New to government contracting?
Here’s why your accounting system matters
By Robert Smith, CPA
CEO of ICAT Systems
August 2, 2022
For decades I’ve helped government contractors solve their accounting system compliance requirements. I have found that many – especially small businesses – find it a nuisance to deal with the accounting system. While these business leaders recognize the necessity, it distracts from their core mission. Setting up a DCAA compliant accounting system is a task that takes precious time away from business development and delivering on their statements of work – and a task they often prefer to delegate.
As a new government contractor, when designing your accounting system, you are laying a cornerstone of your business’s success. Whether you are setting up your chart of accounts for the very first time, or incorporating federal contracts into your existing base of business, you will benefit from investing time early on to get it right.
QuickBooks is a favorite general ledger accounting software among growing businesses. It is well known, easy to use, and solves immediate needs like processing payroll, paying vendor bills, and invoicing customers. Plus, the QuickBooks app ecosystem lets businesses customize their tools to meet their unique needs (e.g., adding DCAA compliant timekeeping, or ICAT for indirect cost allocation and reporting). The challenge is getting started.
While government contractors have many issues to consider when setting up a new accounting system, it’s good to also think about the resulting benefits to your business.
Before opening QuickBooks for the first time, here are three benefits that come from your accounting function for you to consider. These ideas should guide you through the task of organizing and implementing a compliant accounting system for government contracting.
Your accounting system will help you develop pricing
First, your accounting system should aid decision-making when developing pricing. To be a resource for pricing, your accounting system must be organized to account for costs in the same way you propose costs.
Consider pricing a proposal for a prospective customer. You will need to detail how billing rates are developed for your categories of labor. Certainly there are those opportunities where you simply propose a billing rate for labor, or else a fixed price.
But as more sophisticated opportunities come along, you will need to provide detail to support a cost-price analysis. For each labor category you will set a base labor rate, with markup for fringe, overhead, G&A, and fee. The result is your proposed price for an hour of labor (i.e. your fully-loaded labor rate).
How do you determine markups for fringe, overhead, and G&A? This information should be readily available from your accounting system.
A budget projects a future plan and expected indirect rates
Second, your accounting system will help you develop a detailed budget. Government contractors should develop a financial blueprint of how you expect business to unfold. This should be done at least annually.
You never leave for a trip without knowing how you will make it to your destination. The same holds true for running a business. A budget gives you the road map.
For government contractors, budgeting involves not only planning out future work and operations, but also understanding how the indirect cost burden will be allocated and recovered. In addition, it enables you to evaluate any impact of proposed work on indirect rates.
Based on a budget plan, you will have a good idea of what your future indirect rates are expected to be. Those expected indirect rates should be used for pricing.
Why use budgeted rates in pricing? Your current indirect rates do not necessarily reflect what your future rates will be. If you ‘re just starting out and make up a rate for your Overhead or G&A, how can you be certain that you will recover your costs?
Adding new work? It’s likely your current indirect rates will be impacted. Leverage insights from your budgeted rates to price more competitively.
In addition to informing strategic decisions and pricing, budgets can provide business intelligence throughout the year. Your accounting system should generate reports that compare actual financial activity to budgeted financial activity.
Design your accounting system with the SF1408 criteria in mind
Third, your accounting system design should satisfy DCAA compliance requirements. Certain contract types require an accounting system deemed adequate for determining costs on government contracts. This is known colloquially as a DCAA compliant accounting system.
The Federal government has defined configuration criteria which serve as the basis for a compliant accounting system. The criteria are outlined on the government SF1408.
You should set up your accounting system with these SF1408 criteria in mind. You can benefit from starting out with a properly designed accounting system – even if you do not yet have the requirement for an approved accounting system. Plus, when an opportunity comes along, you won’t be scrambling to restructure your accounting function to pass an audit.
The first requirement on the SF1408 provides that the accounting system be established in accordance with Generally Accepted Accounting Principles (GAAP), including utilizing a general ledger based accounting system with fundamental internal controls and reporting. GAAP also specifies the accrual basis of accounting. These are foundational to your accounting function.
“...is the accounting system in accord with Generally Accepted Accounting Principles applicable in the circumstances?”
Section 2 of the SF1408 lists more specific criteria which, properly implemented, support and inform contract pricing, cost accounting, billing, and budgeting.
How you structure your chart of accounts will aid in meeting several of these requirements.
The first of the specific criteria requires that you segregate direct costs from indirect costs.
“The accounting system provides for proper segregation of direct costs from indirect costs.”
When you consider again how billable labor rates are developed for a proposal, this requirement makes perfect sense. You begin with a base labor rate. You mark it up for fringe, overhead, and G&A, then add a fee to establish the price for an hour of labor.
The base labor rate is a direct cost of performing the statement of work requirements of the proposed project. The markups on that direct labor cost for fringe, overhead, and G&A constitute recovery of a portion of your company’s indirect cost burden.
To know how much markup is needed for the fringe, overhead, and G&A, you need to accumulate each of these types of indirect costs into separate groupings in the accounting system. Therefore, your accounting system must be structured to enable this cost accounting.
To accomplish this, organize your QuickBooks chart of accounts into cost pools. You will have a group of accounts for direct costs. You will also have a separate group of accounts for each of the stated types of indirect costs (i.e. separate cost pools for fringe, overhead, and G&A).
There is another requirement to segregate certain types of costs in the accounting system, necessitating another cost grouping in your chart of accounts.
The SF1408 contains a requirement to exclude unallowable costs from amounts billed to government contracts. It therefore makes sense to maintain a separate grouping for unallowable costs in the QuickBooks chart of accounts to easily exclude these costs.
“The accounting system provides for exclusion from costs charged to government contracts of amounts which are not allowable in terms of FAR 31, Contract Cost Principles and Procedures, or other contract provisions.”
Of the remaining configuration requirements in the SF1408, some can be addressed in the QuickBooks setup – others require solutions external to QuickBooks.
Those that can be resolved in QuickBooks include:
- Identification and accumulation of direct costs by contract;
- Identification and accumulation of direct costs by CLIN, task, or units, if required by the contract;
- Labor distribution; and,
- Accumulation of costs under general ledger control.
Timekeeping, indirect cost allocation, and interim determination of costs charged to contracts all require the use of some external solution.
Plan ahead to leverage insights from your accounting system
Proper organization of your accounting system will serve management decision-making throughout the contract management lifecycle. Configuring QuickBooks with these end uses in mind will help you gain more value from your accounting system. You’ll have a clearer view of your financial operation, so you can price more competitively, increase revenues, and grow your business.
ICAT Systems guides you through accounting system compliance, with on-demand training and ICAT indirect cost allocation software for QuickBooks
Have questions about your own company’s setup? Contact us anytime.
Position your business for success in government contracting.