Defense Contract Audit Agency Issues Audit Guidance on Materiality

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DCAA provided a Memorandum for Regional Directors (MRD) to its auditors on applying materiality to incurred cost audits. The memorandum provides guidance that addresses the need to establish quantitative and qualitative factors impacting an audit’s materiality. The guidance should result in greater consistency across DCAA in treating findings as material.

The first element of materiality discussed in the MRD is a quantitative measure. The guidance provides auditors two formulas and a table showing how to apply the formulas. What qualifies as a quantitative factor is different in every case and depending on the facts of the audit, determined by the overall costs and the value of the questioned costs. The formula for determining whether a given questioned cost is quantitatively material is the same in every audit.

The second element of materiality discussed in the MRD is a qualitative measure. Qualitative materiality relies on the nature of the questioned cost, not its numeric value. The MRD does not provide a formula for determining the qualitative materiality of a questioned cost. Rather, the MRD addresses qualitative materiality as “Other Considerations” the auditor needs to address. These considerations include customer concerns and prior findings.

This MRD is helpful in terms of providing a formulaic (quantitative) approach to the issue of which questioned costs in an incurred cost audit are material and providing a common ground for both the government and contractor to have during discussions as to whether a questioned cost is quantitatively material.

The Section 800 Panel, referenced in previous Report and Digest articles, worked with DCAA, AICPA, GAO and Industry to develop an approach to materiality. The Panel’s work can be found in Volume 3, recommendation 71, page 375, of the Section 800 Panel report. The Section 809 Panel developed a proposed “Professional Practice Guide” for auditing, which looks extensively at the concept of materiality in incurred cost audits.

This MRD is the first step toward providing a practical method for both the audit community and the industry in reaching a mutual understanding of the materiality of questioned costs going forward.

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