How Good is Your Accounting System?

May 4, 2007 on 11:23 am | In Cost Accounting Issues | 1 Comment

Companies that do business with the government are required to have an accounting system that is adequate for the types of contracts awarded. For fixed price contracts a relatively minimal accounting system is necessary. There is no requirement that costs be accumulated on any particular basis and the various costs do not need to be allocated to specific projects or segregated in any particular way. When the contract work is performed, the full fixed price is paid and whether there was a profit or loss on the contract is of no real concern of the government.

When cost-type contracts are awarded, however, the government requires that the contractor have an accounting system that can properly track the costs attributable to each project. The key is to make sure that the costs charged against the cost-type contracts are reasonable, allowable, and allocable. The accounting system itself must be audited by the government, usually the Defense Contract Audit Agency (DCAA), to verify that it works properly and has the proper controls in place to ensure that government is billed ONLY for those costs that are reasonable, allocable and allowable. Beyond this system verification, the government will also audit invoices and charging practices to ensure that it is paying only for what it agreed to pay. Since the government refuses to pay for certain normal business expenses (advertising for one example), some companies find that they need to actually have two separate accounting systems in place – one for government work and one for their commercial work.

Many companies avoid these issues by refusing to accept anything other than firm fixed price work; others recognize that their government business base can be expanded if the also accept cost-type contracts. In many respects cost-type work carries less risk, at least in terms of the total cost to perform, to the contractor. But as the example of needing an adequate accounting system shows, the management of such contracts becomes more complex.

In a very recent (like yesterday!) Government Accountability Office (GAO) bid protest decisions, several key points were made that are instructive for the growing firm that is looking to move into cost-type contracting. First, the accounting system MUST be approved by the government through a proper system audit. Merely having an accounting software package that typically suffices is not sufficient. You have to actually install and test the system. Some companies attempt to take a shortcut and either not purchase or not install certain modules of large software packages. So merely HAVING it does not mean that you are USING it!

Secondly, the software package is only one piece of the system. If you do not have the procedures and disciplines in place to make sure that the costs are properly recorded in the first instance it will not pass an audit.

Third, under the provisions of FAR § 16.301-3(a)(1), a cost-reimbursement contract may be used only when a contractor’s accounting system is adequate for determining costs applicable to the contract and appropriate Government surveillance during performance will provide reasonable assurance that efficient methods and effective cost controls are used. Thus the accounting system has to already exist and be verified before costs start accumulating against the project. It is not something that allows you to play “catch-up”.

In this GAO case, the protestor asserted that, even though it did not have a verified accounting system, the agency erred in rejecting its proposal because the firm met the RFP’s requirements through its use of the Deltek accounting system, submission of provisional billing rates to DCAA for audit, and current contracts with cost-reimbursable-type task orders. None of this met the standard of having a verified accounting system, said GAO, especially since the contract the protestor referenced that had cost-type task orders under also had specific language that said THIS contractor could not perform cost-type tasks because it did not have an adequate accounting system!. Only through audit by a government entity can an adequate accounting system for purposes of permitting cost-type contracting be determined.  Further, GAO noted, having a verified estimating system is different than having a verified cost accounting system.

Cost accounting software can be expensive, but it does not have to be excessively so. Elsewhere in the FAR contracting officers are cautioned against forcing contractors to have overly elaborate accounting systems “just-in-case” it might come in handy, such as in the event of a termination. Still, those contractors wishing to grow their government business must accept that there are some front-end costs in getting their accounting system in shape and verified before the first time they get to use it.
Matter of A-TEK, Inc.,  B-299557,  May 3, 2007.

1 Comment

  1. Tom:

    Just some thoughts… In regard to the government not really caring where you ‘put’ costs since it is a fixed price. In my experience, they actually do, whether they consider a T&M or FP type contract! The government has financial and contracts personnel opting out and moving from military training to government positions. Where these people learn their craft usually dictates what the look for! With that said, you may be required to understand where they are coming from in order to discuss your position versus their’s! The last thing you want to do is get frustrated with a COTR or DCAA Auditor! Then the relationship is at risk.

    I would also caution smaller companies not to take the proper allocations and postings to contracts lightly because they have FP contracts!! In reality, they should be training themselves on all contracts to track costs, performance, and burden allocations whether they HAVE TO or not! Good training as they grow and in preparation for winning other type contracts (T&M, CP, etc.).

    As to the government requirement that the system properly track costs attributable to projects and that they are reasonable, allowable and allocable… True, but with a caveat! First of all, when bidding on governmental proposals, scan the document to see if they require an audit prior to the award, or within a specific time or at the contract closure. Secondly, remember that ‘most’ smaller accounting systems are not certified by or address governmental requirements! Small businesses tend to start out with the likes of Quickbooks or PeachTree then migrate to other financial products such as a MAS90, Great Plains or Deltek as they grow. With this said, and with software vendors saying that they are compliant with governmental regs or accepted, “the proof is in the pudding”! You still have to pass an audit to get the final blessing!

    It is how you set up the system that allows the government to see how you treat expenses when posted to a contract. It takes a little more thought and I may add possibly some guidance from an experienced accountant/CPA to plan out your financial structure a little more than the typical 1000 = Assets, 2000 = Liabilities, 3000 = Equity, etc. You have to expand your structure to include references for projects, for allowable and/or allocation! Creating a series of accounts, that are included for your financial statement presentation, but excludable when invoicing the government, is critical in your system structure design. Not to mention that this will then also have visibility for any DCAA auditor to review the balances and trace the costs to that account and see that it is not included in the invoiced amount. Remember that the default set ups from QB or PT do not cover this! This additional leg work may be the difference in expanding your business with contracts other than the potential ‘Risky Business’ of Fixed Price!

    In closing, the reasonableness, allowable, non-allowable or allocable feature is not automatically created or built into any financial system! The costs can be tracked, but the real analysis comes from the cognizance and oversight of the management and those responsible for monitoring the expenses and costs that are incurred. The key here is to analyze the costs, determine what is allowable and what is not, then the challenge is to capture those costs by project, whether billable or non-billable, whether allowable or unallowable.

    Comment by Charlie Moschel — May 7, 2007 #

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