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Developing a Chart of Accounts for Federal Contracting Compliance: Requirements and Recommendations

Navigating the complex landscape of federal contracting and cost accounting requires an understanding of the Federal Acquisition Regulation (FAR) and Generally Accepted Accounting Principles (GAAP). This article explores essential aspects of cost management, emphasizing the distinction between direct and indirect costs, and addressing the treatment of unallowable costs to align with both GAAP and FAR standards.

GAAP and FAR Compliance in Federal Contracting

Under FAR, it is essential that accounting systems conform to GAAP, thereby ensuring financial statements accurately reflect assets, liabilities, owners’ equity, revenues, and expenses. Assets are recognized as probable future economic benefits arising from past transactions and liabilities are future sacrifices of economic benefits due to current obligations. Owners’ equity represents the residual interest in assets after deducting liabilities.

Revenue accounts for inflows or enhancements of assets derived from operational activities, while expenses represent outflows or usage of assets. The FAR mandates the categorization of costs as either direct or indirect. Direct costs are specifically associated with “a final cost objective”, in other words a project or contract, whereas indirect costs pertain to activities supporting multiple cost objectives or the overall operation of the business.

Structuring Indirect Costs According to FAR

The FAR also mandates that indirect costs be grouped logically to facilitate their equitable distribution based on the benefits rendered to various cost objectives. Logical cost groupings allow for indirect rates to be calculated and for indirect costs to be allocated to projects. These groupings include overhead, general and administrative (G&A) expenses, fringe benefits, and facilities costs. Notably, each cost category plays a specific role in the accounting system:


Costs that benefit multiple projects but cannot be directly assigned to any specific project

General & Administrative (G&A)

Expenses essential for the overall operation of the business that cannot be directly linked to any specific project

Fringe Benefits

Additional compensation provided to, or for the benefit of employees


Costs related to office space not located at a customer’s site

Bid and Proposal (B&P)

Costs incurred in preparing bids and proposals for government or non-government contracts

Internal Research & Development (IR&D)

Costs associated with projects not under contract related to basic research, applied research, development, and system and other concept formulation studies

A minority of government contractors (approximately 25%) separately track Material Handling and/or Subcontract Administration costs:

Material Handling

Costs associated with purchasing, receiving, and storage of materials.

Subcontract Administration

Costs associated with the management and administration of subcontracts.

Best Practices for Designing a DCAA-Compliant Chart of Accounts

For a DCAA-compliant accounting system, while no specific coding is required by GAAP or FAR, structuring a chart of accounts efficiently is critical. It is advisable to use numerical codes such as ‘1’ for assets, ‘2’ for liabilities, up to ‘9’ for G&A costs, and letters like ‘M’ for material handling and ‘P’ for B&P activities.

Moreover, the chart of accounts should detail a breakdown of assets and liabilities into current and long-term categories, with subcategories such as cash, receivables, inventories, fixed assets, and intangibles. Similarly, revenue and expenses should be categorized to accurately reflect the organization’s operations and specific contract details.

Segregation of Unallowable Costs

A pivotal aspect in federal contracting is the segregation of unallowable costs as defined by the FAR. These costs include public relations, bad debts, entertainment, and lobbying expenses, among others. It is imperative that these unallowable costs are distinctly identified and segregated in the chart of accounts to prevent their reimbursement by the government.

Conclusion: Ensuring Compliance through Effective Accounting Practices

A well-organized chart of accounts not only facilitates the calculation of indirect rates at various organizational levels but also ensures compliant and efficient financial reporting. The system should be flexible enough to adapt to various contracts, budgeting needs, and management requirements, including divisions, locations, and worksite classifications.

In conclusion, developing a compliant chart of accounts for federal contracting involves an understanding and implementation of the principles of GAAP along with the specific requirements of the FAR. This not only optimizes financial operations but also aligns with legal and regulatory frameworks, supporting informed decision-making and maintaining the integrity of financial management within the challenging sphere of federal contracting. Adherence to GAAP and FAR requirements is crucial for your chart of accounts to hold up to scrutiny by the DCAA and for successful federal contracting.

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