Before You Start

This guide assumes strong knowledge of job costing and accrual accounting. It targets accountants, controllers, and business owners in or entering the government contracting space.

Overview

75 min
Setup Time
Expert
Difficulty
Ongoing
Compliance

What You’ll Learn

  • How to structure your Chart of Accounts for DCAA compliance
  • Understanding and tracking allowable vs. unallowable costs
  • Implementing compliant timekeeping and labor distribution
  • Preparing for DCAA audits and incurred cost submissions
  • Leveraging accounting software for government contract requirements

1. Understanding DCAA Requirements

The Defense Contract Audit Agency (DCAA) mandates specific accounting practices for government contractors, primarily driven by Federal Acquisition Regulations (FAR).

Key Regulatory Frameworks

  • FAR Part 31: Contract Cost Principles and Procedures
  • Cost Accounting Standards (CAS): For larger contracts
  • DFARS: Defense Federal Acquisition Regulation Supplement

Core DCAA Accounting Principles

  • Segregation of Direct & Indirect Costs
  • Consistent Application of Accounting Principles
  • Adequate Documentation and Audit Trails
  • Timely and Accurate Financial Reporting

2. Chart of Accounts Structure

Your Chart of Accounts (COA) is the foundation for a DCAA-compliant accounting system. It must clearly separate direct, indirect, and unallowable costs.

Setting Up Cost Pools

Properly categorizing costs into pools for direct and indirect rates is crucial.

Essential Indirect Cost Pools:
  • Fringe Benefits Pool (e.g., payroll taxes, health insurance)
  • Overhead Pool (e.g., indirect labor, rent, utilities)
  • General & Administrative (G&A) Pool (e.g., executive salaries, marketing)
Other Important Accounts:
  • Unallowable Costs (e.g., lobbying, certain entertainment)
  • Progress Billings/Advance Payments (Contract Asset/Liability)
  • Retainage (Accounts Receivable or Payable)

3. Allowable vs. Unallowable Costs

A critical DCAA requirement is the proper segregation and accounting for allowable and unallowable costs as defined by FAR Part 31.

Expert Tip: Establish a separate expense account in your Chart of Accounts specifically for “Unallowable Costs.” This makes it easier to track and exclude them from billings, proposals, and incurred cost submissions.

Here is a sample accounting entry demonstrating the tracking of an unallowable cost.

{
  "transaction_id": "EXP-2025-001",
  "date": "2025-09-15",
  "account_debit": "Unallowable Costs (Expense)",
  "account_credit": "Cash / Accounts Payable",
  "amount": 250.75,
  "description": "Client entertainment dinner (unallowable)",
  "far_reference": "FAR 31.205-14"
}

4. Timekeeping & Labor Distribution

DCAA requires a robust and verifiable timekeeping system to ensure accurate allocation of labor costs to direct contracts and indirect pools.

  1. 1

    Segregated Time Entry

    Employees must clearly differentiate between direct labor (project-specific) and indirect labor (overhead, G&A).

  2. 2

    Daily Time Recording

    All hours worked must be recorded daily, reflecting actual work performed.

  3. 3

    Supervisor Approval

    Timecards must be reviewed and approved by a supervisor who has direct knowledge of the work performed, ideally before payroll processing.

  4. 4

    Audit Trail & Controls

    Maintain a complete audit trail of timecard entries, changes, and approvals. Implement strong internal controls to prevent fraud.

Common Error: Inconsistent Application

Applying different accounting methods for similar transactions or contracts can lead to DCAA findings. Consistency in cost allocation, timekeeping, and policy application is paramount.

5. Preparing for DCAA Audits

Regular preparation is key to a successful DCAA audit. A proactive approach minimizes risks and ensures compliance.

Audit Readiness Checklist

  • Review and update all internal control documentation
  • Reconcile all balance sheet accounts monthly
  • Ensure all costs are properly documented with supporting evidence
  • Regularly run trial balances and financial statements
  • Conduct internal reviews of incurred cost submissions
  • Provide ongoing training for staff on DCAA compliance requirements

Need Help?

Expert DCAA Consulting

Navigating DCAA compliance can be complex and challenging. Our experts provide tailored guidance to ensure your accounting system meets all government contracting requirements.

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