Compliance Challenges in Government Accounting

When aligning their accounting practices with the regulations set forth by various federal agencies, government contractors often face myriad challenges that are usually stricter than those for the private sector.

Common compliance challenges include adhering to specific accounting principles, implementing government-approved accounting systems, maintaining rigorous internal controls, and continual audit readiness.

In addition, the federal government continuously introduces new regulations to prevent emerging fraud and abuse issues and clarify ambiguities, showing its commitment to protecting taxpayer dollars.

This article reviews various compliance challenges faced by contractors in government accounting and how to overcome them.

Failure to Understand the Government’s Regulations for Contractors

New contractors going into business with the federal government are usually taken aback by the complex and voluminous government regulations.

Small and medium-sized businesses often find they lack the resources to understand or accommodate the requirements. Some requirements include:

Federal Acquisition Regulations (FAR)

FAR is codified in Parts 1 through 53 of Title 48 of the CFR (Code of Federal Regulations) and governs all federal acquisition processes, including cost allowability, cost principles, and mandatory contract clauses.

Cost Accounting Standards (CAS)

CAS applies to companies securing federal contracts exceeding a certain dollar threshold — typically, all federal contracts in excess of $2 million unless exempted by various provisions, but less than $50 million.CAS provides standards for cost accounting practices in government contracts.

FAR Supplements

Agency-specific FAR supplements include the following:

• Defense Federal Acquisition Regulation Supplement (DFARS)
• Department of Education Acquisition Regulation (EDAR)
• Department of Energy Acquisition Regulation (DEAR)
• Agriculture Acquisition Regulation (AGAR)
• Transportation Acquisition Regulations (TAR)

Passing DCAA’s Rigorous Government Accounting System Audit

Contractors must prove the adequacy of their government accounting systems to the Defense Contract Audit Agency (DCAA) before they can be awarded contracts. The DCAA evaluates contractors’ accounting systems for FAR and CAS compliance.

The DCAA Contract Manual Audit (CAM) outlines the criteria for passing these audits. This includes but is not limited to:

• Direct and indirect cost segregation
• Cost accumulation
• Allocation bases and indirect cost rate development
• Timekeeping and labor distribution
• Billing, budgeting, and material management systems

Misinterpretation of Cost Principles

The government follows cost principles that are different from those of the private sector, often leading to confusion and errors. For example, a contractor may follow the accrual basis of accounting for their commercial contracts, but the government requires a specific identification method.

Also, the criteria for allowability may vary. For example, Subpart 31.2 of FAR contains provisions for maximum executive compensation, lest the costs become unallowable.

Challenges With Indirect vs. Direct Cost Allocations

In government contracts, direct and indirect costs must be tracked and allocated separately, unlike in commercial contracts, where the two may be consolidated.

Overhead and other indirect costs are usually challenging to allocate accurately and appropriately. The process must follow complex cost structures and regulations to avoid disallowance and non-compliance.

Contractors are required to select appropriate allocation bases, such as labor hours or direct labor dollars, and use predetermined indirect cost rates to allocate indirect costs to cost objectives. They must also ensure consistency.

Timely Preparation for Unexpected DCAA Audits

The DCAA has the power to audit government contractors on short notice at the request of the contracting officer or other federal entities. Therefore, contractors must always be audit-ready, which can prove challenging since DCAA audits are rigorous and can last several weeks or months.

Accounting principles, policies, government accounting systems, and internal controls must be regularly monitored and updated to ensure compliance and audit readiness.

Staying Updated with Changing Regulations

Doing business with the federal government means managing a perpetual cycle of new and changing regulations. For example, on July 1, 2018, the threshold for the application of Cost Accounting Standards (CAS) was changed from $700,000 to $2 million, representing a significant increase.

Contractors must be able to modify their policies, procedures, systems, and internal controls to maintain compliance. This first requires them to stay up to date on the latest regulations and changes, which also presents challenges for those with limited resources of time and money.

Building a Compliance-Focused Organizational Culture

Accounting compliance in government contracting is a team effort that requires every employee to fill their role effectively:

• Employees must accurately record their labor hours and other cost inputs
• Supervisors must confirm and approve employee recorded costs
• The accounting team must also properly allocate and bill for these costs
• The executive and compliance team must ensure that all policies and procedures are compliant with regulations.

Aligning the entire organization requires more than just effective management. It needs a compliance culture that includes reinforcement for compliance, ongoing training on company values and the importance of compliance, and rewards for exemplary efforts toward compliance.

Partner With Diener & Associates for Expert Government Contract Accounting Services

With over 30 years of experience in government contract accounting, Diener & Associates’ CPAs are well-positioned to help contractors build compliant government accounting systems.

We can also devise and deploy adequate internal control policies and ensure audit readiness. Contact Diener & Associates today for all government accounting compliance needs.