Some of the work agencies award in the fourth quarter is cost-reimbursement or otherwise flexibly priced. For a small firm considering its first contract of this kind, one requirement can be decisive: the government must be satisfied that the contractor’s accounting system is adequate for determining the costs applicable to the contract. A pre-award review of the system often uses Standard Form 1408, a checklist of questions every prospective cost-type contractor should be able to answer well before the solicitation arrives.
Why the government cares
Under a cost-reimbursement contract, the government pays allowable costs as they are incurred, plus any fee. That only works if the contractor’s books can show which costs belong to which contract, which costs are direct and which are indirect, and which are unallowable under the cost principles. The FAR generally permits a cost-reimbursement contract only when the contractor’s accounting system is adequate for determining costs applicable to the contract. A contracting officer may ask an auditor to review a prospective contractor’s system before award, and the SF 1408 lays out the main criteria.
The questions in plain terms
The form’s criteria ask, in general terms, whether the accounting system provides for:
- Proper segregation of direct costs from indirect costs
- Identification and accumulation of direct costs by contract
- A logical and consistent method for allocating indirect costs to contracts
- Accumulation of costs under general ledger control
- A timekeeping system that identifies employees’ labor by intermediate or final cost objectives
- A labor distribution system that charges direct and indirect labor to the appropriate cost objectives
- Interim determination of costs charged to a contract, at least monthly, through routine posting of the books
- Exclusion of costs that are unallowable under the cost principles or the contract terms
- Identification of costs by contract line item and by units, if the contract requires it
- Segregation of preproduction costs from production costs, where relevant
Reviewers also consider whether the system can produce the billings and reports the contract will require, such as cost information to support invoices and data for the eventual incurred cost submission.
Common gaps in small firms
Firms that have done only fixed-price or commercial work often have bookkeeping that serves taxes and financial statements well but does not track costs by contract or segregate unallowable costs. Timekeeping may record hours for payroll but not by project, or may not capture all hours worked, including uncompensated overtime and indirect time. Indirect cost pools may exist only informally. None of this is unusual, and all of it can be fixed, but it takes time to fix properly.
Getting ready
- Set up a chart of accounts that separates direct, indirect and unallowable costs.
- Define your indirect cost pools and allocation bases in writing, and apply them consistently.
- Use timekeeping that records all hours daily by project and charge code, with employee and supervisor approval.
- Close the books monthly and be able to show costs by contract.
- Write short policies describing how your system works, since reviewers look at documentation as well as transactions.
Many small contractors use accounting software configured for government contracting and work with an accountant experienced in this area. Mid-year is a good time to assess your system, well before an opportunity depends on it. The FAR’s rules on contract types and cost principles are at acquisition.gov, and for advice specific to your firm, talk to a qualified accountant.