To assist with preparing for a Pre-Award Survey of Prospective Contractor Accounting System, in this series of articles we are reviewing the Evaluation Checklist criteria on the Standard Form 1408. The Standard Form 1408 serves as a guide for making sure you are prepared for the audit, and as such we will be reviewing each checklist criteria within the SF1408 to help assist in creating and maintaining an adequate accounting system. Our first article discussed proper segregation of direct and indirect costs. In this article, we will discuss the identification and accumulation of direct costs by contract.
As a reminder, these articles are meant to serve as a starting point, not a master guide. DCAA, or other parties performing the audit, will perform varying procedures to determine system adequacy. Achieving a DCAA approved accounting system is feasible for any organization, but may require changes to your policies and procedures and does require a comprehensive analysis of your overall accounting system, and that includes more than just the software itself. In this article, we are going to discuss the following checklist criteria:
2b. Identification and accumulation of direct costs by contract
FAR 31.202 defines a direct cost as “any cost that can be identified specifically with a particular final cost objective”. The most common example of this would be direct labor, direct travel, and direct materials. If you reference back to Part 1 of the series, there is detailed information about segregating direct costs from indirect costs, and what constitutes a direct cost. The checklist criteria 2b above deals with a step after we have identified a cost as a direct cost as opposed to an indirect cost.
Once we have identified a cost as a direct cost, we then must assign these costs to a contract to achieve the criteria above. Let us take direct labor as an example. If we have a Help Desk Technician that works on Contract A, we need to “identify” and “accumulate” that employee’s salary/pay by contract in the accounting system. We must first “identify” the cost by contract. To do so, we need the Help Desk Technician to specify on their timesheet that they worked on Contract A. Next, to “accumulate” the cost by contract, when we are recording direct labor for the Help Desk Technician in the accounting system, we need to tell the accounting system that they worked on Contract A based on their timesheet. If the Help Desk Technician in a different pay period splits their time between multiple contracts, we need to split their labor cost between the multiple contracts in order to accumulate the direct costs by contract. This would be done based on the hours worked on each contract specified by the employee on their timesheet.
Putting the criteria into practice
To illustrate how to satisfy the checklist criteria, we will use QuickBooks as an example, since it is one of the more widely used accounting systems by small businesses in the government contracting industry. The terminology and processes will vary depending on your accounting system, but the concepts remain be the same. In QuickBooks, you have “Customers” and “Jobs”. Each Job must be associated with a Customer. In most cases, the agency or prime contractor you are contracting with will be your Customer. You may have multiple Customers set up for an agency, for example if you are working with multiple contracting offices within one agency, but that setup is not important for this discussion.
Let’s assume we are awarded a contract with NOAA to provide IT Help Desk Support. We will first create a new Customer if NOAA is not already created in the system as a Customer. After the Customer is created, we will add a Job. Notice when you go to add the job in QuickBooks, there is a requirement for there to be a Customer associated with every Job. Once we enter our Job Name and any other relevant information about the Job, we can save our Job and now have our contract set up in the accounting system.
With our contract set up in the accounting system, we can begin to identify and accumulate direct costs by contract, in order to satisfy the criteria for our Pre-Award Survey. The next step in our process will be charging our direct costs to the appropriate contract when entering bills, journal entries, and other transactions into the accounting system. For example, the NOAA IT Help Desk contract may require the purchase of computer equipment specifically for that contract. When the computers are purchased, and the vendor sends a bill for the computers, that bill must be coded to the contract in to identify and accumulate direct costs by contract. In QuickBooks, when creating a Bill and entering the detail information, there will be a column labeled “Customer: Job”. If the Bill is for a direct cost, then it needs to have a Job specified. In this case, we would enter the IT Help Desk Support Job name into the Customer: Job column, which is telling the system that this expense is associated with that Job.
If creating a journal entry to record direct costs, the same concept applies. There will be a column in the journal entry screen also labeled “Customer: Job”, where you would specify the appropriate contract if you are recording direct costs. As part of a monthly review of your financial statements, you can run a Profit & Loss by Job report. When reviewing this report, you should ensure that all direct costs are in fact record to a specific Job. This will help ensure you are following the steps to meet Criteria 2b. If you are using a project-based accounting system such as Unanet or Deltek Costpoint, you can actually set up the system so that charging to a direct cost account requires a project input. Unfortunately that functionality does not exist within QuickBooks, but failure to charge direct costs to a project can easily be spotted with a proper review of your month-end accounting reports.
We will close with a couple additional points to consider. The first is that for direct costs to be properly charged to contracts, any other systems or source documents in use should be designed properly. For example, your timesheets and expense reports need to be designed so that employees can select which contract they are charging their time to or which contract a certain expense was related to, if a direct expense.
The final note is that if you are having difficulty charging expenses to certain contracts, you might need to circle back to Criteria 2a, which specifies that you need to properly segregate direct costs from indirect costs. Assume that your company operates in Maryland, but has two government contracts in Texas, and you want to have office space for the billable employees in Texas. You may have determined this to be a direct cost since the rent expense exists solely to support these two contracts. When you go to identify and accumulate this direct cost by contract, you may be having trouble determining how to record this cost to each of the contracts. The reason for the difficulty is that in almost all cases, this rent expense is going to be an indirect expense given the nature of the charge. Therefore, we have failed to properly segregate between direct and indirect costs and need to focus on properly implementing that first criteria. As we will discuss throughout this series, passing the pre-award survey is not about just about software and configuration. Policies, procedures, and training of personnel are just as critical components to maintaining an adequate accounting system.
LRZ Consulting is a full-service outsourced accounting and bookkeeping firm specializing in the government contracting industry. We provide support for QuickBooks, Deltek CostPoint, and Unanet Financials and assist with maintaining a DCAA approved accounting system. If you are looking for a free comprehensive analysis of your accounting system, please contact us here.