DCAA defines adequate internal controls as your ability to ensure costs charged to government contracts are accurate, allocable, and allowable under FAR Part 31 cost principles. Your controller might have 20 years of public accounting experience, but if your system allows unallowable costs to flow into government contract cost pools, you fail the adequacy test.
The most expensive mistake I’ve seen contractors make involves timekeeping system integration. Companies invest in enterprise resource planning systems costing hundreds of thousands of dollars, then discover their timesheet data doesn’t properly interface with job costing modules. Employees record time against contracts, but the system lacks capability to track time to specific contract line items or distinguish between direct labor, fringe benefits, and overhead labor. When DCAA auditors examine your timekeeping systems, they’re not just checking whether employees submit timesheets—they’re verifying your system can prove that every dollar of labor charged to government contracts is properly supported, allocated, and segregated.
Labor distribution failures represent another systematic problem. Contractors frequently maintain timesheet systems showing employees worked on Contract A, but their accounting systems distribute costs using allocation percentages rather than actual time records. This violates the fundamental requirement that costs must be accumulated and allocated based on actual causal or beneficial relationships. The disconnect between timesheet data and cost accounting distributions creates presumptive noncompliance requiring contractors to prove cost allocations reflect actual work performed.
Indirect cost pool contamination destroys accounting system adequacy faster than any other violation. I’ve watched contractors lose millions because their systems allowed unallowable costs—executive compensation exceeding statutory limits, entertainment expenses, lobbying costs—to flow into overhead pools allocated to government contracts. Your system must have automated controls preventing unallowable costs from contaminating indirect rate calculations. Understanding DCAA compliance requirements means building systemic controls preventing compliance failures rather than detecting problems after they occur.
Five Critical Steps to Accounting System Adequacy
Step 1: Implement Real-Time Job Cost Accumulation Your accounting system must accumulate costs by contract, project, and cost objective in real-time as transactions occur. Waiting until month-end to distribute costs violates the fundamental requirement for accurate job costing. Deploy systems capturing direct labor, materials, subcontract costs, and other direct costs at the transaction level with immediate posting to appropriate contract cost objectives. This isn’t about monthly closing procedures—it’s about building transaction-level controls ensuring every cost hits the right contract bucket when it’s incurred.
Step 2: Create Automated Unallowable Cost Segregation Build chart of account structures with specific classifications for expressly unallowable costs under FAR 31.205 provisions. Configure your system to automatically flag transactions meeting unallowable cost criteria—entertainment expenses, lobbying costs, executive compensation exceeding limits, bad debts, interest expenses beyond allowable amounts. The key is prevention, not detection. Your system should prevent unallowable costs from flowing into indirect pools before costs get distributed to government contracts. Manual review after the fact is too late.
Step 3: Deploy Integrated Timekeeping and Job Costing Systems Eliminate any disconnect between how employees record time and how your accounting system distributes labor costs. Your timekeeping system must feed directly into job costing modules with zero manual intervention or allocation percentage application. If an employee records 8 hours on Contract A, your accounting system must charge exactly 8 hours of that employee’s labor rate to Contract A—no exceptions, no allocations, no statistical distributions.
Step 4: Establish Indirect Rate Calculation Controls Implement automated indirect rate calculations that update continuously as costs accumulate throughout accounting periods. Your system should calculate overhead rates, fringe benefit rates, and G&A rates based on current year-to-date actuals providing accurate billing rates for government contracts. Include systematic controls ensuring provisional billing rates don’t exceed government-approved ceilings and automated alerts when actual rates trend above provisional rates requiring immediate contracting officer notification.
Step 5: Create Comprehensive Audit Trail Capabilities Build transactional audit trails maintaining complete history of all accounting entries from source documents through financial statement presentation. DCAA auditors will trace individual costs from employee timesheets through payroll processing, overhead allocation, and final invoice billing. Your system must enable this traceability without requiring manual reconstruction or supplemental documentation development. The audit trail isn’t an afterthought—it’s a fundamental system requirement demonstrating accounting system adequacy.
Understanding the Federal Compliance Landscape
DCAA accounting system adequacy requirements apply uniformly across all Department of Defense contracts and extend to civilian agency contracts through FAR Part 31 cost principles. There’s no geographic variation—contractors in California face identical requirements as contractors in Virginia, Texas, or Massachusetts. The 18 system criteria under DFARS 252.242-7006 create national compliance standards eliminating contractor ability to leverage favorable local interpretations.
Multi-location contractors face particular scrutiny because accounting systems must maintain consistency across all facilities while properly segregating costs by location, contract, and organizational structure. Your Portland facility and your Arlington facility must use identical cost accounting methodologies with system-enforced consistency preventing local variations that violate CAS 401 consistency requirements.
Let Me Show You How to Fix This Before It Costs You
The accounting system adequacy landscape represents permanent intensification in DCAA enforcement methodology. The agency’s 2025 audit strategy explicitly prioritizes accounting system evaluations for all contractors with cost-reimbursable contracts or proposals requiring certified cost or pricing data. This isn’t a temporary compliance focus—it’s the new permanent standard.
Contractors maintaining proactive accounting system compliance demonstrate approval rates 89% higher than contractors attempting reactive system corrections after DCAA identifies deficiencies. The compliance investment generates immediate returns through sustained billing authority, competitive advantage in source selection, and eliminated risk of multi-million dollar billing restrictions.
Your accounting system isn’t just back-office infrastructure—it’s your contract performance engine enabling government billing authority and competitive positioning. Treat it like the mission-critical asset it is, or watch competitors with compliant systems capture market share while you explain billing restrictions to your bank.
For contractors ready to implement compliant timekeeping and cost accounting systems, Hour Timesheet provides DCAA-compliant solutions designed specifically for government contractor requirements. Our platform delivers the integrated timekeeping and job costing capabilities DCAA demands with automated controls preventing the compliance failures that cost contractors millions.
Additional Resources
Related Hour Timesheet Articles:
- DCAA Compliance Requirements for Contractors
- DCAA Compliance Explained
- DCAA Timekeeping Requirements
Official Regulatory References:
