October 24, 2025

Building strong internal controls is not just a best practice but an essential requirement for government contractors.

A government contractor’s financial systems are under constant scrutiny. Without a strong internal control framework in place, contractors may be left exposed to audit risks, penalties, and even the potential loss of future contracts.

This article explains why internal controls are critical for government contractors and covers key steps for building effective internal controls that every contractor must get right to avoid audit findings.

Why Internal Controls are Critical for Government Contractors

Government contractors operate within a complex web of federal regulations under the Federal Acquisition Regulation (FAR), the Defense Federal Acquisition Regulation Supplement (DFARS), and the Defense Contract Audit Agency (DCAA).

Failure to implement adequate internal controls may lead to serious repercussions. These include:

  • Contractors may be at greater risk of audit findings. This includes disallowed costs, questioned expenses, and adjustments that reduce margins.
  • They may incur additional risks, such as payment withholdings, suspension of drawdowns, or even losing eligibility for certain contract awards.
  • Reputational harm is also a possibility, leading to a decrease in trust with contracting officers and diminished competitiveness when bidding for contracts.

On the positive side, having a strong internal control framework results in:

  • Faster audits and fewer issues.
  • Reduction in costly errors and duplicates, leading to lower expenses.
  • Improved cash flow through timely, accurate billing.
  • Stronger credibility in negotiations and proposals.

In short, internal controls are far more than a compliance requirement; at the end of the day, they make your business stronger.

The Five Pillars of an Effective Internal Control Framework

A robust internal control framework for government contractors is built on five key pillars. These are:

Pillar #1: Control environment

This is where everything starts. First, a clear code of business ethics is established, aligned with FAR requirements. This acts as a means of setting expectations across the firm. Leadership must set the tone at the top, emphasizing that compliance and integrity are non-negotiable. At the same time, roles and responsibilities should be clearly defined, ensuring that no single person has unchecked authority and wields complete control over sensitive systems, processes, or activities.

Pillar #2: Risk assessment

Every government contract comes with unique risks. Whether it’s improper timekeeping, cost transfers, or gaps in subcontractor oversight, the risks must first be identified and assessed for both likelihood and impact. Once evaluated, the risks must be prioritized accordingly. Documenting and updating this assessment annually helps contractors stay current with evolving contracts.

Pillar #3: Control activities

Control activities serve as a means of daily checks and balances, ensuring that financial systems run smoothly. For government contractors, they include:

  • Timekeeping controls: Employees should record their time daily, with supervisors reviewing promptly to maintain a clear audit trail.
  • Cost allocation controls: Cost pools and bases must remain consistent and compliant with Cost Accounting Standards (CAS) and FAR, ensuring indirect rates align with disclosures in proposals.
  • Procurement controls: Vendor selection should be well-documented, with flow-down clauses embedded in all subcontracts. Ensure that only approved vendor lists are used.
  • Billing controls: These controls are equally important, as invoices are reconciled with contracts and supporting documentation is maintained to ensure accuracy and completeness.
  • Data security controls: Access to systems should be restricted based on specific user roles, supported by strong password protocols and cybersecurity policies. Additionally, ensure that all data is backed up and recoverable in full compliance with government standards.
  • Change management: All contract modifications must be documented and approved through a formal change management process.

Pillar #4: Information and communication

Written policies and procedures for all critical processes must be maintained as they form the foundation of a strong internal control framework. Additionally, regular training for employees on compliance requirements, including ethics, time management, and procurement, is a must. Equally

important is ensuring that systems across accounting, HR, project management, and contracts are seamlessly integrated, so information flows accurately and efficiently.

Pillar #5: Monitoring

Internal controls cannot be set on autopilot and then duly forgotten. Contractors should actively monitor them through exception reports and dashboards to spot anomalies. Furthermore, self-assessments of key controls must be conducted periodically, and the findings (if any) must be shared with management and the audit committee. Most importantly, remediation efforts must be closely monitored to ensure that identified issues are fully addressed.

Key Steps for Building Effective Internal Controls

1. Conduct an exhaustive risk assessment

For government contractors, the first step in implementing effective internal controls involves identifying and assessing the risks that can adversely affect compliance and performance under federal contracts. This involves assessing both financial and operational risks, including inaccurate cost allocations, potential fraud, improper timekeeping, errors in financial reporting, gaps in subcontractor oversight, and other related issues.

2. Design and implement controls

Once risks are identified and mapped out, contractors must implement controls to address them. This may involve:

  • Establishing approval workflows for contract-related transactions.
  • Documenting procurement and subcontracting decisions.
  • Scheduling routine reviews to ensure compliance with FAR, CAS, and agency-specific requirements.
  • Implementing access controls for financial systems.
  • Restricting system access to authorized personnel.

3. Train and communicate

Effective internal controls only work if employees understand and follow them. Contractors should not only train employees on the specific compliance requirements related to their roles, but also on why these requirements matter, to ensure both compliance and effectiveness.

4. Monitor, review, and adjust

Internal controls in government contracting are not a one-time implementation but require continuous oversight to ensure they are functioning as intended. This may include regular audits, management reviews, and feedback mechanisms to drive continuous improvement of control processes and build a culture of accountability.

5. Adapt internal controls for improvement

Contracting requirements and regulations evolve frequently. To stay ahead, contractors must continuously update their internal controls as contract portfolios grow, new compliance standards emerge, or audit feedback highlights areas for improvement. Continuous improvement is key to maintaining effective internal controls in the complex environment of government contracting.

Strong Internal Controls Build Stronger Government Contractors

For government contractors, internal controls are more than compliance requirements; they are the foundation of accountability, efficiency, and trust.

Well-designed controls help prevent costly errors, ensure accurate reporting, and keep
contractors audit-ready at all times. They also strengthen credibility with contracting officers and create smoother operations that drive long-term success.

When your internal controls are strong, your business runs smarter, your risks are lower, and your reputation is stronger. Rubino will help strengthen your controls. Click here to connect.

Why Strong Internal Controls Matter More Than Ever

For government contractors, internal controls are not optional. They are a competitive necessity that protects contractors from audit risks, financial penalties, and reputational harm while simultaneously strengthening operations and competitiveness. Investing in a robust control framework not only ensures compliance but also positions contractors for long-term success in the federal marketplace.

Related Postings

© 2025 Rubino All Rights Reserved