Preparing for a DCAA audit can be extremely rigorous—especially the first time—but it doesn’t have to be. If you’re informed ahead of time about what a DCAA audit focuses on and you already have done all you can to prepare for it, then you will be best prepared to meet the challenges.
Being a contractor with the federal government means granting the Defense Contract Audit Agency (DCAA) authority to conduct audits on your accounting system. These audits may occur at any time during the contract, whether prior to the award of the contract or after you have entered into a contract. In both cases, you need to ensure your accounting system follows DCAA compliant accounting policies and procedures.
Complying with the multitude of federal regulations is one of the critical aspects of being a successful government contractor. There are many essential regulations that contractors must adhere to, from the Generally Accepted Accounting Principles (GAAP) to the Federal Acquisition Regulation (FAR) and the Cost Accounting Standards (CAS).
In order to help you best navigate these challenges, we’ve created this comprehensive guide that walks you through each stage of the process.
Preparing for a DCAA audit can be like putting together a puzzle with hundreds of intricate pieces. The DCAA audit manual provides all the required information for government contractors; however, interpreting these guidelines can be cumbersome and time-consuming.
A good place to start is establishing an understanding of the agency itself—what purpose it serves, the influence it wields and why you need to take this audit seriously.
Government contracts represent high-value financial instruments. The DCAA, an agency of the United States Department of Defense (DoD), guards taxpayer money closely to ensure that it is used responsibly.
With that mission, the DCAA is in charge of all contract auditing for contractors working with various federal agencies. Though the DCAA has no direct role in choosing which companies are awarded defense contracts, the agency does have considerable sway through recommendations during the preliminary stages of securing and negotiating contracts.
Specifically, the DCAA makes recommendations to government officials who select contractors for government-funded projects and subsequently negotiate prices for products and services.
The DCAA oversees the close inspection of the accounting and financial structure of contractors who are awarded bids by the DoD. However, even before a contractor is awarded contracts with the DoD, the DCAA conducts pre-award audits to confirm that contractors that bid on contracts are sufficiently financially stable and have the capabilities needed to perform the duties of the contract.
Contractors must be prepared for audits by the DCAA, both pre-award and post-selection.
To assess the compliance and capability of contract performance, the DCAA performs various audits that can occur at any time throughout the duration of a contract. The most common types of audits are outlined here:
Forward pricing audits usually occur prior to a contract being awarded to a contractor. The purpose of this audit is to analyze the contractor’s cost estimate of providing the government with goods and services.
The accuracy of a contractor’s allowable cost calculations is the focus of an incurred cost audit. These audits examine cases in which the contract price is not fixed. The DCAA conducts an incurred cost audit following the contract being awarded to assess the accuracy of the cost representations of the contractor.
A special audit may happen before or after a contract is awarded. Predominantly, however, audits in this category occur by the request of contracting officers. In such a case, an independent financial opinion is needed on specific areas of a contract or on a contractor’s accounting details in order to proceed with the contract work.
The DCAA Standard Form (SF) 1408 pre-award survey commonly affects small businesses applying for government contracts and focuses on DCAA accounting policies and procedures. The main purposes of this audit include:
Contractors that are subject to an audit must demonstrate their accounting system during the audit and implement the system prior to incurring costs for a contract. The SF 1408 focuses on key areas that include:
Given that timekeeping systems are often challenging areas for DCAA compliance, we will detail the key considerations for that in Chapter 2.
It is the responsibility of each contractor to remain compliant with all government regulations that apply to their operations. Failure to do so may be exposed by an audit, investigation or whistleblower action, which will lead to non-compliance consequences.
In addition to the potential for significant legal consequences for non-compliance in severe cases, the business impacts can be devastating from loss of future income, cash flow problems as a result of delayed payment, fines and, in serious cases.
Noncompliance or otherwise illegal or unethical conduct can result in debarment, suspension, terminated or voided contracts, being listed in the Excluded Parties List System (EPLS), or civil and criminal penalties.
The civil penalties resulting from noncompliance depend on the specifics of the violation and invoice. A contractor may be forced to pay up to three times the damage caused.
And while the civil penalties can be harsh, criminal penalties are generally much more severe. Contractors can face imprisonment, with responsibility falling on the person who signed the certificate of cost and pricing data.
One of the most serious forms of punishment that the federal government can issue on a contractor is debarment. Debarment can be issued as a result of a contractor violating antitrust laws, a contractor committing fraud in obtaining or performing a contract, or other serious offenses.
Being debarred from one agency has effects on all government agencies. Solicitation bids and proposals from a contractor that has been disbarred cannot be considered, except for exceptional circumstances.
The authority of federal agencies to rescind or void contracts is provided by the Federal Acquisition Regulation (FAR). The FAR explicitly outlines areas in which federal agencies may void or rescind contracts that include:
With all of these considerations hanging in the balance, you no doubt will want to make DCAA compliance a top priority.
In order to be best equipped, companies should be aware of the certain areas of the DCAA audit that typically present the greatest challenges highest levels of scrutiny. A little awareness goes a long way for a successful audit. With this in mind, it’s good to understand the DCAA auditor’s perspective.
In our years of experience advising government contractors, we’ve noticed that certain aspects attract the most scrutiny from auditors. Given DCAA’s objective of protecting taxpayer money—by securing the best value contracts for the Department of Defense and preventing fraudulent billing to the government—the auditor’s primary concern is around costs (how they are classified, segregated, allocated and reported).
Here are three broad types of issues the auditor will look at closely:
Problems related to time tracking are often discovered during an audit. This aspect is one of the most challenging DCAA accounting policies and procedures for contractors. But the reality is that timekeeping audits are among the most common DCAA audits every year. And these audits are the only ones performed by the DCAA without any advanced notice.
There are extensive and onerous rules around how timesheets should be prepared and submitted to ensure the correct labor cost can be calculated.
Some requirements include:
While the timekeeping can be done in ink or through software, an auditor may conclude that the system of recording is inadequate to track the time spent and cost per contract.
Additionally, there could be issues with audit trail if the auditor cannot trace a transaction through the accounting system all the way back to an approved timesheet.
Of course, lack of employee training or training gaps regarding timesheets could lead to non-compliance, and red flags will be raised if there are not regular floor checks to ensure correct time tracking procedures are followed along with ongoing training.
Careless or improper timecard management is accompanied by penalties and disciplinary ramifications. These include penalties resulting from failure to comply with company policies, as well as federal statutes.
But the good news is that there are many modern-day conveniences available for government contractors. Electronic timekeeping systems allow for accurate monitoring of projects and provide a convenient platform for assigning the project number, charge number and task.
A DCAA audit can also uncover issues related to how your company accounts for financial transactions. Ideally, your accounting system should be integrated with your timekeeping system, be capable of separately tracking direct, indirect and unallowable costs and identify direct costs by contract.
To satisfy DCAA audit requirements, you’ll need to demonstrate that your accounting system adheres to Generally Accepted Accounting Principles, or GAAP.
For example, financial transactions should be accounted for on an accrual basis rather than a cash basis. That means recognizing revenues or costs when you have earned the right to receive money or when you’ve incurred the obligation to pay.
If your chart of accounts is missing receivable/payable accounts or unearned revenue/prepayment accounts, then you could be accounting on a cash rather than accrual basis.
Inaccuracies with revenue recognition are common too. Revenue recognition is centered around agreed deliverables under contract. It can become highly complex depending on:
Revenue recognition rules have changed with the recent implementation of ASC 606, so if you have not updated your revenue recognition policies to be compliant, you need to do so.
According to Federal Acquisitions Regulations (FAR) 31 — Contract Cost Principles and Procedures, direct, indirect and unallowable costs need to be segregated for DCAA audit compliance. Every direct cost transaction should have a job number or project number assigned to it.
Disputes often arise around the topic of indirect costs. These costs must first be grouped into logical categories, such as general and administration, fringe and overhead, then allocated to every contract using a clear methodology. Contractors may potentially need to keep track of multiple overhead and/or fringe pools.
Auditors will examine the government contractor’s indirect rates, which could be based on a two-tier or three-tier structure.
Additionally, FAR 31 stipulates that certain costs (such as unapproved overtime premiums) are unallowable. To comply with DCAA audit requirements, these need to be tracked but made clear that they will not be billed.
Finally, documentation and record keeping problems often become apparent during a DCAA audit. Your business systems, including timekeeping and accounting systems, processes and policies, should be written down.
Supporting evidence for expenses, such as company records, reports and receipts, should be filed in an organized way so that they’re easily made available. Remember, the auditor will want to trace some transactions, such as a travel expense, from trial balance to an expense report, then back to proof of payment.
If you want to boost your chances of meeting DCAA requirements, take a look at your systems, processes and practices to identify any inaccuracies so you can fix them ahead of the review.
To adequately prepare, it’s good to refresh your understanding of how DCAA defines costs. By understanding how to identify and allocate costs correctly, you can put systems in place to safeguard your compliance efforts.
“Pools” of indirect costs are used to allocate indirect costs to more than one project. This step involves employing either a two-tier or three-tier rate structure to effectively allocate costs across multiple projects.
There are two basic types of cost allocation methods. The first relates to direct costs, and it’s straightforward because these can be traced back to a single contract or project. The challenge to achieving compliance is primarily about configuring your system to ensure costs are accumulated at the contract level.
The second type of allocation involves spreading indirect costs over multiple projects, which is more complex and highly subjective. Because it’s an area that often causes confusion for new and seasoned government contractors alike, we’ll take a closer look at how you can allocate indirect costs for DCAA compliance.
Indirect costs cover a wide range of expenses incurred for multiple cost objectives. A cost objective is a technical way of referring to a project, contract, task or even a contract line item. It can also include things like an independent research and development undertaking, or a bid and proposal project. A company can have one or several indirect cost accounts.
DFARS requires indirect costs to be accumulated and allocated in a logical and consistent manner. For instance, you can’t assign a cost element as indirect if similar expenses for a different project have been included as direct cost.
In practice, similar accounts are grouped together and aggregated in indirect cost pools. A typical indirect cost structure has three pools: fringe, overhead and general and administration (G&A).
Apart from ensuring DCAA compliance, getting your indirect costs right is crucial because it forms the basis of your indirect rates. Overstating your rates makes you less competitive and more likely to lose out when bidding for a contract. But, if you understate your rates, you risk losing money on the contracts you do win.
The aim of indirect cost allocation is to work out the proportion of non-direct expenses that each project will bear. This proportion is your indirect cost rate. The allocation should be based on the benefits brought to the contract or project, and the method of allocation is the same for all indirect cost pools: divide the total collected in the overhead, G&A or fringe pool by an appropriate allocation base.
You’ll need to use an allocation base that allows indirect costs to be apportioned reasonably and equitably. There must be a relationship between the allocation base and the cost pool. Accepted allocation bases differ across cost pools.
Using a simple example, let’s say you’ve incurred employee training costs in the overhead pool. Although the training was not taken for the performance of any particular project, it’s reasonable to conclude that all projects would likely benefit from your employees being better trained. In this case, the allocation base related to the cost pool could be direct labor dollars. Therefore, your allocation is the costs accumulated in the overhead pool divided by direct labor dollars.
Let’s further examine the cost accumulation and allocation bases for each indirect cost pool:
The overhead pool captures indirect costs that support operations or direct production. However, these indirect costs cannot be traced to a single contract, project, order or product. There are many examples of costs that might be aggregated in the overhead pool, such as indirect labor, training, utilities, rent, quality assurance, supplies and depreciation of equipment used for multiple projects.
You may choose to have multiple overhead pools depending on the way your business operates. If you have multiple locations, it may be useful to have a separate overhead pool for each site. You may also choose to split overhead pools according to operating divisions and product lines.
You’ll need to choose an allocation base to apportion the costs in your overhead pool. Typical base for allocating costs in this pool is direct labor dollars; however, in certain instances direct labor hours or direct material dollars may be used.
G&A expenses are those incurred to run or manage the overall business. As such, they cannot be associated with a single project, contract, order, product or division. These expenses typically relate to functions that serve to benefit the entire organization, such as executive management, accounting and finance, legal, people and culture, technology, business development, marketing and sales.
Examples of G&A expenses might include:
Typical allocation bases for the G&A pool are as follows:
Fringe costs are incurred to attract and retain employees. These may include employer taxes, health insurance, 401(k), bonuses, compensated absences, and so on. Expenses are usually allocated over total labor dollars, which take into account direct and indirect labor, bid and proposal labor, and internal R&D labor.
A facilities pool is an intermediate pool that tracks costs like rent, utilities, depreciation and other maintenance costs, then allocates them over square footage or headcount for allocation into final indirect pools.
As you can see, the types of allocation methods are very different for direct and indirect costs. While the rationale behind indirect cost allocation remains the same across each pool, the allocation base you should use changes.
One of the most misunderstood terms is “DCAA-compliant accounting system” as it is applied to accounting software. Simply applying that label to accounting software does not guarantee that an accounting system is compliant with DCAA regulations.
What makes software DCAA compliant is how well it meets the requirements. The good news is that there are ways to achieve this without breaking the bank. It doesn’t take a massive investment in purchasing, implementing, maintaining and training for your accounting system to become DCAA compliant. You simply need to understand how accounting software can help you achieve this aim.
Don’t be fooled by marketers: it’s crucial to know that there’s no such thing as a “DCAA-approved” software system or software package. To be DCAA compliant, any accounting system must meet GAAP, FAR and DCAA requirements. Most accounting programs that were not designed for DCAA compliance can be made to be DCAA compliant by the use of “add-on” features or programs.
The reality is that any accounting system that can pass the accounting system audit can be considered DCAA compliant. That being said, accounting software systems that feature specific requirements of DCAA compliance, such as timekeeping, labor distribution, contract setup and funding setup, can assist in making you compliant.
Many small government contractors use QuickBooks for their accounting needs, and if you’re one of them, a proactive step you can take is to configure QuickBooks to match DCAA requirements.
For example, if you select “account number” when setting up accounting preferences in QuickBooks, your accounts will be identified by their account number instead of just the description you use. Together with a chart of accounts that’s set up to distinguish cost pools and direct, indirect and unallowable costs, you can demonstrate proper segregation through account sequencing.
Although QuickBooks is not designed to meet FAR and DCAA requirements on its own, there are add-on components and ways to set up for employees, timesheets, payrolls, contracts and funding that make compliance easier and provide complete reporting.
A chart of accounts is a list of general ledger accounts in your accounting system. Its purpose is to categorize financial transactions into assets, liabilities, revenues and expenses. Grouping records in this way makes it easier to determine the overall health of your business and the financial impact of every project you perform.
A DCAA compliant chart of accounts is different from a typical chart of accounts used by commercial entities because it’s heavily focused on breaking down costs. Given that the chart of accounts forms the backbone of how costs are classified, segregated, allocated and reported in your system, it’s crucial to have it set up correctly. With this in mind, let’s take a closer look at the DCAA compliant chart of accounts and how you can configure it in QuickBooks.
Many small government contractors use QuickBooks as their accounting system, but, while there are ways to set up the software to conform to DCAA rules, it’s not designed to meet DCAA audit requirements straight out of the box.
So, if you’re sending a proposal for a government contract, or have recently submitted one, here are some configuration tips to help.
Achieving DCAA compliance with QuickBooks begins with studying the SF 1408 Pre-award Survey Checklist. This checklist sets out the criteria of what the government is looking for in the accounting systems of its contractors.
The SF 1408 Survey, or Pre-award Audit, tends to be conducted before the award of any cost-reimbursement type of contract, with the purpose of assessing whether your accounting system is robust enough to accumulate costs in accordance with contract terms.
There is a big focus around costs—how they are classified, segregated, allocated, reported and billed—because DCAA’s main objective is to protect taxpayer money through reducing the risk of excessive or incorrect billing.
As a part of fulfilling this objective, DCAA auditors compare your accounting system design and capabilities with the SF 1408 Pre-award Survey criteria. If you cannot demonstrate that your QuickBooks system is adequate, then you will not be awarded the prospective contract.
Fundamental to a compliant accounting system is a chart of accounts that follows Generally Accepted Accounting Principles (GAAP) and is structured to distinguish cost pools easily. The chart of accounts is essentially a list of general ledger (GL) accounts where transactions are posted. Some business owners mistakenly believe that getting this right would automatically result in DCAA audit compliance, but the chart of accounts is just the first step.
When configuring your QuickBooks, it’s essential to be deliberate about dividing direct and indirect costs through your chart of accounts sequencing. Indirect cost accounts should be broken down into pools, such as fringe pool, overhead pool, and general and administrative pool, but it can be difficult for a business to decide between a two-tier or three-tier indirect cost pool structure.
Additionally, you’ll need to have a separate sequence of accounts for unallowable expenses. Your general ledger should include accounts like payables and receivables, as well as prepaid expenses and unearned revenue, to demonstrate your accounting system is on an accruals basis.
Another critical component of the pre-award survey is timekeeping because labor costs are calculated using timesheets. While not a formal requirement, your timekeeping system is ideally automated and integrated with QuickBooks.
Your timekeeping practices should be documented, including policies around:
In terms of QuickBooks setup, make sure you enable time tracking—for payroll employees in company preferences—so relevant reports are available.
You can select “first day of work week” in Company Settings to coincide with the day when weekly timesheets begin. This enables payroll periods and timesheet periods to be the same, and it simplifies accounting and reporting processes.
A common mistake that government contractors make is netting income and expenses when these should be posted separately. It’s also important to remember that reimbursed expenses should be tracked as income.
You’ll need to think about labor distribution when configuring QuickBooks for your business as well. Labor distribution refers to the process of allocating labor costs (including both direct and indirect costs) to the total time recorded on timesheets.
From the DCAA auditor’s perspective, what matters is that labor costs are allocated fairly so no customer or contract receives favorable treatment.
To run a labor distribution report, you’ll need to set up QuickBooks correctly with employee details, compensation data and payroll items. You should have a payroll item for every kind of labor you have, including things like paid time off and holidays. These should be mapped correctly so labor costs can be posted to the right general ledger accounts.
It’s important to have separate cost categories—such as direct labor for government site, direct labor for company site, overhead for government sites and overhead for company sites—and map them to the correct GL accounts so that indirect rates are calculated accurately.
In line with the rules in Federal Acquisitions Regulations (FAR), the pre-award survey checks the ability of your accounting system to identify and accumulate direct costs by contract. For example, if you have five contracts with one of your customers, and if you’re capturing costs, revenue, and billing information on a customer rather than a contract basis, then you’re not meeting FAR or DCAA audit requirements.
However, you can set up QuickBooks to track customer jobs, tasks and sub-tasks at the level you need. In the Customer Center of QuickBooks, you can have multiple layers of customers and select an appropriate level to track revenues and expenses. You can specify the contract type, such as a time and material contract (T&M), firm-fixed-price contract (FFP) or cost-plus-fixed-fee contract (CPFF), and enter other custom contract information. You can also set up several jobs under one customer.
Another area to take into consideration for DCAA QuickBooks compliance is your funding setup.
DCAA audit compliance requires your billing to be based on contract provisions. You have the responsibility to make sure the total amount billed does not exceed any contract or work order funding limitation or any other contract ceiling amount. In practice, this means tracking amounts billed against the contract award, as well as having progress reports to compare estimates versus actuals.
This kind of tracking can be done in spreadsheets, but setting up a funding system in QuickBooks would reduce the chance of errors.
While we have mainly focused on the need for a DCAA chart of accounts from a compliance perspective, it’s worth mentioning the benefits from a business point of view too.
For starters, it allows you to determine your indirect cost rates and your overhead rates with greater accuracy, which means you can submit more realistic bids to avoid losing money on contracts.
Using the right chart of accounts allows you to compare your rates with other contractors as well. If your rates are higher than the competition, then you’ll lose out on work every time. Of course, an accounting system can only provide accurate costs if the underlying labor information is correct. Consequently, a strong labor system is also essential in passing a DCAA audit.
If all of this information sounds like a lot to digest, that’s because it is. For some contractors, it’s simply makes better business sense to enlist the expertise of experienced advisors who can sort out the requirements to ensure systems and procedures are air-tight.
Having DCAA compliant business systems requires adopting best practices, and this means your company will have accurate data for better business decisions, ultimately increasing your competitiveness.
Now that you know the types of issues a DCAA audit can reveal, how will you go about identifying problems with your current systems and processes, and proactively fix them, before the audit begins?
To satisfy DCAA audit requirements, contractors need to have expertise in relevant regulations, skills in setting up various systems and knowledge of the audit process. Just as important is the ability to bring all these skills together for optimal business decisions. It’s a difficult challenge for small contractors, which is why many turn to professionals for help.
Let’s examine the benefits that DCAA compliance consulting provides and when you might consider outsourcing DCAA audit compliance work.
DCAA compliance consulting professionals are highly experienced with the rules that apply to government contracting. These mainly come from Generally Accepted Accounting Principles (GAAP), Federal Acquisitions Regulations (FAR) and Cost Accounting Standards (CAS), which tend to be technical and difficult to understand.
Experienced consultants can explain—in plain language—how you should identify costs as either direct, indirect or unallowable. They can talk you through how to track direct costs by contract and assign indirect costs into pools. Furthermore, they can advise you how to calculate indirect rates and ensure unallowable costs are not billed.
They’ll also be well versed in the extensive requirements for timekeeping. These cover the way your system is set up, when and how much time should be recorded, who fills in the timesheet, the authorizations in place and policy documentation. Additionally, there are requirements around your labor distribution process, billing system and monitoring and review procedures.
Outsourcing compliance work can also help to take the guesswork out of the audit. There are many types of audits, so whether it’s an Incurred Cost Audit or a Pre-Award Survey, a DCAA compliance consulting professional can point out what the auditor will focus on, including which reports, calculations and reconciliations you’ll need to provide, and the audit trail they’ll expect to see.
Consultants know the most common mistakes government contractors make, and they can provide tips on how to avoid them. They can also perform a simulated audit in advance.
While many small government contractors use QuickBooks as their accounting software because it’s affordable and offers flexibility, QuickBooks is not designed to meet FAR requirements straight out-of-the-box.
With the help of a professional, you can find the add-on components needed to achieve compliance and set up your Chart of Accounts to demonstrate proper segregation of costs through account sequencing. You can also get input on how to map service or payroll items correctly, and software configuration tips on timekeeping, labor distribution, payroll and ability to track contract funding.
A professional can explain the way transactions flow through your accounting system, how calculations and allocations are done, review your system for oversights, as well as show you the various reports available in QuickBooks. Apart from helping you extract information for auditors more quickly, this type of knowledge can empower you with deeper operational and financial insights for better business decisions.
Professional guidance concerning DCAA audit compliance can potentially help to improve the financial viability of your business.
For example, contractors often feel they need to “play it safe” if they’re unsure of how a particular cost should be allocated. They treat all costs that fall into a grey area, such as advertising and public relations, as unallowable. However, there are instances when these costs are allowed. By not claiming them, you’ll underestimate your indirect rates and miss out on recouping them from the government, which will negatively impact your bottom line.
When it comes to DCAA compliance consulting, experience pays off. In our decades of supporting government contractors, we have noticed some common misconceptions amongst businesses that get in the way of FAR compliance.
Here are some common misconceptions and help you better understand FAR compliance:
Many business owners think that if their accounting software fulfills DCAA audit requirements, then their company is compliant. While having the right accounting software is integral to DCAA audit compliance, auditors will examine other business systems and processes too.
DCAA’s objective is to protect taxpayer money, and this leads to significant focus around costs—how they are classified, segregated, allocated, reported and billed—in order to reduce the risk of fraudulent, excessive or incorrect charges to the government.
But high costs such as labor involve recording hours on timesheets, with costs determined and accumulated in an accounting system, then invoiced through a billing system. This means the auditor must focus on timekeeping and billing systems, as well as your labor distribution process, to fulfill their audit objective.
Some business owners believe as long as their systems are set up correctly, they will meet DCAA audit requirements. However, DCAA FAR compliance goes beyond having the right chart of accounts or an automated timekeeping system. As stated previously, it’s not about buying and implementing “DCAA-approved accounting software” either.
You are required to have, in addition to compliant systems, policies, processes, and controls to support them. If we use timekeeping as an example, then you need software (or another method) to record labor hours. But you should also have written policies around how time should be recorded, processes to embed your policies, and controls (like a floor check) to ensure rules are being followed.
Businesses that intend to submit a contract cost proposal to a government agency or have recently done so might want to be proactive about FAR compliance by requesting an audit of their accounting system. However, a contractor cannot request an audit to be performed; only the contracting officer can initiate an audit. Similarly, you cannot get DCAA to audit your rates when you’re bidding on a government contract.
Although indirect costs cover a wide variety of cost categories, and businesses can indeed have hundreds of them, there are FAR rules to ensure businesses claim only certain kinds of expenses as indirect costs.
Since FAR requires a “logical and consistent” method for accumulating and allocating indirect costs to contracts, you need to demonstrate uniformity by accounting for comparable items in the same way. It follows that you cannot claim a specific cost as an overhead unless you can show that all or most contracts that incur similar costs are coded as overheads.
Getting indirect costs right is critical from a FAR compliance perspective, but it also affects your price competitiveness against other contractors when bidding for new work. When you submit a proposed budget for a government contract, you’ll likely need to provide an estimate of direct costs, as well as an indirect rate that accurately reflects your indirect costs. An indirect rate is simply your total indirect costs divided by an allocation base.
Advertising is about using media to promote the sale of products or services, while public relations aims to promote or maintain a company’s image. Although many outgoings related to these areas are deemed unallowable in FAR Part 31.205-1, this section also lays out some exceptions.
A general rule of thumb is that if the cost is required by the contract or benefits the government agency, then it is likely to be allowable. If it relates to the contractor mainly, then it is likely to be unallowable.
Consider the concept of business development as opposed to advertising in relation to trade shows. Generic trade show advertising to the general public benefits the contractor and would likely be unallowable. However, if you have a targeted company you want to bid for contracts with because you can create synergies together, then that benefits the government and is therefore a real indirect cost to claim.
Another type of advertising that could be allowable relates to recruitment. If you’re creating job ads to hire the labor you need to support your contracts, then the related advertising costs can be claimed.
FAR Part 31.205-1 lists out a number of allowable public relations costs too. A couple of examples include the costs of responding to inquiries on company policies or activities and communicating with the public.
The impact of this final misconception isn’t so much that it’ll get in the way of FAR compliance; it’s more about how it adds to the cost of compliance.
Due to the voluminous technical information surrounding costs—direct, indirect and unallowable—contractors often end up taking the safe approach by assuming that all costs that fall into a grey area, such as advertising and PR costs discussed above, are unallowable.
However, if you’re not claiming allowable items in your indirect costs, then you’re underestimating your indirect rates. This means you can’t recoup them from the government, and it ultimately decreases your profit.
Getting external advice can be beneficial. Our industry experts at Warren Averett understand how challenging audit compliance can be for small contractors. Whether you would like assistance on determining and allocating indirect costs, to check for potential FAR compliance issues, or gain insight on the competitive landscape, a team of experienced advisors can help. It’s good to evaluate when it’s best to consider seeking outside help. Let’s take a closer look.
With such a diverse range of systems and processes involved, smaller organizations often struggle to have staff with sufficient time and expertise to cover all these areas. Employing a CFO or a controller is unaffordable, and there often isn’t a budget to offer such specialized training for staff either.
Some business owners may also prefer focusing on the business itself, rather than accounting accuracies, and encouraging employees to do the same. But when you leave systems and processes unchecked in a highly regulated business environment, mistakes of all kinds—involving cost allocation, indirect rates, timekeeping or billing—can happen. This could result in poor business performance and decisions, failed audits, losing out on future contracts, delayed payments and fines.
It may be time to consider outsourcing DCAA compliance if:
Remember, accounting is an allowable expense for federal government contracting, so getting help from a DCAA compliance consulting professional can be an especially cost-effective solution.
Even with the wealth of information available, such as the DCAA compliance small business presentations and checklists, it’s clear that passing an audit requires the ability to understand and put together a lot of technical information.
Without a technical expert or the resources to train up internal staff, it’s difficult to be sure that everything is being done according to regulations. Of course, this can be a challenge for smaller firms without dedicated resources for regulatory compliance.
If you have any doubts about your systems and practices, our GovCon experts at Warren Averett can carry out a professional assessment to uncover any potential issues and advise you on how they can be fixed. With years of knowledge and experience, our team of GovCon experts can provide industry insights and equip you with best practices for your field. We can work with you to build DCAA compliant systems and identify potential issues before an audit begins.
While setting up your systems for DCAA compliance requires an investment of time and effort, having sound practices ultimately increases the competitiveness of your company, and therefore your bottom-line, in the long run.