Page label: Government Contractors
Revision date: August 31, 2026
Author: Penny Marbel (JPI Worldwide)
A subcontractor supporting federal work must be able to show where costs came from, which contract received the charge, how indirect costs were allocated, and whether claimed costs are allowable under the contract.
This requirement applies even when accounting is managed by a small team. A basic commercial accounting platform may be useful, but software alone does not establish an adequate government-contracting accounting system.
1. What Does “DCAA-Compliant” Mean?
“DCAA-compliant” is an informal term. The Defense Contract Audit Agency does not approve or certify accounting software.
A more precise definition is:
A DCAA-compliant accounting system is a system of policies, procedures, controls, records, and software that provides reasonable assurance that costs are recorded accurately, allocated consistently, supported by documentation, and charged in accordance with applicable laws, regulations, and contract terms.
For covered Department of Defense contracts, DFARS 252.242-7006 describes an acceptable accounting system as one that provides reasonable assurance that:
- Applicable laws and regulations are followed.
- Accounting records and cost data are reliable.
- The risk of misallocation and mischarging is minimized.
- Contract charges are consistent with billing procedures.
The system may include multiple connected components, including the general ledger, job-cost ledger, labor distribution system, timekeeping platform, billing process, purchasing records, and document-retention controls.
The applicable requirements depend on the contract type, agency, clauses included in the prime contract and subcontract, and whether Cost Accounting Standards apply.
2. Which Rules Should a Subcontractor Review?
A subcontractor should begin with the actual subcontract and the clauses incorporated into it. The system should then be mapped against the applicable regulatory requirements.
The principal sources generally include:
- FAR Part 31, which addresses contract cost principles and procedures.
- FAR 52.216-7, Allowable Cost and Payment, where included or flowed down.
- DFARS 252.242-7006, where applicable to the contract.
- Cost Accounting Standards, where the contract is CAS-covered.
- The DCAA Pre-Award Accounting System Adequacy Checklist.
- DCAA Information for Contractors, DCAAM 7641.90.
A subcontractor should not assume that a commercial firm-fixed-price subcontract has the same accounting requirements as a cost-reimbursement subcontract. At the same time, a firm-fixed-price arrangement may still require cost information for pricing, change proposals, audits, or prime-contractor oversight.
3. How Should the Accounting System Be Designed?
The accounting system should be designed around final cost objectives. In most government contracts, the final cost objective is the contract, task order, delivery order, or another identifier required by the contract.
A practical design process includes the following steps.
Step 1: Create a contract and clause map
For each subcontract, record:
- Contract and task-order identifiers.
- Period of performance.
- Contract type.
- Funding or ceiling limitations.
- Billing frequency and format.
- Labor categories and approved rates.
- Required contract line-item detail.
- Advance-approval requirements.
- Audit, records-access, and flowdown provisions.
- Applicable indirect-rate requirements.
This contract brief should be available to accounting, contracts, program management, and employees who record time or expenses.
Step 2: Build a controlled chart of accounts
The chart of accounts should distinguish among:
- Direct labor.
- Direct materials.
- Direct travel.
- Other direct costs.
- Subcontract and vendor costs.
- Overhead pools.
- General and administrative expenses.
- Unallowable costs.
- Credits, rebates, and refunds.
The general ledger should control the job-cost ledger. Costs recorded in subsidiary systems should reconcile to the general ledger at defined intervals, normally at least monthly where applicable.
Step 3: Establish written cost classifications
A written policy should explain when a cost is direct and when it is indirect.
Under FAR 31.202, a cost identified specifically with a contract should generally be charged directly to that contract. Under FAR 31.203, indirect costs are allocated to intermediate or final cost objectives based on a logical relationship and the benefits received.
The same type of cost should not be treated as direct for one contract and indirect for another under similar circumstances. Limited exceptions may exist for minor costs when the treatment is consistently applied and produces substantially the same result.
4. What Timekeeping Controls Are Required?
Timekeeping is one of the most important controls for government contractors because labor charges may represent a significant portion of total contract cost.
Employees should record all hours worked daily, including time spent on:
- Each assigned contract or task order.
- Internal or indirect activities.
- Training.
- Leave and other compensated absences.
- Uncompensated overtime, where applicable.
Employees should certify their own time. Supervisors should review and approve timecards. A supervisor should not routinely complete an employee’s timecard.
Corrections should preserve the original entry, identify the revised entry, state the reason for the correction, and document employee concurrence where required by company procedure.
The labor distribution system should reconcile to payroll records and trace to the job-cost ledger and general ledger. The system should also support a floor check or employee interview by showing how recorded time corresponds to actual work activity.
A field deployment may create access limitations. If personnel cannot access the normal electronic timekeeping system, the subcontractor should establish a documented alternate process. The alternate process should preserve daily accuracy, employee certification, supervisory review, and later entry into the controlled system.
5. How Should Indirect Costs Be Allocated?
Indirect costs should be grouped into logical pools and allocated using an appropriate base.
Common pools may include:
- Fringe benefits.
- Engineering overhead.
- Site or project overhead.
- Material handling.
- General and administrative expenses.
Examples of allocation bases include direct labor dollars, direct labor hours, direct material dollars, or total cost input. The selected base should have a reasonable relationship to the costs in the pool.
For example, an engineering overhead pool may be allocated over engineering direct labor. A G&A pool may be allocated over an appropriate total-cost-input or value-added base, depending on the company’s operations and applicable requirements.
The number of pools should reflect the business. A small subcontractor may require only one overhead pool and one G&A pool. A more complex organization may require several pools for distinct functions or operating locations.
The method should be documented and applied consistently. A significant change in business volume, subcontracting, facilities, products, or operating structure may require the allocation methodology to be reassessed.
6. How Are Unallowable Costs Controlled?
A subcontractor must identify and exclude unallowable costs from applicable billings, claims, proposals, and indirect-rate calculations.
FAR 31.201-6 requires expressly unallowable and mutually agreed-upon unallowable costs to be identified and excluded. Directly associated costs may also require exclusion.
Examples of costs that may be unallowable under specific circumstances include:
- Entertainment.
- Certain advertising and promotional expenses.
- Bad debts.
- Interest and other financial costs.
- Fines and penalties.
- Contributions or donations.
- Certain legal and proceeding-related costs.
- Costs exceeding applicable contract or regulatory limitations.
A policy should define review responsibility, account coding, approval requirements, and corrective action. Unallowable costs should be separately identified in the books or through another readily reconcilable method.
7. How Should Billing and Monthly Close Be Controlled?
Billing should be based on recorded, allowable, allocable, and properly supported costs. The amount billed should not exceed contract ceilings, funding limitations, approved rates, or other contractual restrictions.
A monthly close process should include:
- Posting payroll and labor distribution.
- Reconciling timekeeping to payroll.
- Reconciling job costs to the general ledger.
- Reviewing direct and indirect classifications.
- Screening for unallowable costs.
- Calculating or updating indirect rates.
- Comparing cumulative costs with contract limitations.
- Reconciling booked costs to billed costs.
- Documenting adjusting entries.
- Retaining supporting records.
Where FAR 52.216-7 applies, final indirect cost rate proposals generally must be submitted within six months after the end of the contractor’s fiscal year unless an extension is granted in writing.
The clause also addresses completion vouchers and updates to billings after final rates are settled. A subcontractor should maintain records that allow the prime contractor to obtain accurate subcontract cost information and complete its own reporting obligations.
8. What Should a First-Time Subcontractor Test Before Award?
A first-time subcontractor should conduct a documented self-assessment before incurring significant contract costs.
The assessment should answer these questions:
- Can the system accumulate costs by contract, task order, and required line item?
- Can direct and indirect costs be separated?
- Are indirect pools and allocation bases documented?
- Are unallowable costs identified and excluded?
- Do employees complete and certify time daily?
- Do supervisors approve timecards?
- Can labor distribution reconcile to payroll and the general ledger?
- Are adjusting entries approved and supported?
- Can invoices be reconciled to current and cumulative cost records?
- Are records retained and retrievable?
- Can the company explain its system to a prime contractor, contracting officer, or auditor?
The objective is not to purchase a product labeled “DCAA-compliant.” The objective is to implement a controlled process that can be explained, operated, tested, and supported with records.
9. How JPI Worldwide Can Support Subcontractor Operations
A subcontractor’s accounting controls are part of broader operational readiness. Personnel, technology, logistics, field deployment, procurement, and contract administration must remain coordinated.
JPI Worldwide supports government agencies, prime contractors, and subcontractors with technical infrastructure and integrated capabilities, including communications, networking, cybersecurity, AI and systems integration, technical staffing, logistics, and field services. JPI also supports government and contractor teams in CONUS and OCONUS environments.
JPI’s role may include technical deployment, field support, systems integration, logistics coordination, or other defined subcontract requirements. These services can help reduce operational friction for primes that require a reliable partner able to support work from planning through deployment and sustainment.
To discuss how JPI Worldwide may help support your business, agency, or department, use the JPI contact page or email connect@jpiworldwide.com. Do not submit classified information, Controlled Unclassified Information, export-controlled technical data, passwords, credentials, or other sensitive material through the public contact form.
Sources and Administrative Notice
This article is provided for informational purposes. It is not legal, accounting, audit, or contract-specific advice. Requirements may vary by agency, contract type, subcontract terms, applicable clauses, and current regulatory guidance. Contractors should review the governing contract and obtain qualified professional advice where appropriate.