Most Government contractors and prospective contractors realize that an "adequate" accounting system is a necessary prerequisite to winning a negotiated contract. And, there is no mystery to what constitutes an "adequate" system. The attribute are listed on SF Form 1408 - Pre-Award Survey of Prospective Contractor Accounting System. We've covered these attributes on this blog several times. See, for example Preaward Surveys - SF From 1408 and Two Kinds of Accounting System Audits. Contractors (and prospective contractors) should not underestimate the importance of an adequate accounting system. Companies have lost out on opportunities by not having adequate systems. See, for example Accounting System Adequacy and Bidder Disqualified for Failing to Provide Evidence of an Adequate Accounting System.
DCAA (Defense Contract Audit Agency) is the Federal Agency most responsible for auditing accounting systems although other agencies perform such reviews and in the past few years, commercial firms have also gotten into the business. Implementing an adequate accounting system is not difficult but it does require discipline. Companies at risk include those without accountants - where the accounting function is performed by perhaps a founding member who is also responsible for other functions including direct work on a contract. Another group that seems to struggle are those that are moving from a commercial to a Governmental environment.
DCAA published the top five reasons why accounting systems fail the adequacy review. Prospective contractors should consider whether their accounting systems might have similar deficiencies:
1. Contractors not making interim (at least monthly) determination of costs charged through routine posting to books of account. This deficiency is quite common among small contractors without regular accounting help. The idea that someone will get around to it someday will not satisfy the auditor. If you find yourself in this situation and cannot afford an accountant, look to outsource the function - it doesn't have to be expensive.
2. Failure to properly segregate direct and indirect costs. This speaks to the design of the accounting system. Somehow, the accounting system must be capable of capturing direct and indirect costs as the costs are booked. Some companies set up their charts of account for that purpose. But there are other methods of accomplishing the same thing, depending upon which accounting software is used.
3. Improper timekeeping. This could mean a lot of things from no functional timekeeping system to one that has insufficient controls. For a rundown on what constitutes an adequate timekeeping system, see Timekeeping Systems - Regulatory Requirements.
4. Failure to exclude unallowable costs. FAR 31.201.6, Accounting for Unallowable Costs, requires contractors to identify and exclude unallowable costs (e.g. interest, advertising, bad debts, alcohol, etc) from any proposals, claims, billings, or progress payments submitted to the Government. Obviously to know what to exclude requires a basic understanding of the FAR Part 31 cost principles and then once identified, a system to ensure that those costs don't become part of any submission to the Government.
5. Procedures to ensure that subcontractor and vendor costs are only included in billings if payment to subcontractor or vend 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. The key here is that contractors should not make payment to vendors and subcontractors contingent upon reimbursement from the Government. There is always some expectation that contractors will need a certain amount of working capital to pursue Government work in the same manner that it would require for commercial work.