Skip to content

Basic Requirements of a Government Accounting System

Jan 31, 2020

The Determining Overhead Rates in Government Contracts series begins with a primer on government contracting terminology and government contract types before discussing the basic requirements of a government accounting system.


Anthony Faugno: The Federal Acquisition Regulation, known as the FAR, is established for the codification and publication of uniform policies and procedures for acquisition by all executive government agencies. In fact, the state agencies also use the FAR as guidelines also. The Federal Acquisition System consists of the FAR, which is the primary document, and the agency acquisition regulations that implement or supplement the FAR, Corporate and individual tax payers, they have to follow the IRS code. Public companies follow securities laws. Government contractors have to follow the FAR, so it's another layer of regulations. Also, most departments in government agencies have supplements to the FAR. We'll talk a little bit more about that too. So there's additional layers on top of some of this.

A few definitions that we'd like to cover as it relates to calculating overhead rates. Cost objective is a term you'll hear in the government arena. A cost objective is, I would liken that to a chart of accounts or a specific account in your accounting system. A final cost objective that is a group of accounts that make up a job cost. So for instance, if you have contract A, you want to accumulate your cost by that final cost objective. A cost pool generally relates to the indirect rates. A cost pool could be something like G&A costs or overhead costs or fringe benefit costs. So you'd want to group like accounts in an organized way into a cost pool to make calculation of overhead rates easier. Also a couple other definitions - the direct costs, which we're going to cover, are costs that can be directly identified with a cost objective. We'll talk more about that. And then there's indirect costs and unallowable costs, which we'll talk about as we get into rate calculations. Indirect costs are the basis for calculating your indirect rate.
James Seary: When the government procures services from the private sector, it typically contracts under three broad categories. It's fixed price contracting, time and material or T&M contracting, or cost plus contracting. Each one are unique and have their advantages and disadvantages for the contractor. In a fixed price contract, usually you'll see a firm fixed price, fixed price incentive fee or fixed price level of effort. And usually the procuring agency will use the contracting type that best is used by the government. If the government procurer is fixed price, they usually do that when there's an established market and the level of effort is usually determinable or easily determinable. 

For example, if the government was going to want to procure building a bridge, they generally know what the hours are, what cost for material and they will try to limit that cost based on that service. Fixed price costing obviously is the riskiest to the contractor because if there's overruns or slippage the contractor becomes responsible for that. So as a contractor, one of the most important things you could do is make sure when you're performing work under a firm fixed price contract is to stay within the scope of services or the statement of work, the SOW. A lot of times your government counterpart or the person you're performing work for will often ask you to do things out of scope. And if you end up doing that out of scope and then you have overruns, there's no recourse. So if a customer ever asks you to do that, you should document it, go back to the contracting office and try to get a modification or change order to address those types of issues. Once you pass that point, you'll become responsible for those overages.

The next type of contract is time and material. Time and material contracts are typically where you're providing services based on a labor category and the number of hours. So in that case, in your labor rate that you build up, it calculates and is designed to cover the cost of direct labor, any indirect overhead G&A and fee is built in. In addition, all your materials are billed out at a cost plus a negotiated fee. From a contractor perspective, T&M, time and material contracts, are very beneficial. You work the hours, you charge the hours, you bill the hours and you collect. Where there is exposure to the contractors, since this is predominantly labor driven, the government looks at those very closely to make sure that the people who are performing the work on a contract are qualified. So qualification is very big to make sure that the people who were working under a labor category meet those qualifications.

In addition, there's a heavy, stringent testing on the government side around time sheet policy and labor distribution. So if you're going to be working on a time and material contract, if you're new to government contracting, it's important that you adopt good time sheet policies such as having allowable charge codes, limited access to charge codes, work authorizations, daily time sheet submissions, things of that nature so that when a time sheet audit comes in from the government, you could certainly well document your position for charging those hours and meeting those qualifications. The next type of a contract is cost reimbursement contracts and often you'll see cost plus fixed fee, which is probably the most common. Cost plus award fee - that's where you'll get a base coverage on your cost and then for completing certain milestones or incentives, just like incentive fees, there'll be additional profit to be earned above and beyond the cost.

Cost reimbursement contracts are often issued when there's uncertainties involved in contract performance. So typically you'll see for R&D where you're trying to develop something new, you can't really predict what the hours are unlike with our example before when you talked about building a bridge. We want to say for a DOD contract, we want to make a weapon system that could shoot a laser two miles with pinpoint accuracy. Well it's almost impossible to say we know that we could do that for x hours at x cost so often the contract will procure those services through a cost reimbursement contract. Similar to firm fixed price contracts, you still need to be careful when you do out of scope work because what happens is you get a cost plus a fixed fee, for this example, that fixed fee is fixed on the original award.

That's not a fixed fee that gets added to all your costs. So if you have overruns or start performing work that’s out of service, you'll get to a point where the government will say, well, you basically spent to your funding, but you still have to complete what you had promised us. So you may be in a renegotiation state where you have to perform for maybe just costs with no fee. So it's just like the firm fixed price example, you have to make sure that you're staying within scope and communicating with the government customers that you're avoiding excess and out of scope work. One other contract type and it's more of a procurement tool that's not listed here is something called an IDIQ contract. And the government's going towards this type of contracting.

IDIQ stands for indefinite delivery, indefinite quantity. In order for the government to try to speed up its procurement process, it goes out and says, let's do this big solicitation. Let's say we're going to go and put out a solicitation for $20 billion. We're going to have a competitive bid process where contractors, prime contractors will come perform, build bids and proposals. They'll probably build a team of 20, 30 team members, companies supporting them. They’ll have a host of bids and proposals that come in and the government will go through a competitive process and say, all right, we're going to award it to the 10 best contractors. Once they do that, you win an IDIQ contract which is really like a license to hunt for future work. So once you have a prime position on an IDIQ contract, the government will come in and say, all right, now we want this specific amount of work done, we're going to issue a task order. Then all of those contractors that have a prime position can go out and bid on that task order.

So it will become many contracts, their task orders under a larger IDIQ contract. The government is using that as a way to secure quicker, more agile type of procurement methods and that's what you'll see a lot today and those contract awards can be both competitive and noncompetitive. So you could still see small business set asides and sole source contracting as well under those. James, I’ve got a question here from the audience and it maybe referred to one of the slides prior to this…my company was looking to bid on a DOD contract. What other guidance should we be aware of is out there? From a DOD perspective, underneath the FAR a lot of these executive agencies or these federal agencies have a FAR type compliance document that they use.

For instance, in this case, the DOD uses something called DFARS, which is Defense FAR, and that's specific guidance to doing work for the Department of Defense. For DOD also if you looked into the audit agency called the DCAA – Defense Contract Audit Agency. They have their own manual that's in place and it’s called Information for Contractors. Between those three documents that should pretty much cover you. And obviously the thing that basically drives you in all the work you do under a government contract is the contract itself. So you may have things in the FAR that when you look at your contract, you know what would normally be an allowable charge under the FAR, your contract may disallow that specifically under that contract. So even beyond the broad based guidance you would have to look a little bit deeper and go to the contract itself. The contract is always your best source document for something specific to the work you're doing.

The next section is the basic requirements of a government accounting system. Part of determining your government rates – and this is all about the process of calculating your overhead rates. But in order to do that, the government mandates that you have an adequate accounting system. So in order to calculate your overhead rates, indirect rates, you must have an accounting system that is deemed adequate. There's certain requirements that the government looks at to determine an adequate accounting system. I'm just going to run through these real quickly. Accounting systems should be under a GAAP basis. So a lot of small companies that are trying to get into the government contract space face that are using tax basis or a modified accrual, you'd have to make the adjustment to be in compliance on the GAAP side.

You need to have adequate internal controls over financial functions, whether that's checks and balances, a review process, all the segregation of duties, what have you. It's important that you have a chart of accounts. The government specifically has their own system of charging accounts. So you usually have a direct labor bucket or direct charge accounts, overhead, some other indirect, whether it's G&A, and you have to specifically identify unallowable costs in your chart of accounts. Now, that chart of accounts, what you use for government reporting may not be the same as for financial reporting or tax reporting. So you may have something that qualifies as an overhead cost within your government pool but that may be treated as an allocable cost on your financial statement, maybe direct charge, maybe treated as G&A. So you will have differences between financial statement reporting under GAAP and a cost pool collection.

It’s a requirement that your subsidiary costs accumulated under general ledger control must be reconciled. All those sub ledgers have to be able to tie into the general ledger and then also tie that the accumulation at the micro level to your specific contracts or what they call the final cost objective. A monthly general ledger postings are required and that's a real important one for especially companies that are smaller in nature and may not be as sophisticated. A lot of times obviously contracts are awarded based on the government schedule, whether it's a fiscal year or they may go and pick May to May for an award cycle. Now if you're a calendar year financial filer and at the end of the year your accountants or auditors come in and there's a significant amount of adjustments that they make for depreciation, some other adjustments that they may find and they booked those in December.

The reality of it, and if you had a contract that ended in May, some of those expenses really should have been affected on in your May reporting for the contract purposes. So you do have to be careful that you get in the system of doing hard closes, making sure that all your accounting is under a GAAP reporting on a monthly basis.
AF:I have a comment on that - just real quick, I had an issue with a government auditor once where the client was not posting their depreciation on a monthly or at least quarterly basis. They did it at the end of the year and the auditor actually wrote them up as an inadequate accounting system because of that. So that's important.
JS: Next slide is just a continuation of your accounting system needs to segregate between direct and indirect costs. And really what that is telling you is you need to have accounts that accumulate costs that are specifically identifiable to a project or a contract. And then you need to accumulate costs, whether it's an overhead or G&A or some other indirect pool that is not specific to a contract, but it's an allocable cost to get allocated across to all of the contracts. And a little bit later we'll go through the process of how you do that as part of the presentation. Another big one obviously is maintain a cumulative job cost ledger. That's important because that job ledger is going to be all your support and all your buildup of cost specific to a contract or a project.

And it's important that you are able to bill it, whether you're billing or accumulating costs at a project and some projects may require you to go down to a CLIN or a SLIN level where you'll have to segregate your costs even deeper and at a deeper level than just at the contract level. Next slide is basic or specific requirements for a government accounting system. You need to provide a mechanism to monitor and meet funding limitations. This is important because what we talked about before is you could have a large award contract that you won, say an IDIQ, and you're given a task order under it. You may have a task order that says we want you to bill SLIN A and SLIN B. And if you're accumulating cost at that task order level and not breaking it down to the SLIN level and there's a good chance that you could be in an overrun situation. Make sure cumulatively you're not over the total funding but because you misaligned your SLIN reporting, you could be in an overbill situation where even though you did the work, you may be unable to bill it or collect it. So that's just something you have to watch out for and make sure you could report and accumulate costs at that level of detail. Like I said before, we'll walk through some of those examples later. Just a couple of more things. Segregation of pre-production costs from production costs - what that really means is in certain situations, the government, even though you have an award day, let’s say it's January one, but you may have had some prep time to get ready for that award. In certain situations, the government will say, we understand this is a new area, we’re asking for the contractor to make some investments.

We're going to allow you to pick up 90 days of pre-production costs and charge that to the contract, although the award date didn't happen until a subsequent date. You have to be able to build progress payments, provide adequate and reliable data for pricing and follow-on acquisitions and specifically identify unallowable expenses. The identification of an exclusion of unallowable expenses is important because under the FAR, if you charge for an unallowable expense that is specifically identified as an unallowable expense, there's heavy penalties that you could be charged with. So that's why having that chart of accounts that segregates out those unallowable expenses is crucial if you’re going to be a government contractor.

Proper Cost Pools

This video from our series Determining Overhead Rates in Government Contracts breaks down how Proper Cost Pools must be established within a government contractor’s accounting system. This means segregating costs into direct, indirect, and unallowable cost pools.

FAR Part 31 – Cost Principles & Procedures

This video from our series Determining Overhead Rates in Government Contracts explores some basics of FAR Part 31, the specific section of the government regulations that details cost principles and procedures.

Indirect Rate Calculations

As a federal government contractor, your overhead rate is essential to maximizing cost recovery. This video series provides an overview of the elements that come into play when structuring overhead rates, and presents examples of how to calculate overhead rates.

What's on Your Mind?

a man in a suit smiling

Anthony J. Faugno

Anthony Faugno is Partner-in-Charge of the firm’s Federal Government Contracting Group assisting clients in complying with the government accounting regulations related to their federal contracts/grants for closely held and family owned businesses.

Start a conversation with Anthony

Receive the latest business insights, analysis, and perspectives from EisnerAmper professionals.