If DCAA walked into your office tomorrow, would your accounting system pass?
Not your books. Not your tax returns. Your accounting system: the structure, the policies, the controls, and the documentation behind every dollar you bill the federal government. Most contractors believe their system is adequate because their financials balance. DCAA does not measure adequacy by whether the numbers balance. DCAA measures adequacy by whether the system itself meets 18 specific criteria outlined in DFARS 252.242-7006.
A DCAA compliant accounting system must satisfy requirements across cost segregation, timekeeping, labor distribution, budget monitoring, and unallowable cost exclusion. Amerifusion Bookkeeping evaluates these systems for government contractors weekly. Below is the exact checklist we use, built from the SF 1408 evaluation criteria and the DFARS adequacy standards DCAA auditors apply during pre-award and post-award reviews.
What DCAA Evaluates in Your Accounting System
DCAA evaluates accounting systems against the 18 criteria listed in DFARS 252.242-7006, not against generally accepted accounting principles alone. A system passes when it demonstrates the ability to accumulate and segregate costs by contract, cost element, and cost type. A system fails when it lacks even one of these structural capabilities, regardless of how accurate the financial statements look.
The evaluation happens at two points. Before contract award, the contracting officer requests an SF 1408 pre-award accounting system survey to verify your system meets minimum standards. After contract award, DCAA auditors test the system through incurred cost audits, floor checks, and targeted compliance reviews.
Here is what contractors misunderstand. “Adequate” does not mean your books are clean. It means your system has the structural architecture to produce reliable cost data for government billing. A contractor with perfect financials but no written policies for cost segregation will fail. A contractor with a few journal entry errors but strong policies, consistent allocation methods, and documented controls will pass.
The DCAA Compliant Accounting System Checklist
This checklist covers every requirement DCAA auditors test during an accounting system review. Each item maps to a specific DFARS 252.242-7006 criterion or SF 1408 evaluation point. Use it as a self-assessment before your next pre-award survey, incurred cost audit, or internal compliance review.
| # | Requirement | What DCAA Looks For | Pass? |
|---|---|---|---|
| 1 | Direct/indirect cost segregation | Separate accounts for direct costs (by contract), indirect cost pools (fringe, overhead, G&A), and unallowable costs [CAS 402, CAS 405] | |
| 2 | Job cost tracking by contract | Every direct cost traces to a specific contract number. Labor, materials, subcontracts, travel, and ODCs all track at the contract level. | |
| 3 | Timekeeping system | Daily time recording by all employees. Supervisor approval. After-the-fact corrections with written justification. No pre-populating timesheets. | |
| 4 | Labor distribution | Labor costs flow from approved timesheets to the general ledger. The labor distribution report reconciles to timesheets and payroll. | |
| 5 | Indirect cost pool structure | Separate pools for fringe benefits, overhead, and G&A at minimum. Each pool has a defined allocation base [CAS 418]. | |
| 6 | Consistent allocation methods | Allocation bases remain the same period to period. Changes require disclosure and contracting officer notification [CAS 401]. | |
| 7 | Unallowable cost exclusion | Entertainment [FAR 31.205-14], alcohol [FAR 31.205-51], lobbying [FAR 31.205-22], and other unallowable costs recorded in separate accounts and excluded from billing [CAS 405]. | |
| 8 | Budget vs. actual reporting | Ability to compare budgeted costs to actual costs at the contract level. Variances identified and explained. | |
| 9 | Interim billing capability | System produces interim invoices based on incurred costs and provisional billing rates [FAR 52.216-7]. | |
| 10 | Written accounting policies | Documented policies for: timekeeping, compensation, travel, direct/indirect charging, cost accumulation, and unallowable cost identification. | |
| 11 | Chart of accounts design | Account structure supports separation of direct costs, each indirect pool, and unallowable costs. See our QuickBooks chart of accounts guide for the exact hierarchy. | |
| 12 | Accumulation of costs by cost element | Costs tracked by element: labor, materials, subcontracts, travel, other direct costs. Not lumped into a single expense category. | |
| 13 | Exclusion of unallowable costs from billing | Unallowable costs identified at the point of entry and excluded from all indirect rate calculations and government billings. | |
| 14 | Financial statement preparation | System produces a trial balance, income statement, and balance sheet. Accounts reconcile monthly. | |
| 15 | Internal controls | Segregation of duties where possible. Approval workflows for purchases, payroll, and journal entries. Documented review procedures. | |
| 16 | Compensation reasonableness documentation | Executive compensation benchmarked against BLS data. Salaries under the FAR 31.205-6(p) cap (adjusted annually; verify current amount at acquisition.gov). Bonus criteria documented before bonuses are paid. | |
| 17 | Subcontract cost tracking | Subcontract costs tracked separately from other direct costs. Consent documentation on file for subcontracts requiring contracting officer approval [FAR 44.201-1]. | |
| 18 | Audit trail | Every transaction traceable from source document to general ledger entry to financial statement. No gaps. |
Print this checklist. Walk through each item with your accounting system open. Every blank in the “Pass” column is a gap DCAA will find before you do.
The 5 Gaps That Trigger Adverse Findings
Five system deficiencies account for the majority of “inadequate” determinations in DCAA accounting system audits. These are not obscure technical violations. They are structural gaps that signal the system lacks the architecture to produce reliable cost data for government billing.
1. No separation of unallowable costs
CAS 405 requires contractors to identify and exclude unallowable costs at the point of recording. The most common failure: entertainment, alcohol, and lobbying expenses sit in the same general ledger accounts as allowable costs. When DCAA pulls your G&A pool and finds $8,000 in client dinners mixed with legitimate travel, the entire pool draws scrutiny.
The fix takes 30 minutes. Create dedicated unallowable cost accounts in your chart of accounts. Record every unallowable expense to those accounts on the day it occurs. Never rely on year-end reclassification.
2. Missing or undocumented timekeeping procedures
Timekeeping is DCAA’s number-one audit focus. Auditors test whether employees record time daily, whether supervisors approve timesheets before payroll runs, and whether corrections follow a documented after-the-fact adjustment process.
A contractor with no written timekeeping policy fails this requirement automatically, even if employees actually record time every day.
The documentation matters as much as the practice. Write the policy. Train employees on it. Keep the training records.
3. Inconsistent cost allocation
A cost classified as direct on one contract and indirect on another violates CAS 402. DCAA tests this by pulling the same cost type across multiple contracts. If engineering supplies are a direct charge on Contract A but included in overhead on Contract B, the auditor flags a consistency failure. This single finding triggers a review of every cost pool.
4. No budget-to-actual tracking
DFARS 252.242-7006 requires the system to produce budget-versus-actual reports at the contract level. Many small contractors skip this because fixed-price work does not require it. Then they win a cost-plus contract and realize their system has no mechanism for tracking cost performance against the funded amount. The gap becomes visible during the first quarterly review.
5. Weak labor distribution
The labor distribution report is the bridge between timesheets and the general ledger. DCAA reconciles three documents: timesheets, the labor distribution report, and payroll records. When hours on the timesheet do not match hours on the labor distribution report, the auditor questions every labor charge on every contract. A $200 discrepancy in one pay period triggers a system-wide labor review.
Having the System vs. Proving the System Works
Passing a DCAA accounting system review requires two things: a system that meets every DFARS criterion, and documentation proving the system operates as designed. Most contractors focus on building the system. They ignore the second half. The documentation is where audits are won or lost.
DCAA does not accept “we do it this way” as evidence. The auditor asks for the written policy, then tests whether actual practice matches the written policy. A contractor who segregates unallowable costs perfectly but has no written policy describing the segregation method fails the documentation requirement under DFARS 252.242-7006.
| System Element | Having It | Proving It |
|---|---|---|
| Timekeeping | Employees record time daily | Written timekeeping policy, signed employee acknowledgments, correction log with supervisor approvals |
| Cost segregation | Separate accounts for direct, indirect, unallowable | Written charging policy specifying which costs go where, with examples |
| Indirect rates | Consistent allocation bases applied each period | Written description of each pool, its allocation base, and the rationale for the base selection [CAS 418] |
| Compensation | Salaries within FAR caps | Compensation plan with salary benchmarks, bonus criteria documented before the performance period |
| Internal controls | Approval workflows in place | Written procedures manual, segregation of duties matrix, documented review schedules |
Here is what most contractors miss: the documentation must exist before the auditor asks for it. Creating policies during the audit signals to DCAA the system operated without controls. Retroactive documentation does not cure the compliance gap for the period it was missing.
Setting Up a DCAA Compliant Accounting System in QuickBooks
QuickBooks supports DCAA compliance when configured correctly. The default setup does not meet a single requirement on the checklist above. Building a DCAA compliant accounting system in QuickBooks requires restructuring the chart of accounts, enabling job costing, connecting a compliant timekeeping tool, and creating the indirect cost pool hierarchy that maps to your rate structure.
Start with the chart of accounts structure. Create parent accounts for each indirect cost pool: fringe benefits, overhead, and G&A. Under each parent, create sub-accounts for specific cost types. Create a separate parent account group for unallowable costs. This structure gives you the segregation that DFARS 252.242-7006 criteria 1, 5, and 7 require.
Enable class tracking to separate costs by contract. Each active contract gets its own class or customer:job. Every direct cost transaction includes the contract identifier. This gives you the job-cost traceability that criteria 2 and 12 require.
Connect a DCAA-compliant timekeeping system. QuickBooks Time (formerly TSheets) integrates directly and supports daily time entry, supervisor approvals, and after-the-fact corrections with documentation. The timesheet data must flow into your labor distribution without manual re-entry. Manual re-entry creates the reconciliation gaps DCAA tests for. Our QuickBooks DCAA setup guide walks through each configuration step.
Budget-versus-actual reporting requires either QuickBooks’ built-in budget module or an external report. Create a budget for each cost-type contract. Run the budget-versus-actual comparison monthly. Export and save the report. The auditor will ask for it.
How to Run Your Own System Assessment
Print the 18-point checklist from the table above. Block two hours with your bookkeeper or controller. Open your accounting system and test each requirement live. Do not answer from memory. Pull the actual reports, policies, and account structures.
For each checklist item, assign one of three ratings:
- Pass: The system meets the requirement, and written documentation exists to prove it.
- Partial: The system partially meets the requirement, or the practice exists but the documentation does not.
- Fail: The system does not meet the requirement.
Any “Fail” on items 1 through 7 is a critical gap. Those items cover cost segregation, timekeeping, labor distribution, and unallowable cost exclusion. DCAA will not issue an adequate determination if any of those seven requirements are missing. Fix critical gaps first.
“Partial” ratings on documentation items (10, 15, 16) are the fastest to fix. Writing the policy takes a day. Implementing a system change takes weeks. Prioritize documentation gaps second because they deliver the highest compliance return for the time invested.
Run this assessment quarterly. The indirect rate calculator helps you verify your cost pool structure aligns with the allocation bases documented in your policies.
Frequently Asked Questions
What is a DCAA compliant accounting system?
A DCAA compliant accounting system meets every adequacy criterion in DFARS 252.242-7006. It must segregate direct and indirect costs, track costs by contract, exclude unallowable expenses from billing, maintain daily timekeeping records, and produce budget-versus-actual reports.
Written policies documenting each of these functions are required.
Does QuickBooks work for DCAA compliance?
QuickBooks supports DCAA compliance when configured with a GovCon-specific chart of accounts, job costing enabled by contract, indirect cost pool accounts, unallowable cost segregation, and a connected timekeeping system. The default QuickBooks setup does not meet DCAA requirements.
Proper configuration takes 8 to 12 hours for most small contractors.
What happens if DCAA finds my system inadequate?
An inadequate system determination triggers payment withholding of up to 5% on all flexibly-priced contracts. The contracting officer issues a corrective action request with a deadline. Until the contractor demonstrates full DFARS compliance and DCAA verifies the fix, the withholding continues and new cost-type contract awards are at risk.
How often does DCAA audit accounting systems?
DCAA conducts pre-award system reviews before cost-type contract awards using the SF 1408 survey. Post-award reviews happen during incurred cost audits, which DCAA performs after receiving the contractor’s annual incurred cost submission. Floor checks (unannounced site visits testing timekeeping) occur on their own schedule, often without advance notice.
What written policies does DCAA require?
DCAA expects written policies covering timekeeping procedures, compensation and benefits, travel reimbursement, direct and indirect cost charging, unallowable cost identification, purchasing and subcontracting, and property management. Each policy must describe the procedure, assign responsibility, and match actual practice.
Policies created after the audit starts do not satisfy the requirement retroactively.
Key Takeaways
- Print and complete the full checklist against your live system. Do not answer from memory. Pull actual reports and policies. Every blank is a gap DCAA will find.
- The five most common failure points are unallowable cost segregation, timekeeping documentation, allocation consistency, budget-to-actual reporting, and labor distribution reconciliation. Fix these first.
- Documentation is half the requirement. A system that works correctly but lacks written policies fails the DFARS 252.242-7006 adequacy test.
- Run a self-assessment every quarter. System gaps compound over time, and retroactive fixes cost 3 to 5 times more than building correctly from the start.
Amerifusion Bookkeeping builds and reviews DCAA compliant accounting systems for government contractors at every stage: pre-award, post-award, and ongoing monitoring. Take the Compliance Readiness Check to identify your system gaps, or book a discovery call to walk through the checklist with a CPA-supervised team.
