ACO will authorize the adjustment.
Rate adjustments are normal. Provisional rates are estimates. Actual rates almost never match provisional rates exactly. The concern is magnitude rather than existence. A large gap between what you billed and what you actually incurred raises a question about the quality of the forward pricing estimate behind your provisional rates. No FAR provision defines a percentage that triggers scrutiny, and we hold no dataset that would let us name one. What draws attention is the auditor’s judgment, the dollar amount involved, and the complexity of your cost structure.
Phase 5: Final Rate Agreement
The end state is a final rate agreement signed by both you and the contracting officer. This agreement establishes your actual indirect rates for the fiscal year, settles any overbilling or underbilling, and closes the incurred cost audit for that period.
Once rates are finalized:
- All contracts billed at provisional rates during the fiscal year are adjusted to final rates
- Overbillings are credited to the government. Underbillings are paid to you.
- The fiscal year is closed for incurred cost purposes (subject to fraud or reopener provisions)
- Your final rates become part of the historical data supporting future provisional rates and forward pricing proposals
The timeline from submission to final rate agreement varies, and the honest anchor is the statute rather than a rule of thumb. For DoD work the clock is 60 days to a qualification decision and one year from a qualified submission to audit findings [10 U.S.C. 3842(g)]. A low-risk memo arrives faster than a full audit because it skips fieldwork entirely. We publish no elapsed-time figures of our own, because we hold no dataset that would support them. Contractors with several fiscal years of unaudited submissions sit behind a longer queue.
What to Do While You Wait
The period between submission and audit is not passive time. Use it to strengthen your position.
- Keep your records accessible. The auditor will request documents covering the fiscal year you submitted. If those records are archived, disorganized, or on a departed employee’s hard drive, retrieval delays extend the audit.
- Run a self-audit. Pull a random sample of 20 transactions from each cost category. Verify supporting documentation exists for each one. If you find gaps now, you find them before the auditor does.
- Review your unallowable cost screening. Re-examine the expenses excluded from your indirect rate pools. Verify every FAR 31.205 category was screened. If you discover an unallowable cost that slipped through, document the correction and the process improvement you implemented.
- Update your provisional rates. If your actual rates for the submitted fiscal year differ materially from the provisional rates you are currently billing, update your provisionals. Continuing to bill at rates you know are inaccurate creates avoidable overbilling or underbilling.
- Prepare next year’s ICS early. Do not wait until month five to start gathering data for the next fiscal year’s submission. Contractors who maintain ICS-ready data monthly submit on time with fewer errors.
Frequently Asked Questions
How long does a DCAA incurred cost audit take?
For Department of Defense contracts, 10 U.S.C. 3842(g)(3) requires audit findings within one year of receipt of a qualified incurred cost submission, and (g)(4) treats the audit as complete if that year passes without them, subject to a waiver by the Under Secretary of Defense (Comptroller) under (g)(5). How much of that year gets used depends on the complexity of your cost structure, the number of contracts, and DCAA’s audit backlog. Responding quickly to information requests and keeping records organized shortens the fieldwork inside it.
What is a low-risk memo from DCAA?
A low-risk memo is DCAA’s determination that your incurred cost submission does not warrant a full audit based on their risk screening criteria. The memo includes a rate agreement letter using your proposed rates. You sign the letter, and your indirect rates for that fiscal year are finalized without detailed audit fieldwork. This is a favorable outcome indicating DCAA views your submission as low risk.
What happens if DCAA questions costs in my incurred cost audit?
Questioned costs are reported to the Administrative Contracting Officer (ACO), who makes the final determination on allowability. You have the right to respond with additional documentation, alternative FAR interpretations, or evidence supporting your position. The ACO considers both the audit report and your response before issuing a final determination. Not all questioned costs are ultimately disallowed.
Do I need to file an incurred cost submission every year?
Yes, if you hold any flexibly-priced contracts (cost-reimbursable, time-and-materials, or labor-hour) that were active during the fiscal year. FAR 52.216-7(d)(2)(i) requires submission within six months of the contractor’s fiscal year-end. Missing that date has a direct documented consequence: under FAR 4.703(b)(3) the record retention periods in FAR 4.705 are automatically extended, so you hold the paperwork longer. Two related powers are often attributed to this deadline and belong elsewhere. FAR 42.703-2(c)(1) lets the contracting officer set rates unilaterally when a proposal is not certified, and FAR 42.705(c)(1) lets the officer determine the amounts due and record it in a unilateral modification when a completion invoice is not filed within 120 days after rates settle.
What is the difference between provisional and final indirect rates?
Provisional rates are estimates used for billing during the contract performance period. Final rates are the actual indirect rates established after the incurred cost audit (or low-risk memo) settles. The difference between provisional and final rates creates either an overbilling (you owe the government) or underbilling (the government owes you). Final rates replace provisional rates retroactively for all billings during the fiscal year.
Close the Loop on Your Incurred Costs
The incurred cost audit is the final accountability checkpoint for every dollar you billed on flexibly-priced contracts. Understanding the process, preparing your records, and responding promptly to audit requests puts you in the strongest possible position for favorable rate finalization.
Treat the filing as a checkpoint rather than a finish line. Faster rate agreements and fewer questioned costs come out of a continuous process: accurate bookkeeping, compliant timekeeping, clean indirect rate pools, and organized documentation, all year long.
Amerifusion Bookkeeping manages this entire cycle for government contractors. From monthly bookkeeping that maintains ICS-ready data, to annual submission preparation, to audit support when DCAA selects your fiscal year for review. Start with the Compliance Readiness Check to assess your current readiness, or book a discovery call to discuss your incurred cost compliance needs.
