In government contracting, one element stands as an unequivocal determinant of success — proper cost accounting. A keen understanding and effective implementation of cost accounting ensures compliance with the stringent regulations set by government agencies. It can also be the defining factor between the profitable execution of a contract and a financial pitfall.
Below is an in-depth look at what proper government contract accounting entails and its importance.
Understanding Government Contract Accounting and Its Importance
Government contracting involves spending billions worth of public funds annually. As such, government agencies are strict in evaluating contractors’ capabilities and accountability before awarding contracts. Government contract accounting is based on generally accepted accounting principles (GAAP). At its core, it aims to accurately track, record, and report the costs associated with a contract.
Pre-award surveys involve scrutinizing a contractor’s accounting system to ensure that it meets DCAA-approved SF1408 criteria. It also evaluates the contractor’s capabilities to meet the requirements of the prospective contract.
In the least extreme cases, a flawed accounting system design can delay contract award; it can also lead to disqualification. Non-compliance may also invite increased scrutiny from the DCAA for already awarded contracts. Below are the essential requirements of government contract accounting and their importance.
Identification of Costs as Either Direct or Indirect
The accounting system must be designed meticulously to identify all costs incurred as either direct or indirect. According to Federal Acquisition Regulation (FAR) 31.202, direct costs are those incurred directly due to contractual efforts. These include labor costs for the employees, materials, supplies, and any other expenses incurred directly.
FAR 31.203 defines indirect costs as those not attributable to a specific contract but rather incurred to support its operations. A cost cannot be categorized as both direct and indirect, as per FAR 31.203(b). Once costs are identified as direct or indirect, they must be accurately recorded in respective ledger accounts.
The process allows for the accurate determination of expenses incurred in fulfilling contractual obligations, which are then used to inform pricing, bidding, and resource allocation. This allows contractors to stay competitive during bidding and to ensure profitability when executing the contract.
Allocation of the Costs
An accounting system should be able to allocate all direct costs as contract line items (CLIN) or by the objective for which they were incurred. This accumulation takes place in a job cost ledger. The actual costs must align with what was proposed and agreed upon.
Unlike direct costs, indirect costs can’t be explicitly attributed to a specific contract or cost objective. They are, therefore, accumulated together in similar pools.
The pools are then linked to the direct costs that exhibit a cause-and-effect relationship with them, per Federal Acquisition Regulation 31.203. Accurate allocation of costs ensures accountability in the use of taxpayer dollars.
Identification and Isolation of Unallowable Costs
Certain expenses borne by contractors fail to qualify for reimbursement by the government. Defined in FAR 31.201-2, these are deemed unallowable costs. FAR 31.205 identifies some expressly unallowable expenses, including lobbying expenses, fines and penalties, advertising and marketing expenses, and alcoholic beverages.
Unallowable costs must not feature in any direct or indirect cost in any billing, claim, or proposal to the federal government, in accordance with FAR 31.201-6. Non-compliance could lead to penalties. This requirement ensures that government funds are only used for necessary expenses.
Labor Cost Accounting System
Contractors must have proper cost accounting procedures for labor costs. Their system needs to accurately capture and allocate direct labor hours worked on specific tasks and indirect labor such as administrative and overhead staff.
Contractors should promote transparency and accountability in labor cost accounting, ensuring that the government is only billed for actual work on their contracts.
Written Policies and Procedures
When evaluating a contractor’s accounting system, government auditors also review written policies and procedures related to cost accounting. These written guides serve as the bedrock upon which effective and compliant accounting systems are built.
They ensure that the contractor follows compliant accounting practices across different accounting periods. This consistency is necessary in maintaining transparent and accountable financial management within government contracting.
Code of Business Ethics and Conduct
Contractors are required to establish a written code of business ethics and conduct, which should be readily accessible to all employees engaged in the execution of the contract.
There is an added responsibility for larger contractors to provide ethics and compliance training to all involved employees, agents, and subcontractors. This code prevents criminal conduct while ensuring immediate reporting of non-compliance to the appropriate government agency.
Optimizing Government Contract Accounting With Professional Help
With so many requirements, contractors often have difficulty with government contract accounting. There is a lot at stake, too, with the upside being extensive, long-term contracts worth millions and the downside being severe penalties and potential debarment for non-compliance. Seeking professional assistance can prove invaluable.
Diener & Associates’ experienced CPAs can assist contractors in developing and implementing compliant accounting systems, reviewing existing policies and procedures, and providing training on cost accounting regulations.
We can also help conduct internal audits to identify issues and provide corrective actions. Contact Diener & Associates for expert guidance in government contract accounting.