Government Contracts
Accounting for government contracts is one of the most specialized areas of business finance, requiring precise compliance, detailed cost tracking, and a comprehensive understanding of federal regulations. Unlike commercial accounting, government contracting involves stringent rules set by the Federal Acquisition Regulation (FAR) and oversight by agencies such as the Defense Contract Audit Agency (DCAA). As a professional accountant working with government contractors, I’ve seen how essential it is to establish proper accounting systems from the outset. Without them, businesses risk failed audits, contract disputes, and potential repayment of funds.
One of the most critical distinctions in government contract accounting is the need for segregated cost tracking. Direct and indirect costs must be identified and allocated accurately, unallowable costs must be excluded, and labor must be tracked carefully by project or contract. Unlike commercial bookkeeping, government contracts require detailed records for every expense, supported by documentation that can withstand rigorous audits. A robust system ensures that costs are allocable, reasonable, and allowable under FAR standards, which is essential to prevent audit findings.
Compliance with FAR regulations is foundational. FAR outlines cost principles, timekeeping rules, and reporting requirements that govern every aspect of government contracting. Costs must be reasonable, allocable, and properly documented, and unallowable costs such as entertainment, alcohol, fines, and certain lobbying activities cannot be billed to the government. Accountants play a central role in ensuring that all financial systems and reporting mechanisms align with these regulations, providing businesses with both guidance and audit-ready documentation.
The DCAA audit process has become increasingly rigorous in 2025. Audits can occur pre-award, post-award, or as incurred cost submissions. They examine accounting systems, labor distribution, indirect cost allocations, and compliance with FAR. Contractors with poor record-keeping or inconsistent internal controls are at high risk of audit failures. Preparing for these audits requires accountants to implement robust systems, maintain accurate records, and ensure all labor and expenses are fully supported.
Contract type also shapes accounting requirements. Fixed-price contracts require careful cost control to protect profit margins, while cost-reimbursable contracts demand meticulous documentation of all allowable expenses and accurate indirect rate calculations. Time-and-materials contracts necessitate precise labor tracking, and IDIQ or task-order contracts require each task to be accounted for separately. Selecting and implementing the correct accounting approach for each contract type is crucial to compliance and financial success.
Timekeeping compliance is among the most critical requirements for government contractors. Employees must record hours daily, differentiate between direct and indirect labor, and obtain supervisory approval. Retroactive adjustments are closely scrutinized, and incomplete or inaccurate time records are a common reason for audit failures. Modern digital timekeeping systems simplify this process, maintaining secure audit trails and ensuring accurate labor allocation across projects.
Indirect cost rates, including overhead, G&A, and fringe benefits, form the backbone of government billing. These rates must be calculated consistently, documented properly, and updated annually. Improper allocation can lead to overbilling, underbilling, or failed audits. Accountants ensure that these rates comply with FAR standards, support accurate billing, and align with incurred cost submissions.
Understanding allowable versus unallowable costs is equally important. Businesses must segregate expenses that the government will not reimburse, including personal expenditures, fines, lobbying, and certain advertising costs. Proper segregation of unallowable costs ensures accurate billing and reduces the risk of audit findings, which can be costly and time-consuming.
Job costing is essential for each contract, as it provides visibility into labor, materials, subcontractor expenses, travel, and allocated indirect costs. Accurate job costing enables contractors to monitor profitability, manage cash flow, and justify indirect rates to auditors. Without detailed job-cost tracking, businesses are vulnerable to financial losses and compliance issues.
Document retention and audit readiness are critical. Government contractors must maintain comprehensive records for years, including invoices, timesheets, payroll reports, contracts, and indirect cost calculations. If documentation cannot substantiate a claimed cost, it cannot be billed. A structured, organized record-keeping system is therefore a necessity, not an option.
Annual incurred cost submissions are required for many contractors. These submissions include detailed schedules of direct and indirect costs, reconciliations, and certifications. Preparing these reports accurately ensures compliance and demonstrates financial integrity. Professional accountants guide clients through this complex process, helping them avoid errors that could trigger penalties or repayments.
Accounting system reviews are another key requirement. Agencies evaluate a contractor’s ability to segregate costs, maintain timekeeping compliance, allocate indirect costs, and produce audit-ready reports. Businesses that prepare in advance with professional accounting support are far more likely to pass these reviews successfully.
Modern cloud-based accounting systems have transformed compliance and reporting. Integrated platforms provide automated labor distribution, real-time job costing, unallowable cost segregation, and audit-ready documentation. These tools simplify complex reporting requirements and allow accountants to focus on advisory support rather than manual data entry.
In conclusion, accounting for government contracts in 2025 is highly specialized and requires careful attention to detail, robust internal controls, and proactive compliance. Professional accountants provide essential guidance, ensuring accurate bookkeeping, proper cost allocation, and readiness for audits. With the right systems and expertise in place, contractors can manage risk, optimize performance, and confidently pursue government contracts, positioning themselves for long-term success in a regulated environment.
