Government Contract Accounting and DCAA Compliance
Government contract accounting is the discipline of segregating, accumulating, and reporting costs so that a federal contractor can bill flexibly priced contracts and survive audit by the Defense Contract Audit Agency. The core requirement is deceptively simple: direct costs must be charged to the contracts that caused them, indirect costs must be pooled and allocated on a consistent, causal basis, and unallowable costs under FAR Part 31 must be identified and excluded. Everything else, from timekeeping controls to incurred cost submissions, exists to prove those three things are actually happening in your ERP.
What an Adequate Accounting System Must Demonstrate
DFARS 252.242-7006, Accounting System Administration, lists the criteria an adequate system must satisfy, and DCAA evaluates against them during a pre-award survey using Standard Form 1408 or during a post-award system audit. The recurring themes are segregation of direct from indirect cost, identification and accumulation of direct cost by contract, a logical and consistent method for allocating indirect cost to intermediate and final cost objectives, accumulation of costs under general ledger control, timekeeping that identifies employee labor by cost objective, and exclusion of unallowable costs. Notably, the standard requires the job cost ledger to reconcile to the general ledger. That single reconciliation causes more findings than almost any other criterion, because many contractors run project accounting as a separate system that drifts from the GL.
Direct and Indirect Cost Structure in ERP
The typical structure uses three indirect pools: fringe benefits allocated over total labor dollars, overhead allocated over direct labor dollars or hours, and general and administrative expense allocated over a total cost input base. Larger contractors add separate pools for material handling, engineering overhead, and site-specific overhead where the causal relationship differs. In ERP this is implemented through account and cost center structures plus a rate application engine that applies provisional billing rates during the year and actual rates at year end. Consistency is the legal requirement: costs incurred for the same purpose in like circumstances must be treated the same way, so a cost cannot be direct on one contract and indirect on another.
- Segregate unallowable costs into dedicated GL accounts at the point of entry, not through a year-end scrub
- Maintain provisional billing rates submitted to the cognizant ACO and true them up at least annually
- Ensure the job cost ledger reconciles to the general ledger every month with documented evidence
- Keep contract briefs current with funding, ceiling, CLIN structure, and applicable FAR and DFARS clauses
Timekeeping and Labor Distribution Controls
Labor is the single largest area of DCAA scrutiny because it is the least verifiable through documents. The expected controls are well established: employees record time daily to a specific cost objective, employees make and own their own entries, changes are made only by the employee with a documented reason and supervisor approval, supervisors approve after the fact rather than pre-populating, and the system produces a complete audit trail of every original and revised entry. Uncompensated overtime for exempt salaried staff must be handled with a documented and consistently applied policy, since total time accounting affects how labor dollars distribute across contracts. Floor checks, where an auditor asks an employee on the shop floor what charge number they are working to, remain a standard DCAA technique.
Incurred Cost Submissions and Contract Billing
Cost-reimbursable contracts require an annual incurred cost proposal, generally due six months after fiscal year end under FAR 52.216-7, submitted using the ICE model schedules that reconcile claimed costs to the general ledger, present final indirect rates, and list contract-level claimed amounts. Interim billing runs on provisional rates through public vouchers submitted in the Wide Area Workflow module of PIEE. Fixed-price contracts with progress payments use SF 1443 and require careful tracking of costs incurred against the payment percentage. Managing the limitation of cost and limitation of funds clauses is an operational, not accounting, obligation: notice requirements are triggered by percentage thresholds of funded value, and missing them can leave real costs unrecoverable.
- Track funded value versus costs incurred by contract so limitation of funds notices go out on time
- Build the incurred cost submission from ERP extracts that tie to the GL, not from rebuilt spreadsheets
- Reconcile cumulative billed amounts to cumulative costs incurred plus applied indirect on every voucher
- Retain supporting documentation for claimed costs for the full audit period, typically several years past closeout
How Netray Supports DCAA-Ready ERP Operations
Netray configures ERP cost structures for government contractors and deploys compliance agents that continuously monitor the controls DCAA tests. The agents reconcile job cost to the general ledger nightly, flag transactions posted to unallowable accounts that appear to be billed, detect timecard patterns that draw auditor attention such as clustered retroactive edits, track funded value consumption against limitation of funds thresholds, and assemble the data extracts that feed the incurred cost submission. For contractors preparing for a pre-award survey, this compresses readiness work that typically runs three to six months into a structured program of weeks, with documented evidence for each SF 1408 criterion.
Frequently Asked Questions
What does DCAA look for in an accounting system audit?
DCAA evaluates whether the system segregates direct from indirect costs, accumulates direct costs by contract, allocates indirect costs on a consistent and causal basis, operates under general ledger control, identifies and excludes unallowable costs under FAR Part 31, and captures labor by cost objective through compliant timekeeping. A reconciliation between the job cost ledger and the general ledger is expected. These criteria are drawn from DFARS 252.242-7006 and Standard Form 1408.
Do I need a special ERP system to be DCAA compliant?
No. DCAA does not certify or approve software; it evaluates how a contractor's system and controls operate. Mainstream manufacturing ERP platforms can support compliance when configured with proper direct and indirect cost segregation, contract-level cost accumulation, unallowable cost accounts, and audit-trailed timekeeping. What fails audits is usually configuration and process, such as project accounting that never reconciles to the general ledger, rather than the underlying software.
When is the incurred cost submission due?
Under FAR 52.216-7, the allowable cost and payment clause, contractors with cost-reimbursable work generally must submit a final indirect cost rate proposal within six months after the end of their fiscal year. The submission typically follows the ICE model schedules, which reconcile claimed costs to the general ledger, present final indirect rates by pool, and detail claimed amounts by contract. Extensions are possible but must be requested from the cognizant contracting officer.
Key Takeaways
- 1What an Adequate Accounting System Must Demonstrate: DFARS 252.242-7006, Accounting System Administration, lists the criteria an adequate system must satisfy, and DCAA evaluates against them during a pre-award survey using Standard Form 1408 or during a post-award system audit. The recurring themes are segregation of direct from indirect cost, identification and accumulation of direct cost by contract, a logical and consistent method for allocating indirect cost to intermediate and final cost objectives, accumulation of costs under general ledger control, timekeeping that identifies employee labor by cost objective, and exclusion of unallowable costs.
- 2Direct and Indirect Cost Structure in ERP: The typical structure uses three indirect pools: fringe benefits allocated over total labor dollars, overhead allocated over direct labor dollars or hours, and general and administrative expense allocated over a total cost input base. Larger contractors add separate pools for material handling, engineering overhead, and site-specific overhead where the causal relationship differs.
- 3Timekeeping and Labor Distribution Controls: Labor is the single largest area of DCAA scrutiny because it is the least verifiable through documents. The expected controls are well established: employees record time daily to a specific cost objective, employees make and own their own entries, changes are made only by the employee with a documented reason and supervisor approval, supervisors approve after the fact rather than pre-populating, and the system produces a complete audit trail of every original and revised entry.
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Terms used in this article
Ask Netray for a DCAA readiness review of your ERP cost structure, timekeeping controls, and job cost to general ledger reconciliation.
Related Resources
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