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Basic Record Keeping Requirements

(Editor’s Note. We have addressed adequate accounting systems several times in the past – what is an adequate system, what you can expect from DCAA and how you can evaluate your own system. Whereas several types of audits have been transferred to the Defense Contract Management Agency (e.g. large forward pricing proposals, purchasing systems reviews) and others have been reduced (e.g. low dollar incurred cost proposals) those remaining audit areas are getting more intensive scrutiny by DCAA. Since DCAA is tasked with determining whether contractors’ accounting systems are adequate, we have found many changes in their approach so we thought now was a good time to identify what now constitutes an adequate accounting system and what we see DCAA focusing on these days.)

When the term “accounting system” is used it does not necessarily refer to the accounting software or lack of it a contractor chooses to use. A contractor is free to use whatever software program they choose (even manual “show box” systems can be approved) and they can use actual or standard costing methods. Rather it is considered to be a combination of records, internal controls and written policies and procedures that together form the basis of estimating, accumulating and reporting financial data. Though an adequate accounting system is important for all companies, it is especially important for government contractors where they must establish an accounting system not only consistent with generally accepted accounting principles (GAAP) but also a variety of unique government accounting requirements.

Though some auditors may forget this lesson, the size of the firm and the extent of government contracts should dictate the depth and breadth of the accounting system. Small companies with relatively few contracts can probably generate all the necessary cost data using manual or spreadsheet systems. Large contractors with several segments or complex manufacturing will require much more. Accounting software that does not accommodate government accounting requirements (e.g. job costing) can be supplemented by spreadsheets as long as they are reconcilable with official books and records. If a contractor wishes to obtain government contracts over a relatively long period we recommend it obtain government-compliant accounting software that will interface with its corporate accounting transactions. The software obtained should emphasize government cost accounting and reporting of government projects, timekeeping, labor distribution, revenue recognition and contract management capabilities. The system should also have billing capability to invoice costs, pre-established labor billing rates for T&M contracts, unit pricing, indirect costs and fees billed on top of appropriate costs (e.g. overhead billing on direct labor, general and administrative billed on total costs, fees on top of all or certain costs).

Basic Record Keeping

The types of books and records used in an accounting system vary widely where they need to be suitable for individual companies. For government contract purposes, the main requirement is that record keeping must provide sufficiently detailed contract costs so that they can be identified at interim levels for purposes of repricing contract work, negotiating revised targets, billings, and determination of when contract costs have hit 75% or 85% of approved funding levels. The record keeping system must include, at a minimum, a general ledger, a job cost ledger that tracks all direct costs, labor distribution records (e.g. hours and costs attributed to specific contracts), time records, subsidiary journals, a chart of accounts and financial statements such as Profit and Loss and Balance Sheet.

Several functions are considered essential to the adequacy of any basic record keeping system for government contractors:

1. Segregate direct costs by contract or job and then identify direct costs by cost element such as labor, material, subcontracts, travel, and other direct costs. Government accounting jargon for contracts or jobs goes by final cost objectives (FCOs) and may differ widely. Sometimes FCOs may be a contract or subcontract, task or delivery order, CLIN, out-of-scope work in anticipation of a request for equitable adjustment, terminated and non-terminated portion of a contract, etc.. In addition, significant IR&D and bid and proposal projects will need to be considered a FCO.
2. Segregate indirect costs by account and title depending on the indirect cost rates that will be applied for pricing and costing purposes. Common indirect costs include fringe benefits, labor-oriented overhead, material/subcontract related handling costs, G&A costs and service centers so these costs need to be readily identifiable. Also, be able to demonstrate that actual annualized indirect cost rates are monitored during the year.
3. Accumulate costs on both a current and cumulative basis such as year-to-date and cumulative-cost-to-date.
4. Establish the accounting period and reconcile time sheets to labor costs identified in job cost ledgers and ensure these costs are identifiable in the company’s general ledger.
5. Enter costs to the books of account on a current basis e.g. at least monthly.
6. Separately identify unallowable costs in either the books of accounts (i.e. separate unallowable cost accounts) or less formal costs accounting techniques may be acceptable. For example, a contractor may elect to review all or a sample of accounts in certain risky accounts and identify a percentage of costs in that account that are unallowable. Though such after the fact screening methods were considered acceptable in the past some auditors are challenging such approaches asserting determinations of allowability should be made when the costs are either incurred or entered into the books of account and not later.

Special Emphasis on Treating Labor Costs

Verification of labor costs, because they are usually the highest cost element, attract indirect cost dollars and are vulnerable to inaccuracies because there is no third party verification (e.g. vendor invoices), is of paramount importance to the government. The key document in accounting for labor is the timesheet or timecard. Since timesheets can be easily altered by others, government contract employees must be made aware of their responsibility and the importance of accurate timesheet preparation. The government relies on the accuracy of timesheets and related internal controls to ensure the accuracy of labor costs presented for payment, contract costing and estimating. It is essential that the internal controls over labor reporting be clearly established and GCA REPORT that they be reviewed by management periodically. Adequate timesheets must include the following information: employee name, employee identification number, time period, employee and supervisor signature, daily entries, project name, project number, daily totals, project totals and room to insert comments on changes or other matters. Electronic systems are acceptable provided they have such internal controls as only the employee may make entries or make changes or changes made after initial entry are visible to provide an audit trail. (Editor’s Note. For more detail see past articles on proper timekeeping and floorchecks – use our keyword function at our website to access these articles.)