Most contractors new to government contracting are totally focused on winning that first contract as a subcontractor or even as a prime contractor.

Business owners wear so many hats – business development, meeting payroll, sending out invoices, paying vendors, etc – that focusing on the accounting for the business gets lost in the shuffle. Accounting needs to be more than just keeping an eye on the cash balance in the bank.

Failure to adequately plan for an acceptable accounting system can leave a contractor flat-footed when opportunities come knocking.

The federal government and even large prime contractors need to be comfortable with your ability to properly account for costs on any contract that you have with them.

To that end, the Defense Contract Audit Agency (DCAA), or the large prime contractor you are working under, will often want to see evidence that you have an acceptable accounting system. This is particularly true if the effort you will be working on is a Time and Materials (T&M) or Cost-Plus-Fixed-Fee (CPFF) arrangement.

The DCAA will often perform a pre-award survey of your accounting system to see if it meets the minimum standards for government contracting. Large primes will generally farm this out to consulting or accounting firms and ask for an opinion letter for their files.

It should be understood that contract terms and requirements for the prime contractor also are pushed down to subcontractors.

Many government contracting consultants have gotten frantic calls from small contractors saying they need to get their accounting systems compliant in a hurry or they will lose out on a business opportunity. It’s better to have this in place ahead of time, rather than fix something on the back end.

What are the characteristics of a compliant government contract accounting system? The following is a short list:

• 1. Expenses need to be segregated between direct costs (labor, materials, etc) and indirect costs (fringe, overhead, and general and administrative).
• 2. Costs need to be accumulated by cost element – i.e., by contract, project, task, etc.
• 3. Allowable costs must be segregated from unallowable costs (as defined by the FAR, Part 31).
• 4. Labor costs must be accurately captured by an adequate timekeeping system, either integrated with the accounting system or capable of being uploaded to your accounting system.
• 5. Ability to maintain indirect cost pools that will allocate indirect costs (fringe, labor, G&A) to contracts based on a beneficial or causal basis. The indirect pools are set up based on a contractors particular set of circumstances.

“Failure to adequately plan for an acceptable accounting system can leave a contractor flat-footed when opportunities come knocking.”

These requirements are especially important for T&M and absolutely required for CPFF contracts. Contracts that are Firm Fixed Price (FFP) generally have less stringent accounting system requirements, since billings to a customer are spelled out in the contract, regardless of the costs involved.

However, for FFP and T&M contracts, where indirect costs are not billable to the contract as they are in a CPFF contract, it is still vitally important to know how much of these costs should be allocated, in order to gauge profitability or to develop billing rates or bid prices that will result in a profit.

Accounting systems well-known in the government contracting community, such as Deltek®, will automatically allocate these indirect costs to each contract, project or task. Less expensive accounting packages such as QuickBooks® can allocate direct costs to particular contracts and will provide a gross profit by contract.

Indirect costs will need to be tracked off-line on a spreadsheet and manually allocated to the contract. This extra effort is worth it – you can’t determine the true profitability of a contract without allocating all costs to it, including the indirect costs.

In addition to the accounting system characteristics noted above, contractors should also make provisions for the following:

• 1. Accumulate costs on a monthly basis and close the books monthly using the accrual basis of accounting.
• 2. Maintain an adequate paper trail for all accounting records. This includes printing and saving trial balances, subsidiary schedules (A/R, A/P, etc), bank reconciliations, support for expenses and the like. This will help in bidding on future work.
• 3. Comply with all FAR clauses including Limitations of Costs/Funds, etc.

New contractors who are not well-versed in accounting should seek advice from an accountant to help them set up an accounting system that complies with government contracting requirements and provides them with the information they need to profitably run their business.

Jeffrey Burr, CPA is a Director with Federal Strategies Group, LLC. He provides government contract and management consulting, M&A advisory, forensic accounting and expert testimony to the government contracting industry. He can be reached via email at JeffB@FedStrat.com.