Setting Up a DCAA Compliant & Approved Government Accounting System

Business.com / Accounting / Last Modified: February 22, 2017

For government contractors, especially those that are fortunate enough to receive a cost reimbursable contract, the award of the ...

For government contractors, especially those that are fortunate enough to receive a cost reimbursable contract, the award of the contract many times is dependent upon the contractor passing an audit of their accounting system to meet stringent government requirements.  These requirements are fully outlined in the Federal Acquisition Regulations (FAR).  The Defense Contract Audit Agency (DCAA) is the office in the government that is normally called upon by the Contracting Officer to audit the accounting systems.  The DCAA  publishes an "Information for Contractors" guide to help prepare for an audit and I highly suggest contractors familiarize yourself with this prior to an actual audit.  You can find it on the DCAA home page (link above).  The DCAA also publishes on this page a "Contract Audit Manual" if you really want to see where the auditor will be coming from.   This manual often refers to the GAGAS (I'm not making this up) which is another set of detailed specifications to be followed by the auditor.  By the way, GAGAS stands for "Government Approved General Audit Standards".  As you can see, this quickly becomes a bureaucratic nightmare. 
This guide is intended only as an overview and I highly recommend that if you are serious about government contracting, and an approved accounting system, that you hire a professional expert to help guide you through the maze. 
The following 15 criteria are the basic requirements that the DCAA will look for to have an approved accounting system:
1.  Generally Accepted Accounting Principles (GAAP).  Through observation or discussion, the auditor will determine if the contractor's accounting system compliant with GAAP.  This includes using an accrual basis accounting system.
2.  Proper segregation of costs.  Direct costs (costs pertaining only to one specific contract) and indirect costs (costs that can be spread over more than one contract) must be clearly identified and segregated.  Controls must exist to prevent direct charging of indirect expenses and indirect charging of direct contract costs.
3.  Direct costs by contract.  The contractor should use either a subsidiary job costs ledger or account receivable ledger which accumulates costs by contract at a level of detail consistent with that used by the prospective contractor in its proposal.
4. Allocation of indirect costs.  Indirect costs must be accumulated in logical groupings and groupings must be allocated based on benefits accrued to intermediate and final cost objectives.  The cost accounting system should be formally documented, with a written description of the contents of bases and pools.
5. Accumulation of costs under general ledger control.  The job cost ledger and other books of account are reconcilable and currently posted to the general ledger control accounts.
6.  Timekeeping system.  Labor must be charged to intermediate and final cost objectives based on a timekeeping document (paper or electronic timecards) completed and certified by the employees and approved by the employees' supervisors.  This system should provide a full and clear audit trail including change controls.
7.  Labor distribution.  The labor cost distribution records must be reconcilable to payroll records and the labor distribution records must trace to and from the cost accumulation records in the labor subsidiary or general ledger accounts.
8.  Interim determination of costs.  The contractor must post contract costs at least monthly to books of account.
9.  Exclusion of Unallowables.  The contractor must have a plan to identify and exclude unallowable cost if the contract is awarded.
10.  Costs by Contract Line Item.  The system should be capable to be expanded to the requisite level of detail, and have a procedure to determine what this level might be.
11.  Preproduction Costs.  There must be a way of routinely segregating preproduction costs to assist in repricing or follow-on contract price determination.
12.  Limitation of Costs.  The indirect expense rates must be calculated from the books of accounts, and routinely monitored.  Need to define who is responsible for monitoring total contract expenditure against contract limitations on price or cost, and how frequently it is this reviewed.  Must have controls in place to ensure compliance with the reporting requirements of FAR 52.216-16 or FAR 52.232-20,-21 and -22.,
13.  Billings.  The contractor must have controls or procedures that would provide that interim billings of direct cost are prepared directly from the books and records, excluding unallowable costs.  The contractor should have procedures to ensure that subcontractor and vendor costs are only included in billings if payment to the subcontractor or vendor will be made in accordance with the terms and conditions of the subcontract or invoice and ordinarily within 30 days of the contractor's payment request to the Government.  Billings should be reconciled to the cost accounts for both current and cumulative amounts claimed.
14.  Adequate, Reliable Data.  The contractor's system should be capable of producing cost information at a sufficient level of detail for use in pricing follow-on contracts.
15.  Accounting system in operation.  the accounting system should be in full operation at the time of the audit.  If not, it should be demonstrated  which parts are operational and the schedule of when the full implementation will occur.

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