1. How to Make Your QuickBooks System
DCAA Compliant
So, you won a government contract! Congratulations! However, you may find
yourself wondering what comes next? After winning the contract, it is highly likely
that a torrent of thoughts will flood your mind. Hopefully, while preparing your
proposal, you did some pre-planning so you could act quickly upon hearing the
government agency’s decision. Perhaps you arranged project teams, put together
lists of possible subcontractors, or even prepared bids for materials necessary for
the contract. However, there are several concerns that warrant careful attention,
particularly related to the internal controls of your business. Considering that
Defense Contract Audit Agency (DCAA) compliance is critical, it is worthwhile to
take a moment and examine this in detail.
A primary concern of a new
government contractor is, “will
my current accounting system
be adequate?” If you pose this
question to software vendors
who sell packaged accounting
systems that claim to be all
inclusive, odds are that you
will hear that your system is
broken, unusable, or not allowed under the rules of DCAA. The truth is – most of
the time, these claims are simply not true.
If you are a small to mid-size business, you don’t have to spend thousands of
dollars implementing a new accounting system to be DCAA compliant. Most of
the time, you can configure your existing system. If you are using QuickBooks,
which is one of the most common accounting systems, there are predefined steps
that will allow you to maintain your current system and records. The truth is,

2. compliance has more to do with the way you configure a system than with the
system itself.
Let’s take a look at some of the basic government requirements so you can
understand more about accounting systems and DCAA compliance:
Who is the DCAA?
When you work for the federal government, you are subject to the overview of the
DCAA. This agency’s job is to evaluate contractors’ financial policies, procedures,
and internal controls. Ultimately, they are responsible for performing audits that
can identify opportunities for contractors to minimize, eliminate, or avoid costs.
Contract Types
The extent of the DCAA’s involvement is determined by the type of contract that
will be awarded. The three types of contract are Fixed Price, Cost Reimbursable,
and Time and Materials. The basic characteristics of the contracts are as follows:
 Fixed Price: As the name suggests, these contracts provide a fixed price that
will be paid to the contractor regardless of the costs associated with the
completion of the project. In very specific, appropriate cases, this price may
be adjusted, but in general, what you see is what you get.
 Cost Reimbursable: In cost reimbursable contracts, the government agency
will provide for the payment of allowable costs, up to a prescribed amount
specified in the initial contract. An initial estimate is provided to the
government so that they can obligate and appropriate quantity of funds.
 Time and Materials: Time and materials contracts provide for the payment
of direct labor paid at specified rates and materials paid at cost. These
contracts will always include a ceiling price for expenditures.
Direct Versus Indirect Costs
A significant portion of accounting for government contracts is the classification of
costs, commercial and government, as either direct or indirect. In addition, all costs
need to be assigned to a “final cost objective.” Generally, a final cost objective is a
contract. Accordingly, costs of a contract are comprised of direct costs and the
contract’s allocable share of indirect costs. Costs that are identified specifically

3. with a contract are direct costs of the contract and need to be charged directly to
the contract. Contractors need to spend some time and effort identifying exactly
which costs are direct, because what remains is, by default, indirect.
Certain costs are unallowable and must be separated in an accounting system.
These costs include such things as alcohol, entertainment, interest expense, bad
debts, advertising, lobbying costs, patent expenses, and more. Obviously, it is
important to check to see if any of your costs fall under this category.
Consistency
The government has no desire to pay for other commercial contract costs in
addition to their own costs. To that end, no final cost objective can have a direct
cost allocated to it if other costs were incurred for the same purpose in like
circumstances. No direct costs can be included in any indirect cost pool or be
allocated to that or any other final cost objective. For example, if a commercial
contract has overrun costs, they cannot be charged to the indirect pool because the
government would then pay for a portion of what should have been a direct cost of
the commercial contract.
You may not have two sets of books and/or accounting practices for your
government business and your commercial business. If you have a government
contract, then your entire system across your company must use the same
processes. If, for instance, you have a single government contract then your entire
business must use an approved timekeeping system that every employee uses
consistently, even if the majority of employees do not work on the contract. This
regulation is in place because every business has overhead expenses, and because
the government will pick up its share of the overhead, the entire organization must
be compliant.
Indirect Rates
Indirect costs must be classified and grouped together into indirect cost pools:
either an overhead cost pool or the general and administrative (G&A) cost pool.
The pools are then allocated to final cost objectives using an indirect cost
allocation base that best links the cost pool to the cost objectives.

4. To allocate means to distribute overhead pool costs to contracts. In order to
distribute indirect costs, the contractor must select an allocation base. There must
be a relationship between the selected allocation base and the pool of costs to be
allocated to contracts. For example, an engineering overhead pool would logically
be allocated over total engineering direct labor dollars or engineering direct labor
hours.
Accounting Systems Requirements
Now that you know some of the criteria and terminology for government
contracting accountability, let’s take a look at how to configure your existing
QuickBooks accounting system for compliance. Numerous other companies have
used QuickBooks to pass DCAA audits and continue to use it even as they have
grown.
Project Accounting
You must set up your system for Project Accounting, which QuickBooks provides
for. All final cost objectives, or contracts, must be tracked on a per-project basis.
Any direct cost transactions will require entering a general ledger account
(separating direct costs from indirect) plus a customer job. QuickBooks will be
able to track customer jobs, tasks, sub-tasks, etc. to whatever level is necessary.
Chart of Accounts
You will need to revamp your Chart of Accounts. There will be two major expense
components: Direct and Indirect. Direct Costs are generally further broken down
for Direct Labor, Direct Subcontracts, Direct Travel, Direct Materials, and Other
Direct Costs. Indirect Costs are broken into logical categories that will support
your indirect rate calculations. It is imperative that you have a separate series of
accounts for all Unallowable Costs. Each type of unallowable cost should have its
own general ledger account.
The indirect cost accounts must then be broken into pools, such as Fringe Benefit
Pool, Overhead Pool, and G&A Pool. Under each pool, there are separate accounts
that further logically group expenses into categories like Facility Costs, Equipment
Costs, etc. Within each of those categories, specific accounts should be set up for
things like Rent, Utilities, Property Taxes, etc.

5. Timekeeping and Labor Distribution
Here is where specific DCAA approval is extremely important. While the DCAA
doesn’t require any particular software, it does have certain criteria that a
timekeeping system must meet in order to be DCAA compliant. Because
QuickBooks doesn’t offer a built-in, compliant time-tracking system, it is
necessary to use an external system that integrates well with QuickBooks and has
all controls required for DCAA approval.
Following are the requirements for a DCAA-compliant timekeeping system. Keep
in mind, the employee must input his or her own time. Managers cannot fill out or
change an employee timesheet. Employees must:
 Record time on a daily basis
 Provide, in writing, an explanation for any change to a prior day’s time
records and approve those changes
 Enter the correct distribution of time by project numbers, contract number or
name, or other identifiers for a particular assignment. To ensure accuracy, a
listing of project numbers and their descriptions should be made in writing
to the employee
 Record all hours worked, paid or unpaid
 Sign the timecard at the end of each work period and have the supervisor
approve the time.
It is important, particularly when evaluating third-party timekeeping solutions, to
make sure that all of these systems are in place, and preferably automated. Usually
it is best to give the vendor a call and have them talk you through each of these
steps personally. The best vendors will be happy to give you a live demo and
answer any questions you may have.
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