Requirements for an Adequate Accounting System for Government Contractors

The requirements for acceptable government contractor accounting systems are well established and widely known by most contractors. However, we are regularly asked about this topic by small to mid-sized contractors.

Most contractors are introduced to these requirements when proposing on cost reimbursable contracts as either a prime contractor or as a subcontractor. Accounting system requirements are detailed in SF-1408 Pre-Award Survey of Prospective Contractor – Accounting System. An adequate accounting system is also the first requirement of the Defense Federal Acquisition Regulation Supplement’s (DFARS) Business Systems rules. The Business Systems rule encompasses six system requirements via the Contractor Business Systems clause at DFARS 252.242-7005.

Covered systems include the following:

  • Accounting System
  • Estimating System
  • Purchasing System
  • Earned Value Management System
  • Material Management and Accounting System
  • Property Management System

While not all business systems are relevant to all contractors, the need for a well-crafted accounting system is universal within the government contracting industry. As business owners, you can meet the requirements without investing in a fully integrated accounting package. Through proper design, even the most basic systems, such as QuickBooks, can be set up to meet the requirements. Our outsourcing practice primarily utilizes Sage Intacct as the system to support compliance for our government contractor clients.  

The most important aspects of an adequately deigned accounting system include the following:

  1. Proper segregation of direct costs and indirect costs: The chart of accounts must be set up to identify the different categories of cost to include both direct costs and the various pools of indirect costs.
  2. Methodology for identifying and accumulating direct costs by contract: Commonly, a project accounting module, like we utilize with Intact, or the class structure afforded by QuickBooks can easily meet this requirement.  Alternatively, the requirement can be met by creating strings of account numbers within the chart of accounts (however, this is not recommended as this can lead to an excess number of active account numbers).
  3. A logical and consistent method for allocating indirect costs to intermediate and final cost objectives (i.e., a contract): Integrated accounting software packages include cost allocation modules that calculate indirect rates and post indirect costs to the project sub-ledger. The same results can be achieved via an off-line spreadsheet coupled with month-end cost allocation journal entries. The key is to establish your cost allocation methodology through an indirect cost rate agreement, negotiated with your contracting officer, and to consistently follow the approved methodology. Any changes to the indirect cost rate pools or allocation bases must be disclosed.
  4. Accumulation of costs under general ledger control: A double entry accounting system is a must.
  5. Timekeeping system that identifies an employee’s labor by intermediate or final cost objectives: However, an integrated timekeeping system is not required as there are several software packages that can be used to meet the timekeeping requirement and include systems offered by large payroll providers.
  6. Labor distribution system that charges direct and indirect labor to the appropriate cost objectives: Labor hours charged need to be monetized and recorded to the appropriate contracts (direct labor) or indirect cost pools.  This requirement will be met if your timekeeping system is designed to properly account for total time.
  7. Interim (at least monthly) determination of costs charged to a contract through routine posting of books of account: Simply put, reconcile your books on a monthly basis.  If you don’t have the time or the capability to reconcile your books, please contact a service provider who can assist.
  8. Exclusion from costs charged to government contracts of amounts which are not allowable in accordance with the terms of FAR 31, Contract Cost Principles and Procedures, or other contract provisions: Your chart of accounts must be designed so that unallowable costs can be charged to accounts that will not be invoiced to the government.  In addition, unallowable costs cannot be included in indirect cost pools. In addition, and equally important, is the requirement to develop a set of policies and procedures that allows your accounting staff to identify unallowable costs.

There are other requirements not discussed above, but which are generally applicable to manufacturers.

If you would like to discuss any aspect of accounting systems, please give call us at 301-564-3636, and we would be happy to discuss all of your questions.  If you would like to a) discuss accounting system design and implementation with our experts, b) conduct an accounting system “audit” by our audit professionals, or c) outsource your government contractor accounting process via our SOAR Team, please contact us.