By J.C. Watkins, Procurement Consultant, Kentucky APEX Accelerator
This article was originally published in our monthly KY APEX Accelerator Newsletter. If you have any questions about this topic, your KY APEX Accelerator consultant is here to help! Not a client? Sign up here.
As firms grow into governmental contracting, their management systems need to evolve. One area where this is readily observable is in the accounting system. In most cases, firms need to be mindful that if their accounting firm assists in the creation of major elements of their accounting system, then the accounting firm is precluded from auditing the client. In simple terms, the folks who help construct the systems cannot audit their own work, which would be the case if they audited the governmental contractors. If your firm is using manual entry or is just becoming familiar with simple automated accounting systems such as QuickBooks, Xero, Oracle NetSuite or countless others, it would be prudent to be aware of what your accounting system will need to do to keep your firm operational while still meeting your governmental contracting needs. Government contract accounting, while based on Generally Accepted Accounting Principles (GAAP), places less emphasis on traditional “debits and credits”. Accounting Systems need:
1. A method to identify costs as direct versus indirect
The accounting process must be established to allow identification of all costs incurred, either as costs incurred “directly” as the result of contractual efforts (FAR 31.202) or indirect costs incurred in support of business operations and not identifiable with any specific contractual commitments (FAR 31.203).
2. A method to collect direct costs by contract, contract line item or other cost objectives
Direct costs incurred relative to contractual commitments need to be collected in the same detail as proposed and negotiated.
Costs can be recorded in more detail but in not less detail than on government contracts. This allows for the tracking and comparison of actual costs to costs proposed and negotiated.
3. A method to segregate allowable and unallowable costs relative to cost elements
There are certain costs incurred by contractors that the Government will not reimburse. These unallowable costs are defined in FAR 31.201-2 and identified in FAR 31.205, Selected Costs, or possibly in your contract.
Expressly unallowable costs (those specifically identified in FAR 31.205) or costs agreed to be unallowable, along with directly associated costs (those normally allowable costs incurred as a direct result of incurring an unallowable cost) must not be included as a direct or as an indirect cost in any billing, claim or proposal to the Federal government (FAR 31.201-6).
4. A labor time and effort system applicable to all employees
Labor generally represents one of the most significant costs incurred by a contractor. It is essential that a labor recording process be established that is applicable to all employees, direct and indirect, recording the total hours worked by each employee by authorized account and/or charge number.
When recording their time, every employee should indicate the time spent on both direct and indirect activities including sick time, vacation, etc.
The process for recording hours may be manual or electronic and must include the ability to track all changes made to the hours as initially recorded, documenting who made the change and why.
All time recorded must be approved by the employee and his or her supervisor before processing.
5. An accounting or fiscal manual documenting all parts of the accounting operations
When evaluating a contractor’s accounting system, one of the first things reviewed by the government auditor is the established policies and procedures.
Even if a contractor is compliant with all of their accounting processes, they must maintain written policies and procedures documenting responsibilities and established policies and practices.
This manual also functions as an internal insurance policy, providing guidance to ensure that compliant accounting practices will be performed consistently from period to period.
6. A Code of Ethics and Business Conduct, preferably compliant with the COSO Framework
Please note COSO framework is not a requirement.
The Government also looks for an established Code of Business Ethics and Conduct defined at FAR 52.203-13.
The Code must be in writing and made available to all involved employees.
Larger contractors need to provide training for all involved employees, agents and subcontractors.
The company must exercise due diligence in preventing and detecting criminal conduct and must promptly disclose any non-compliances to the appropriate government agency. The appropriate hotline posters must be displayed.
The requirements for an adequate accounting system are defined in the Federal Acquisition Regulation (FAR) at: 9.104-1(e), Responsible Prospective Contractors – General Standards; 16.301(a)(1), Cost Reimbursable Contracts; Part 31, Contract Cost Principles and Procedures; and the Defense Federal Acquisition Supplement (DFARS) at 252.242-7006, Accounting System Administration. Please keep in mind that when contractors are proposing to sell to the government, the contractor must be able to certify that their accounting system is compliant with these regulations and is adequate for government contracting as defined at FAR 53.209-1(f), Pre-award Survey of Prospective Contractor Accounting System (SF1408). If the contractor cannot make this certification or pass a pre-award audit as would be performed by a cognizant government auditor, they will not be awarded a government contract. Please be mindful that the information presented here is not financial advice. Firms should consult with a licensed professional for advice concerning their specific situation. For clarification on any of the information above, or for general government contracting assistance, please contact your Kentucky APEX Accelerator Regional Procurement Consultant. If you are not sure how to connect with your consultant, you can request assistance by contacting us at kyapex@kstc.com or by registering on our website.