Key Details: As 2023 begins to wrap up, government contractors may be looking towards 2024 business growth planning and strategies to remain compliant and competitive on future contract awards. One topic that remains a key compliance area for government contractors is the tracking and allocation of direct and indirect costs to contracts. Setting up the chart of accounts, the determination of pools and bases, tracking of costs, and the final calculation of indirect rates may seem daunting at first. Ryan & Wetmore is poised to take your business to the next level by assisting with the establishment of an adequate accounting system. The basic article below briefly walks through various steps your business can take to ensure your accounting system is adequate. Have further questions? Reach out to us today to begin your compliance journey.
What are Indirect Rates?
Indirect rates provide a method for determining in a fair and efficient manner the proportion of departmental, organizational, or administrative costs each program or contract should bear. As such, rates are an essential element in any contract as they provide a basis for billing. Indirect rates are necessary as indirect costs cannot be assigned to a singular final cost objective without first going through a calculation process. A final cost objective is considered a final accumulation point for both direct and indirect costs such as a particular award, an internal project, or other direct activity. Before reaching a final cost objective, indirect costs are typically accumulated in an intermediate cost objective to then be subsequently allocated to one or more indirect cost pools or final cost objectives.
Chart of Accounts
The Chart of Accounts (CoA) provides a basis for government contractors to build a DCAA (Defense Contract Audit Agency) compliant accounting system. The CoA is a list of all general ledger accounts that are grouped by function or category. As such, each account holds individual transactions for that type of account. A standard CoA includes the following categories:
- Assets
- Liabilities
- Equity
- Revenue
- Expenses
- Direct Expenses
- Fringe
- Overhead
- General & Administrative
- Unallowable
Each section can be further broken down into subcategories that are sorted by account number. This means that assets and liabilities can be broken into current and non-current sections and expenses can be broken into direct, indirect, and unallowable sections. Further subcategories can be made for indirect expenses which will aid in the eventual calculation of indirect rates. These costs can be separated into fringe, general & administrative (G&A), and overhead (OH).
Contractors should aim to have a standardized CoA that is easy to follow. This will improve efficiency and lower errors made during the calculation of indirect rates. This will also provide for the ability to properly segregate costs.
Standard Form 1408 - Pre-Award Survey of Prospective Contractor Accounting System
The SF 1408, titled “Pre-Award Survey of Prospective Contractor Accounting System” is a checklist used by the government before award of a contract and is not considered an audit. We advise and encourage our clients to make sure they can meet and exceed all the requirements set forth in SF 1408 on an ongoing basis even if it is not currently required by the government or needed in a proposal. The SF 1408 is simply a review to ensure and determine your accounting system is set up in a way that is in accordance with the criteria set out on page 2 of the form.
Contractors should note that certain government issued RFPs may require the completion of an SF 1408 certification. Contractors are encouraged to thoroughly review their RFPs.
The bullet points below highlight each item required on SF 1408 and provide explanations that will help improve your accounting system. An important item to note while completing SF 1408 is that your accounting system should be controlled by written policies. You will need to provide written documentation of these policies while completing the form.
- “Except as stated in section I narrative, is the accounting system in accord with generally accepted accounting principles applicable in the circumstances?”
- To be compliant, your business's accounting system must be in accordance with GAAP. This means reporting on an accrual basis and having a system that can generate basic financial reports.
- “Accounting system provides for: proper segregation of direct costs from indirect costs.”
- Your accounting system must be able to separate each cost element through having separate accounts. This allows proper invoicing of direct costs and allocation of indirect costs. Direct costs are defined as costs that benefit a single cost objective.
- “Accounting system provides for: identification and accumulation of direct costs by contract.”
- Job costing is essential for this item. Your direct costs must be accumulated by project through proper separation by project number. This will allow you to maintain a job costing ledger which shows costs separated by project.
- “Accounting system provides for: a logical and consistent method for the allocation of indirect costs to intermediate and final cost objectives.”
- Proper allocation of indirect cost must be defined and followed for all contracts through logical groupings. Groupings can include overhead, G&A, and fringe. For example, certain employee benefits would fall into the fringe grouping.
- “Accounting system provides for: accumulation of costs under general ledger control.”
- The accounting and tracking of direct and indirect costs must be reconciled (at least monthly) with your general ledger.
- “Accounting system provides for: a timekeeping system that identifies employees’ labor by intermediate or final cost objectives.”
- Your timekeeping system must be able to properly allocate labor to projects both directly and indirectly. This means you must track both employee hours and dollars by job and accounts. Timekeeping is one of the most important aspects of government contracting.
- “Accounting system provides for: a labor distribution system that charges direct and indirect labor to the appropriate cost objectives.”
- You must be able to reconcile your business’ timekeeping system to your payroll system, job cost ledger, and general ledger. This means each employee must properly track the hours spent on different contracts. This relates to total time accounting, which adjusts an exempt employee’s effective wage rate. The adjustment is based on the total time they worked in a period.
- “Accounting system provides for: interim (at least monthly) determination of costs charged to a contract through routine posting of books of account.”
- You must be able to show total costs incurred for a given project (including any indirect costs allocated to that project) monthly.
- “Accounting system provides for: exclusion from costs charged to government contracts on amounts which are not allowable in terms of FAR 31, Contract Cost Principles and Procedures, or other contract provisions.”
- Unallowable costing requirements follow FAR 31.201-6. Your accounting system must be able to properly track any unallowable costs and ensure that they are not charged to the government by having separate accounts. Examples of unallowable costs include donations, entertainment costs, gifts, and interest.
- “Accounting system provides for: identification of costs by contract line item and by units (as if each unit or line item were a separate contract) if required by the proposed contract.”
- If required, your accounting system must be able to charge direct costs and allocate indirect costs to line items. This means adequate identification of costs by CLINs when required.
- “Accounting system provides for: segregation of preproduction costs from production costs.”
- Preproduction costs are incurred before the effective date of a contract but are required to meet a contract requirement. These must be properly accounted for and captured separately.
- “Accounting system provides financial information: required by contract clauses concerning limitation of cost (FAR 52.232-20 and 21) or limitation on payments (FAR 52.216-16)”
- Your accounting system must be able to accumulate direct costs by project and allocate indirect costs to relevant projects. It must also show the current period, as well as date cost reports that relate to funding. This means your accounting system must track costs / billings cumulatively and can reflect the percentage of funds used.
- “Accounting system provides financial information: required to support requests for progress payments.”
- The main point of progress payments is that contractors can bill up to 80% of contract costs monthly. To do this, your accounting system must be able to properly track your costs and billings and accumulate them under the identified job.
- “Is the accounting system designed, and are the records maintained in such a manner that adequate, reliable data are developed for use in pricing follow-on acquisitions?”
- Your accounting system must be able to continuously track all features (such as costs and billings) in a reliable manner. This means being compliant with all items above.
- “Is the accounting system currently in full operation?”
- To receive a favorable rating, your accounting system should be able to demonstrate that at full operation, it is able to comply with the items listed above.
Contractors are encouraged to work through this checklist and to perform a self-assessment to identify any gaps in their accounting system that may result in non-compliance. Ensuring compliance with the SF 1408 Pre-Award Survey will enable contractors to easily track and calculate their indirect rates and lower the risk of non-compliance in the future. Need an accounting system examination completed? Contact Ryan & Wetmore today.
Compliance – Timekeeping
A critical component of all government contracts is the accurate tracking of direct and indirect labor to support hours charged to various labor categories. Contractors should aim to have a timekeeping system that can properly allocate direct and indirect labor to projects. This means the timekeeping system must be able to track both employee hours and dollars by job and accounts. Government contractors should also aim to internally reconcile their timekeeping system to their payroll system, general ledger, and job cost system. Additionally, government contractors are encouraged to maintain and regularly update their timekeeping policies and procedures. Key items in these policies should include:
- Purpose, scope, and key definitions.
- Procedures for training and informing employees of policies.
- Timesheet preparation.
- Timesheet approval process.
- Timesheet submission process.
- Adequate document retention regarding audit trials.
- Labor and charge codes.
- Employee authorization to charge labor to various project codes.
- Timesheet review process.
- Timesheet reconciliation process.
- Timesheet corrections policy.
Government contractors working on all contract types are encouraged to thoroughly review their timekeeping system to remain compliant and competitive in the future.
Conclusion and Next Steps
Government contractors are encouraged to internally evaluate their accounting system to ensure expenses are accurately recorded and allocated to final cost objectives. Additionally, government contractors can take the following steps to enhance their accounting system ahead of the new year:
- Ensure your company has a security and compliance officer.
- Review and update your company’s internal policies and procedures relating to:
- Billing policy
- Bonus policy
- Direct cost policy
- Indirect cost policy
- Job cost policy
- Timesheet preparation policy
- Travel policy
- Unallowable cost policy
- Review your Chart of Accounts and determine if any revisions are required.
- Internally calculate your indirect rates and reconcile with the rates calculated within the accounting system.
- Internally walk through SF 1408 to determine areas where additional policies are updates are required.
- Create a contract matrix that tracks the various clauses and regulations to which you are subject.
For accounting system assistance, contact Ryan & Wetmore today.
Today’s Thought Leaders
About Peter Ryan
Partner, Co-founder, & CPA
Peter T. Ryan co-founded Ryan & Wetmore in 1988 with business partner Michael J. Wetmore. Peter provides clients with the best strategies for success. His expertise extends across various industries. Peter obtained a Master of Business Administration in Finance from the University of Baltimore and a Bachelor of Arts in Accounting from the Catholic University of America.
About Rosie Cheng
Finance Consultant
Rosie Cheng is a Finance Consultant at Ryan & Wetmore. She focuses on government contracting services and produces many of the firm’s government contracting newsletters. Rosie graduated from Georgetown University with a Master of Science in Management and from William and Mary with a Bachelor of Business Administration.