Quick Answer: “DCAA compliance” means your accounting system can pass the government’s SF 1408 pre-award evaluation: it segregates direct and indirect costs, accumulates costs by contract, allocates indirect costs through logical pools, excludes unallowable costs under FAR Part 31, and captures labor through a daily timekeeping system with an audit trail. DCAA does not certify software — it audits how your system actually operates.
What DCAA Actually Is (and Isn’t)
The Defense Contract Audit Agency is the audit arm of the Department of Defense. It audits contractor accounting systems, incurred cost submissions, and forward pricing proposals. Two things trip up first-time contractors. First, DCAA does not “certify” or “approve” anything — there is no official DCAA-compliant designation, and no software purchase makes you compliant by itself. Second, what matters is whether your system, as operated, meets the criteria on Standard Form 1408, which DCAA uses in a pre-award survey before you can win cost-reimbursable work.
The SF 1408 Criteria, In Plain English
DCAA’s pre-award checklist asks whether your accounting system provides:
- Segregation of direct costs from indirect costs, on a consistent basis and in line with GAAP
- Accumulation of direct costs by contract (job costing at the contract or task-order level)
- A logical and consistent method for allocating indirect costs to intermediate and final cost objectives
- Costs under general ledger control — your job cost ledger must reconcile to the books
- A timekeeping system that identifies each employee’s labor by cost objective, and a labor distribution that charges direct and indirect labor to the right place
- Interim (at least monthly) determination of costs charged to each contract
- Exclusion of costs that are unallowable under FAR Part 31 from anything billed to the government
- Identification of costs by contract line item when required, and data supporting Limitation of Cost and progress payment clauses
If you already run disciplined job costing — the way well-run construction contractors do — you are closer than you think. Contract-level cost accumulation, labor distribution, and burden allocation are the same muscles.
An adequate accounting system is a specific list, not an opinion.
Direct and indirect costs segregated, timekeeping that holds up, and a job cost ledger reconciled to the general ledger every month. When a pre-award survey goes badly, the gap is almost always the reconciliation rather than the software.
FAR Part 31: The Unallowable Cost Trap
FAR Part 31 lists costs the government will not reimburse, and FAR 31.201-6 requires you to identify and exclude them — and their directly associated costs — from billings, claims, and proposals. The classic expressly unallowable costs include entertainment (FAR 31.205-14), alcoholic beverages (31.205-51), lobbying and political activity (31.205-22), and interest on borrowings (31.205-20). The compliant approach is structural: build unallowable accounts directly into your chart of accounts so these costs are segregated the day they are incurred, not scrubbed out at year end. Penalties can apply when expressly unallowable costs show up in certified incurred cost proposals.
Indirect Rates: A Worked Example
Most small contractors run a three-pool structure: fringe, overhead, and G&A. Suppose your year looks like this:
- Direct labor: $1,200,000
- Fringe pool (payroll taxes, health insurance, PTO, retirement match): $360,000 → fringe rate = 360,000 / 1,200,000 = 30%
- Overhead pool (facilities, project supervision, indirect project labor): $480,000 over a base of direct labor plus fringe ($1,560,000) → overhead rate = 30.8%
- G&A pool (executive salaries, accounting, business development): $412,000 over a total cost input base of $2,452,000 → G&A rate = 16.8%
A dollar of direct labor therefore carries roughly $0.30 of fringe, $0.40 of overhead, and $0.29 of G&A — about $1.99 of allowable cost before fee. Getting the pools, bases, and consistency right is where professional judgment matters most: a base chosen badly in year one follows you into every audit after.
The Incurred Cost Submission Deadline
If you hold cost-reimbursable or time-and-materials contracts containing the Allowable Cost and Payment clause (FAR 52.216-7), you must submit an adequate final indirect cost rate proposal — the Incurred Cost Submission — within six months after your fiscal year end. DCAA’s ICE model (an Excel workbook) is the standard format. Miss the deadline and the government can set your rates unilaterally and withhold billings; chronic delinquency invites audit scrutiny you do not want.
Timekeeping: Where Audits Are Won and Lost
DCAA’s expectation is daily time entry by each employee, recording all hours to the correct charge codes, with corrections documented and approved. Floor checks — unannounced interviews verifying employees are charging time correctly — are a routine audit technique. A contractor with clean indirect pools and sloppy timesheets still fails.
Common Mistakes
- Buying “DCAA-compliant” software and assuming the label does the work — auditors test operation, not branding
- Booking all labor as direct and discovering at proposal time there is no indirect rate history
- Netting unallowable costs into overhead instead of segregating them in the chart of accounts
- Weekly or batch time entry reconstructed from memory
- Missing the six-month ICS deadline because nobody owned it
FAQs
Do I need a DCAA-approved accounting system to win any federal contract?
No. Firm-fixed-price work generally does not require it. The accounting system evaluation is triggered by cost-reimbursable and other flexibly priced awards, including many SBIR Phase II contracts.
Can QuickBooks pass an SF 1408 review?
It can, when configured with contract-level job costing, indirect pools, unallowable accounts, and a compliant timekeeping process around it. The system design and the discipline matter more than the platform.
What is the difference between provisional and final indirect rates?
You bill during the year at provisional rates, then true up to final rates established from your Incurred Cost Submission. Large variances create billing adjustments, so provisional rates deserve real forecasting.
What happens if unallowable costs end up in my incurred cost proposal?
They are removed, and expressly unallowable costs in a certified proposal can carry penalties. Prevention through account structure is far cheaper than remediation.
How long does it take to get ready for a pre-award survey?
A contractor with clean books can typically restructure its chart of accounts, pools, and timekeeping within a couple of months; starting from commingled books takes longer.
For a deep dive on the control DCAA scrutinizes hardest, see our guide to DCAA timekeeping requirements — the nine controls, floor checks, and total time accounting.
Once your accounting system is compliant, the annual filing it feeds is the incurred cost submission, due six months after fiscal year end.
Get Your Accounting System Contract-Ready
We build job cost accounting, indirect rate structures, and month-end discipline for contractors every day — the same foundation an SF 1408 review tests. If you are pursuing your first cost-reimbursable award or facing an incurred cost deadline, talk to us about monthly accounting and CFO advisory support. Related reading: Davis-Bacon vs. New York prevailing wage and setting internal equipment rates.
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Precision Accounting & Consulting works with contractors, law firms, medical practices and property owners across the country. If something on this page raised a question about your own books, send it over and we will give you a straight answer.