How to Identify an Adequate Accounting System for Government Contracts [12 Important Elements]

Written by Hobie Frady on October 8, 2020

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A critical factor in securing government contracts is having a DCAA compliant accounting system. In fact, many Requests for Proposals (RFPs) and negotiated contracts require an adequate cost accounting system in place prior to any consideration.

In particular, cost-reimbursable contracts require contractors to comply with the Federal Acquisition Regulation (FAR) Subpart 16.3.

These guidelines establish estimates of the total cost of contracts for obligating necessary funds, and they set the ceiling for contractors that they may not exceed without the prior approval from the contracting officer.

Another important requirement of FAR Subpart 16.3 is that all cost-reimbursable contracts must feature a contractor employing an accounting system approved by the government.

Gaining this approval represents a major accomplishment for government contractors as it can be a difficult process to prove an adequate accounting system for government contracts.

How Do I Get Government Approval?

There are a number of requirements you must pass in order to gain government approval of your accounting system. We will briefly discuss each of these elements below and detail how contractors can address these critical aspects for government approval.

1. Differentiate Between Indirect and Direct Costs

This criterion refers to a contractor needing to show that its system effectively differentiates between indirect and direct costs. This requirement entails employing an accounting system that is able to segregate indirect and direct costs separately by account.

Also, policies that outline all criteria that charge indirect costs to cost pool accounts and direct costs to contracts need to be evident. Staff members who are responsible for coding these costs must show proficiency with these policies.

The final component is that the contractor must show a history of effectively differentiating between direct and indirect costs for use in contracts.

2. Maintain an Adequate Job Costing System

This aspect deals with the importance of having a job costing system that is compatible with your accounting system.

A contractor must show that costs are assigned to cost elements and by the specific project. Normally, this can be achieved through establishing a job number system and using the cost element account to charge transactions to specific jobs.

3. Homogenous Indirect Cost Pools and Allocation Bases

After the segregation of direct costs from indirect costs is determined, contractors need to develop homogenous indirect cost pools. It is important to logically group indirect costs so they have a similar relationship to the base upon which they will be allocated.

For example, it would be inappropriate to group the indirect costs associated with operating a service business with costs associated with running a manufacturing operation.

Also, it’s crucial to allocate indirect costs in an equitable manner. This step is vital so that the proper allocation base effectively represents the cause for which the indirect costs were incurred.

4. The General Ledger Must Control All Costs

Fortunately, many accounting system packages deal with this criterion automatically. Specifically, these packages ensure that all costs are under general ledger control.

As entries are deleted, changed or added in the subsidiary ledger, the general ledger accounts for these changes automatically.

5. Comply with Generally Accepted Accounting Principles (GAAP)

Your accounting processes and procedures must adhere to the generally accepted accounting principles.

Therefore, your indirect and direct costs must be recorded in the appropriate period as they occur and not when they are paid. Costs should be accounted for when you are liable for costs.

6. Cost Accounting for Pre-Contract Costs

Government contractors must account for pre-contract costs separately. These costs occur in advance of the effective date of the contract required to meet the contract schedule or contract requirements.

To show compliance with this requirement, contractors need to demonstrate the accounting system distinguishes these costs effectively from other contract costs.

7. Maintain an Effective Timekeeping System

Labor represents a significant contract cost, so labor costs represent a critical component in cost accounting. It is crucial to ensure that systems accurately charge labor costs to cost objectives.

8. Effective Labor Distribution System

Contractors must provide a labor distribution report that is based on its timekeeping system. Generally, this entails including labor and hours per employee, reflecting all types of labor. These will include direct labor, indirect labor and labor included in fringe benefits.

9. Recognizing Unallowable Costs

Contractors need to be able to distinguish unallowable costs from direct costs and indirect cost pools. Typically, unallowable costs are included in a separate unallowable account and are not claimed in determining indirect cost rates. Unallowable costs cannot be claimed in any proposal, claim or billing.

10. Accumulated Costs

Transactions need to be posted and updated in accounting systems at least monthly. Also, costs need to be presented on a year-to-date, current and cumulative basis following this same frequency.

Job cost reports can meet these requirements on a year-to-date, current period and inception-to-date bases.

11. Track Costs by Line Item

Some contracts require tracking costs by contract line item (CLIN). In these cases, projects need to segregate by CLIN. As a result, accounting systems need to consider every CLIN as a cost objective and charge costs to CLINs consistent with how projects are charged.

12. Important Clauses

The Limitation of Costs and Funds clauses apply to many contracts, which require contractors to track contract costs and funding. Typically, a contractor must notify a contracting officer after costs reach 85% of the allotted funding.

Other clauses may be present, in which case, contractors must display the ability to meet them.

Achieving DCAA Compliance for Your Accounting System

An adequate accounting system for government contracts is a critical factor for being awarded lucrative contracts with federal agencies. It is a prerequisite for many Requests for Proposals and specific contracts, particularly cost-reimbursable contracts.

Being able to satisfy a DCAA audit is a crucial step in becoming a government contractor. To ensure that your accounting system complies with all guidelines and regulations, it is important to meet each of the 12 critical elements discussed above.

If you need help in managing your cost accounting system, contact the experts at Warren Averett to find out how their experience can ensure you peace of mind.

Guide: DCAA Compliance - A Comprehensive Guide for Government Contractors

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