6 Minute Read | 3 Minute Skim

Would your business pass a labor audit?

What DCAA compliance standards can teach small business owners about record-keeping practices

Even if your business doesn’t work with government contracts, business owners can still learn a great deal from cost accounting and DCAA compliance practices to develop strong business systems. No audit is fun, but passing a DCAA audit means contractors and business owners have developed strong accounting and employee management systems.

What is cost accounting?

Cost accounting is when you track the costs associated with a specific contract or project to a customer. This allows you to use the records to improve your cost and project management. Say you run a construction company and you bid on a project with a prospective customer. You agree to a contract and, of course, a price. Your contract includes specific costs, called “direct costs,” and a percentage of the company’s administrative costs, called “applied costs.” 

All cost accounting practices tie different costs to a specific product, service, project, or customer. Contract cost accounting ties direct costs to customers, then ties administrative costs to the direct costs by customer. The administrative costs are tied to the direct costs with a rate. This method of cost accounting is used to price products or services in a way that guarantees all expenses will be covered and profit will truly be just that—profit.

How cost accounting can help you

With the help of cost accounting, it’s much easier to budget and track your costs. Labor costs, in particular, can be monitored and controlled more easily. Essentially, cost accounting provides a snapshot of your company’s health and the revenue you make or lose on each product, project, or customer. Done correctly, it can also support DCAA compliance standards for government contracts.

To summarize, cost accounting has four major benefits:

1. It improves cost and project management.
2. It guarantees all costs will be covered in your pricing.
3. It segregates costs into specific pools within your accounting system.
4. It accounts for all of the hours your employees work for a project or customer.

What is the DCAA?

The Defense Contract Audit Agency (DCAA) is the U.S. Department of Defense’s (DOD) premier audit agency. The DCAA conducts audits of government contractors and business owners. To understand the DCAA’s audit efforts, it’s important to note the government awards different types of contracts to businesses:

1. Cost-plus (CPFF or CPIF) contracts.
2. Firm-fixed-price (FFP) contracts.

Fixed-price contracts are similar to commercial contracts in that a price is proposed and accepted. Once the price is agreed upon, the business takes the risk of the contract and is paid only what’s set on paper. On a cost-plus contract, the government pays the business for all expenses incurred, plus a profit. Most DCAA audits are conducted on cost-plus contracts.

What is a DCAA labor audit?

The DCAA conducts a number of audits, called “audit programs.” Among the list are several types of labor audits, including:

• Non-Major Contractors Labor Floorchecks

• Operations Audits for Labor Elements

• Major Contractors Labor Floorchecks/Interviews

• Cost Accounting Standard No. 407, the Use of Standard Costs for Direct Material and Direct Labor

Floorchecks and timesheet audits

Many government agencies and the contracts they award expect employees to fill out daily timesheets. So when the DCAA conducts a labor audit, they’re confirming that employee timesheets have been filled out in a timely manner. The labor “floorchecks” listed above are surprise spot visits from government auditors to confirm employees are following company policies and that policies reflect the audit program’s labor criteria for adequate time-keeping and training.

Business system audits

The DCAA also conducts audits for business systems, forward pricing cost proposals, incurred costs proposals, labor and materials, and provisional billing rates reviews. This is where cost accounting and the act of segregating costs come into play. The more clearly your costs can be tracked to customers and projects and administrative pools, the more likely you are to pass an audit.

And it’s important for a business to pass a DCAA audit. An “adequacy” determination on a business system audit holds considerable weight for contracting officers. Loan officers, for example, appreciate the organized structure of financial statements created from pooling similar costs. An adequate determination is a green light for a contract award and signifies that a company has set up its books to accumulate and record costs correctly.

3 benefits of meeting DCAA compliance standards—even if you don’t work for the government

Businesses awarded government contracts are held to strict standards because taxpayers’ money funds government contracts. Similarly, small businesses are vying for the hard-earned dollars of customers and other businesses. Clean books and pristine records that follow rigorous guidelines tell partners and customers your business is reliable and worth the effort. Meeting DCAA compliance standards promotes better record-keeping practices for job costing, better employee time tracking practices, and better labor and cost tracking for business stakeholders—things that can make you more profitable. Here’s how.

1. Better record-keeping practices for job costing

Cost accounting requires meticulous records. Revenue is tracked to each customer, and expenses are separated into specific groups. It’s an efficient process that allows for strong job costing reports, which provide timely information on whether the company is making a profit on each customer.

Under DCAA compliance standards, job costing reports are very detailed, showing each customer and project, as well as revenue and direct costs. The amount of information can be extremely helpful for business owners who want to take on similar projects or customers in the future.

2. Better employee time tracking practices

Adequate time-keeping is important for DCAA compliance because labor tracking is an internal system. The only legal validation of labor costs a business owner has is an employee’s signature on their time cards, verifying the hours worked on each project or labor account. Labor tracking is vital, as labor is the most misallocated cost element in government contracts—often confused with an employee’s salary, which includes taxes and benefits like paid time off.

For best results, employees new and old, salaried and hourly, should be trained on a time tracking system that suits their needs and comes with clear, consistent policies. The better training employees receive, the less likely a business owner is to run into costly timesheet errors.

3. Better pricing and labor and cost tracking for business stakeholders
Contract cost accounting assures that all costs will be included in product pricing before a profit is applied, guaranteeing higher profit margins. Plus, loan officers, tax accountants, prospective board members, and angel investors fall in love with an organization based on its mission…and its financial statements. It is often difficult for these tax accountants, loan officers, and boards of directors to interpret messy financial statements to determine a business’ stability. A well-organized business brings a better understanding of the company’s growth and sustainability to the negotiating table.

Practices that protect your future

Not every business will have to face a government labor audit, but all small businesses can benefit from standardized accounting and record-keeping practices. From cost accounting to employee time tracking, strong systems can put businesses above the competition and protect their futures.

About the author
Meg McKeon holds a breadth of titles, including DCAA auditor, analyst, accountant, coach, and consultant. She is the founder and owner of ProAcct LLC, an accounting and consulting firm specializing in government cost accounting. ProAcct also provides QuickBooks setup for government contracts and cost accounting coaching. Meg holds a master’s in accountancy. She has also worked in performing arts and film, communications, manufacturing, and project management.

*Based on a survey of 924 businesses that use TSheets for payroll and report savings. On average, they report reducing gross payroll costs by 6% by increasing accuracy and reducing overpayments. TSheets conducted an internal survey in January 2018.

Get time tracking that supports DCAA compliance requirements and saves 6% on payroll costs.*