Government Contractor Accounting Practices

So you have decided to get federal government work.  You may even have a contract already and are doing business.  You are a small business.  You are flying under the radar of the Defense Contract Audit Agency (DCAA).  But are you ready for an audit?  How do you set up your accounting system properly in preparation?  

DCAA is the big brother of government contracting, and they will eventually be in your business just like the Internal Revenue Service (IRS).

DCAA does not recommend any accounting software so you must separate your chart of accounts into three areas:  Direct Costs, Indirect Costs, and Unallowable Costs.  The complete explanation is located in the Far Cost Principles Guide on the DCAA website. 

The decision of whether a cost is direct or indirect is based on the ability to identify the cost associated with the contract, rather than nature of the goods and services specifically.  Indirect costs that cannot be directly tied to the project or ongoing operational expenses are not allowed.  

Expenditures for which it is often impractical to calculate dollar amounts and itemize as direct expenses, because while these expenses are necessary to support a contract, they are also shared across the organization and are therefore not easily identified with a specific contract.

Direct Costs

• Specifically identifiable to contract
• Directly related to performance of contract
• Identified in proposal as direct costs
• Billable to contract and customer
• Labor, Subcontractors, Equipment Cost, Materials
• Travel (Lodging, Mileage, Per Diem, Meals, Rental Car, and Parking)
• Other Direct Costs

Indirect Costs

•  Shared costs that apply to multiple contracts or activities
•  Cannot be identified to specific contract
•  Fringe, Payroll Taxes, Leave, Benefits
•  Facility Costs (Internet, Rent, Office Supplies, Postage, Telephone)
•  Overhead Costs (Labor, Bonuses, Travel, Consultants)
•  General & Administrative (G&A)
• Proposal Costs
• Legal Costs accrued for legal advice on proposals
• Executive Labor and Bonuses
• Bank Service Charge
• Accounting

Unallowable

• Payroll Expenses, Charitable Contributions, Advertising
• Interest Expense, Fines, and Penalties
• Legal Fees, Alcohol, Entertainment, Officer and Owner Insurance
• Federal Corporate Taxes

The following table is a quick lookup.  Remember I am not an accountant and your best resource is a DCAA familiar accountant.

Cost	Description	Type
Advertising	Advertising, brochures, and displays.	Unallowable
Alcoholic Beverages	Alcoholic beverages are unallowable as a direct or indirect cost.	Unallowable
Bad Debts	Losses from uncollectible accounts, collection costs and related legal costs.	Unallowable
Books, Journals, and Subscriptions	Books, journals and subscriptions to professional and technical> publications.	Direct – books, journals, and subscriptions specifically related to a contract.  Indirect – books, journals, and subscriptions that benefit research in general or the researcher in general.
Charitable Expenses	Charitable Expenses	Unallowable
Consultant	An individual hired to perform professional, short- term services.	Direct – if specifically related to a contract Otherwise, indirect.
Delivery	Service Overnight delivery service or special shipping services, other than routine postage costs.	Direct – shipping of samples, receiving goods for contract use or other delivery of items directly related to the contract work. Indirect – submitting proposals or other administrative purposes.
Depreciation	The cost of an asset (building or equipment) spread over the asset’s useful life.	Indirect
Donations and Contributions	Includes gifts, memorials and purchase of tables.	Unallowable
Entertainment	Amusement, social activities, and related costs (tickets, meals, lodging, and gratuities).	Unallowable
Equipment	Tangible personal property with a useful life of more than two years and a unit cost greater than or equal to $5,000.	Direct – if specifically related to a contract. Otherwise, indirect.
Federal Corporate Tax	Federal Income Tax	Unallowable
Fines and Penalties	Costs resulting from violations of laws and regulations.	Unallowable unless directly related to compliance with specific provisions of the contract.
Fringe Benefits	Medical Insurance, Dental Insurance, Workers' Compensation, FUTA, SUI/DI ER Expense, SS Tax ER Portion, Med Tax ER Portion, PTO, Holiday Pay	Indirect
Goods or Services for Personal Use by Employees	Items or services are providing direct personal benefit to employees.	Unallowable
Insurance	Insurance coverage for normal business purposes, whether provided by an external company or through a self-insurance program.	Direct – if specifically related to the contract. Otherwise, indirect.
Interest	Interest payments on business loans, credit card balances, or other business debt.	Unallowable
Investment Management	Costs of investment counsel.	Unallowable
Legal Costs of Defense, Prosecution, Claims and Appeals	Generally unallowable. Depends on whether the claim is civil, criminal, involves contracts or is against the Federal government.	Unallowable
Lobbying	Attempts to influence outcomes of elections or other political actions.	Unallowable
Losses on Contract Agreements	Costs in excess of available funding are unallowable as a direct cost on another contract.	Unallowable
Maintenance and Repair Costs	Maintenance and Repair Costs to keep the property in efficient operating condition. Not including costs that increase property value.	Direct – if specifically related to the contract. Otherwise, indirect.
Meals	Meals are allowable if associated with a staff travel, conference or symposium where technical information is presented.	Direct – meals directly related to contract performance in the case that per diem rates are not utilized. Otherwise, indirect.
Meeting Refreshments	Meeting refreshments, site visit meals and guest meals.	Unallowable
Memberships	Memberships and dues to belong to a professional or technical> organization.	Direct – memberships and dues required exclusively for a particular contract. Indirect – memberships and dues that benefit the employee, in general, are a professional development cost.
Office Supplies	Office supplies are those items usually maintained in a departmental stock for general use by all staff. Such items would include pens, pencils, writing a paper, file folders, departmental letterhead, envelopes, staples, staplers, and rulers. Office supplies generally support multiple activities of contract> personnel.	Direct – lab-related office supplies or office supplies purchased for specific contract use. Otherwise, indirect.
Officer and Owner Insurance	Insurance expense for officers and owners that exceed a general insurance benefit for rank and file employees.	Unallowable
Payroll Expenses	The cost of payroll services.	Unallowable
Photocopy	Photocopying of documents.	Direct – photocopying of technical material related to a particular contract.  Indirect – routine photocopying of a general business nature (employee timesheets, professional materials, proposals).
Postage	Routine postage costs.	Direct – postage costs for large mailings or surveys related to the contract. Indirect – routine postage costs, including general agency correspondence and mailing of proposals.
Pre-award Costs	Costs incurred prior to the effective date of the contract.	Unallowable
Professional	Services Professional contractual services, consulting and external legal counsel. Retainers require evidence of service.	Direct – if specifically related to the contract. Otherwise, indirect.
Proposal Costs	Proposal preparation, including typing, copying and mailing costs, for new and renewal applications.	Indirect
Public Relations and Marketing	Public relations, marketing, and related advertising cost intended to promote the organization or improve community relations.	Unallowable
Recruiting	Recruiting costs to select a new employee.	Indirect.
Rent	The cost to lease building space or equipment.	Direct – Building rent is a direct cost to the extent if related to contract Equipment – in proportion to use on the contract. Indirect – administrative equipment rental (fax, copier) are normally indirect costs.
Salaries and Fringe Benefits- Administrative and Clerical Personnel	Departmental administration, including professional and clerical staff, and central administration staff are serving the entire organization.	Direct – administrative and clerical cost incurred for a technical purpose or related to the contract.  Indirect – routine, the base level of administrative support provided to all organizational activities.
Salaries and Fringe Benefits- Technical and Programmatic Personnel	Personnel performing services related to a contract.	Direct – work performed must specifically relate to the contract. The direct cost charge must be based on the percentage of effort devoted bythe employee.
Specialized Service Facilities or Service Center	Operating units that use specialized equipment or technical expertise to provide goods or services for a fee.	Direct – appropriate billing rates and charging practices must be followed.
Supplies and Materials – Technical	Purchased materials and supplies consumed in the performance of the contract. The cost to the contract should be net of credits, discounts, and rebates. Freight costs are part of supply and material costs.	Direct – All Cost should be accounted for against a particular contract.
Telephone and Facsimile	Equipment and service cost for telephone and fax service.	Direct – Long distance telephone, if the charge can be specifically identified with a contract. Indirect – Local telephone and fax service.
Termination Costs	Additional costs incurred due to early termination of a contract.	Direct
Transportation	Freight, express delivery and other transportation related to goods purchased.	Direct – if associated with a contract. Otherwise, indirect.
Travel	Transportation, lodging, subsistence and related costs for official business, in accordance with organizational policy.	Direct – travel expenses directly related to contract performance. Otherwise, indirect.
Tuition	The cost of classes at an educational institution for employees.	Indirect

Choosing a Business Bank Account

So you have incorporated, and that is a significant step in the right direction.  All is well in the world, but now you need a place to do financial transactions.  Part of registering your business to do work for the federal government involves having a bank account to transfer money back and forth.  Choosing a business bank account is harder than choosing a personal bank account because of all the options.

The choice of business bank accounts boils down to whether you are going to carry a large balance and how many transactions you have each month.  That will determine your monthly fees. 

To establish a bank account you need the following:

• Articles of Incorporation for Corporation or LLC
• If a Sole Proprietor or Partnership you will need one of the following:
• Fictitious Name Certificate or Statement
• Certificate of Assumed Name
• Business License
• Registration of Trade Name
• Employer Identification Number (EIN)

You have choices between banks.  You can choose a big nationwide Bank, a community bank, a credit union or an internet bank.  I wanted a nationwide bank because of my business with the federal government.  Currently, I have contracts in several states, and I needed the ability to have a bank that was not local.  To compare all options, including local credit unions, NerdWallet provides an extremely handy tool called “Compare Business Checking Accounts.”  I provided my experience in the table below of three nationwide banks.

Bank	Monthly Fee	Minimum Opening Deposit	No Charge Transactions and Deposits	Interest Bearing	Online and Mobile Access
Wells Fargo (Simple Business Checking)	$10	$50	Includes 50 transactions and $3,000 in cash deposited monthly	No	The have both.  However, their online system is not as friendly as other banks.  It is somewhat difficult to use. They have online statements and access to check images.
Chase (Total Business Checking)	$10 when you are enrolled in Paperless Statements (or $12 for paper statements); waived when you maintain a $1,500 minimum daily balance	$25	Includes 200 transactions per month without a fee and $7,500 in cash deposits each month without a fee	No	Chase has the best online banking and mobile access system.  If this is important to you, then choose them.
Bank of America	No monthly fee first two months, then $17/month	$100	500 transactions per month at no cost. Additionally you can deposit up to $25,000 cash to the account without a fee.	No	I have not used their online or mobile access, but they do provide it.

If you know me, Linda Rawson, I am commonly called she-geek.  So the relatively small difference in cost made me want the high-quality online banking.  We use Quickbooks Online, and it synchronizes with Chase.  Don't make the decision for a business bank account quickly but analyze your true needs as a business owner.

Choosing a Corporate Structure (One size does not fit all)

DISCLAIMER:  I, Linda Rawson, am not an attorney or accountant.  I am merely giving you my opinion and lessons learned from my experiences.

 

Okay.  Pay attention to that disclaimer as I will be referencing it again.  The proper way to choose a corporate structure is to consult an expert such as an attorney or accountant.

One of the first and most important choices when starting a business is the selection of the type of legal entity your company will be.  This decision will affect how much you pay in taxes, how much paperwork you will need to do, determine personal liability and impact the ability to raise money through the sale of equity.

I reviewed C Corporation, S Corporation and Limited Liability Company (LLC) when I started my business. 

C Corporation and S Corporations require a corporate return, corporate minutes and give you the option to establish shares to sell for equity.  It sounded like a lot of high-cost record keeping work that I wanted to avoid.  Nobody likes to do paperwork. 

When I started, it was just me.  I didn’t imagine I would be anything else other than a consultant.  I thought I would be claiming all my income on my individual tax return Schedule C.   I wanted simpler taxes, so I incorporated as an LLC without consulting an attorney or accountant.  The State of Utah makes it so easy to incorporate.  It even generates the articles of incorporation for you.  Why would I want to do all that extra bookkeeping?

Then the next thing is filing with the IRS.  Here is where I made a critical error that almost prevented me from obtaining my 8(a) status when I first applied.  They classified me with my Employment Identification Number (EIN) as a Single-Member LLC.  Single-Member LLC was great until the SBA said an LLC is defined as one or more people and we cannot approve your application unless you get this changed.  I had ten days, I added my daughter as the other member, expedited the articles of incorporation, and our 100 percent Woman-Owned Small Business (WOSB) expanded to two people.  That was in 2009 when our 8(a) application was approved by the SBA.

Later, after participating in the Mentor-Protégé Program, we used a lawyer to convert DynaGrace Enterprises to an S Corporation to have the option to sell shares if we needed to raise capital.  Payment for government work can be delayed up to 90 days and as a company you have to carry that money and wait for the government to catch up.  You will get paid, but it may take some time. 

The main advantage to switching to an S Corporation was to minimize Social Security and Medicare taxes for myself and to limit my personal liability.  The profit and losses are still passed to me utilizing a K-1 form and reported on my individual return.   I didn’t choose to experience the double taxation that is the downside of the C Corporation.

When I started my business, Sole Proprietorship wasn’t talked about much but it is my understanding if you own 100 percent of your business this may be the option for you.  Again please consult an attorney or accountant to figure out the best choice.  

Remember in business, as in life, one size does not fit all.  

It can be expensive to convert to a different corporate structure later, but it is not a critical mistake, and change can mean growth but know the facts and make the best decision at the time.

Why start a government contracting business?

I have owned DynaGrace Enterprises, a Woman-owned Small Business (WOSB) and 8(a) firm for almost a decade.  So why did I start a government contracting business?  The answer is quite simple.  I was younger and dumber and wanted to see if I could.  I did not know what I should have known when I started.  Maybe this article can give you some insight and help you determine if it was the good idea you thought it was. 

There are several types of government contractors, and the one I am most familiar with provides services to the federal government.  The manufacturing part and being able to offer a product to the government might be better for you, but I am not as familiar with that type.

Federal government contracting can be a way to start a small business.  The market is worth over $100 billion in sales to small businesses each year.  Providing services or products to the government is quite different than selling to the commercial sector.

Government contracts can guarantee ongoing revenue to your business. A stable cash flow enables a business to develop marketing budgets, hire staff and grow their business intelligently. Reoccurring monthly business generated from government contracts can also hedge against months that are slow. In fact, many contracts have 3-5 continuous year contract terms.  Keep in mind though it can take 30 to 90 days to get paid.  But once the payments start you are usually fine.

The procurement process for a government contract is extensive.  You can speed up this process by marketing to government customers that have a budget.  That can be like finding a needle in the haystack.  The government goes through cycles for services.  Sometimes they ramp up contractors and some years they ramp up on civilian employees. 

You should be prepared for long hours when responding to solicitations.  The last couple I have lost to very low bidders.  I am not sure how they expect to give any benefits to their employees, but the government will get what they bid for, hence the term, “low bidder”.  It is like buying the cheapest vehicle and realizing the plastic cracks in the sun after a month of owning it.  I refuse to win a bid on the backs of my employees so the contract goes to a company that will.

The good part is I have some fantastic employees, and I have met some wonderful business people who are involved in government contracting.  I started out as a civilian employee way back when and then worked for about four contractors before starting my own small contracting business.  Having a small budget or lack of budget is a huge problem.  The government employees in charge of budgets are usually friendly and appreciate the services we have to offer. 

I would never even have thought about having my own business, and this opportunity has given me the experience and the pleasure of being an entrepreneur.  It is an excellent way to get started and the SBA offers some training but expect to learn a lot on your own and with the help of mentors.

Transparency on the Internet

Is there such a thing in the current realm of the internet? Can you truly remain stealthy in your personal life when everything is posted on Facebook, LinkedIn, Twitter or other social networking sites? I choose to embrace the fact that I am transparent on the internet and methodically post things about myself to ensure my image. I am currently in the process of human branding myself to embark on a new business adventure. The only way to truly do that is to write about what you know and be who you are. The old cliché "I've Gotta Be Me" is one of my favorite sayings.

Society gravitates toward genuine people because of the increasing gift of detecting who a person is by the integrity of their actions and words. Craig NewMark, founder of craigslist.org, says “'Trust is the new black.' I totally agree with this statement and I think being trustworthy is trendy and cool.

I am trustworthy. I keep my word. I let people know about me through my social networking sites. I find having trustworthy behavior in business creates long term relationships. If I share a little too much then so be it. People know who I am.