If you’re like most small contractors, the extent of financial oversight consists of focus on the bottom line and your bank balance. Keeping up with getting your invoices out and paying your vendors can consume much of your time.

However, reliably prepared financial statements conforming to Generally Accepted Accounting Principles (GAAP), are also important to properly managing your business, and inspiring confidence in the Small Business Administration, your bank, and other users of the financial statements.

The following are some key accounting mistakes made by small businesses, and how to correctly record them.

Unbilled Accounts Receivable/Billings in Excess of Costs

Many contractors record revenue equal to billings. This is correct in some instances, but not all. Cost reimbursable contracts where provisional indirect rates are used for billing, require revenue to be based on actual costs, including indirects. A contractor under-running their indirect rates will find themselves owing money back to the government for overbilling – a Billings in Excess of Cost liability. Conversely, overrunning indirect rates will result in additional money owed to the contractor (assuming no indirect rate ceilings and adequate contract funds) – a Costs in Excess of Billings asset.

Matching Principle

The matching principle simply requires that revenues, and the expenses incurred to produce those revenues, be recorded in the same accounting period.

Revenue recorded in one month and expenses recorded in the next month (because of a missing subcontractor invoice, for example), will result in overstatement of net income for the current period, and an understatement of net income in the next period.

This can result in fluctuating profit from month to month. Ensure that all expenses for the month are recorded before closing the books.

Deferred Rent

Sometimes contractors get a good deal on new office space, with several months at the beginning of the lease rent free. You still have to record rent expense though, even if no cash is going out the door. Per GAAP, rent expense is straight-lined over the life of the lease (total cash expense over the life of the lease divided by the number of months). The difference between the rent expense recorded (same amount each month over the lease) and cash out the door is recorded in a liability account, deferred rent. This concept also applies if there are rent escalations over the lease period; you have to record rent expense on a straight line basis. The deferred rent liability is a timing issue; the liability will revert to zero at the end of the lease.

Depreciation

Under GAAP, fixed assets and intangibles such as software, generally (there are some exceptions) need to be depreciated (or amortized) straight-line over their useful lives.

An issue arises when companies record depreciation based off of tax depreciation schedules, which use accelerated methods, or even expense items altogether under the Section 179 regulations. This may not be material for a large company with hundreds of thousands of dollars of fixed assets, but can seriously distort the financial performance of a small company. Fixed assets can easily be tracked on a spreadsheet. Reasonable useful lives are: Software – 3 years; Computers – 3 years; Office Equipment – 5 years; Furniture – 5-7 years; Leasehold Improvements – life of the lease.

Bonuses Pursuant to a Written Plan

While not an accounting issue per se, federal acquisition regulations require that bonuses be awarded to employees and owners pursuant to a written plan.

As noted in the Federal Acquisition Regulations - FAR 31.205-6(f), “Incentive compensation…are allowable provided the awards are paid or accrued under an agreement…before the services are rendered or pursuant to an established plan or policy…”

This applies particularly to contractors with cost reimbursable contracts where these bonus expenses are included in an indirect rate pool. The government wants to make sure that bonuses are not given out randomly, without any reference to objective criteria for awarding them. This issue has been given increased scrutiny by the Defense Contract Audit Agency. Contractors can avoid problems by documenting ahead of time the criteria for awarding bonuses.

Executive Compensation

Contractors should note that allowable compensation is limited by both the FAR and, if the company is part of the 8(a) program, the SBA. Allowable amounts are based on a variety of criteria. A discussion of this is outside the scope of this article.

Contractors should work closely with their outside accountants or business advisors to ensure that, at a minimum, their year-end financial statements are accurate and that they are in compliance with applicable government contracting regulations, especially those with cost reimbursable contracts.

Jeffrey S. Burr, CPA/CFF, CFE, MBA is a director with Federal Strategies Group LLC, a government contracting, management consulting, M&A advisory and forensic accounting firm to the government contracting and high technology industries. He can be reached via email at JeffB@FedStrat.com.