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Originally Published: September 2022 | Updated: July 2026
Government contractors need to have a specifically designed accounting system to be awarded certain contracts. They also need to pass the checklist items on the Pre-Award Survey Form SF1408. SF1408 is a checklist used by a Defense Contract Audit Agency (DCAA) auditor to determine if a government contractor has an acceptable accounting system to be awarded a cost-plus contract. Even if a government contractor is a subcontractor to a prime, they may need to pass the checklist items regardless of their contract.
On form SF1408, Section II – Evaluation Checklist, Item #2 states that the government contractor’s accounting system needs to have proper segregation of direct and indirect costs. It also requires the identification and accumulation of direct costs by contract. To meet this requirement, government contractors need a proper chart of accounts to classify these costs into direct or indirect expense categories.
For contractors preparing for a pre-award survey or reviewing whether their accounting system meets DCAA expectations, Wendroff & Associates provides DCAA Accounting services for government contractors, including SF1408 support, chart of accounts development, indirect rate analysis, and audit readiness.
First, let’s understand the importance of a chart of accounts. A chart of accounts is a list of general ledger accounts grouped by their function in an accounting system. These accounts may appear on a balance sheet, which shows assets, liabilities, and equity, or on a profit and loss statement, which shows revenue and expenses. The chart of accounts is the foundation of an organized accounting system across all industries and organizations. Some examples of accounts include payroll, rent, travel, and utilities.
For government contractors, the organization of the chart of accounts must be more customized to group direct and indirect costs. Government contracting accounting often requires a more detailed structure than standard small business bookkeeping because contractors need to track costs by contract, cost pool, and allowability. Having these additional groupings will help pass a DCAA audit and calculate indirect cost rates. Indirect cost rates can also be calculated to allocate indirect costs to a contract and assess a government contractor’s profitability on these contracts.
Direct costs are defined by the Federal Acquisition Regulation (FAR, Section 2.1) as any costs that can be identified specifically with a final cost objective. A good way to determine this is to consider whether the cost would be incurred if the specific contract did not exist. Some examples of direct costs are direct labor, direct materials, manufacturing supplies, and travel directly related to a contract.
Indirect costs are the expenses of doing business that are not tied to a particular grant, contract, or project function but are necessary for the general operation of an organization. Some examples of indirect costs are employee medical insurance, office rent, and general and administrative labor.
The best way to organize these costs is using a DCAA-compliant chart of accounts. In addition, a DCAA-compliant chart of accounts has cost pools that contain these direct and indirect expenses. Such as the direct cost pool, which contains direct expenses, and indirect cost pools, such as a fringe benefit pool, an overhead pool, or a general administrative pool, which contain indirect expenses. The point of the indirect cost pool, which contains a grouping of indirect expenses, is to eventually allocate these expenses to a final cost objective, such as a contract.
Once the major cost categories and cost pools are identified, subaccounts can be used to organize the individual expense categories within each area.
For direct costs, subaccounts can help break out expenses such as direct labor, direct subcontractors, direct materials, direct equipment, and direct travel. Direct travel may be broken out even further into categories such as lodging, airfare, mileage, per diem, business meals, rental cars, taxis, tolls, parking, and other travel-related expenses.
Subaccounts can also be used within indirect cost pools. For example, a Fringe Benefit pool may include subaccounts for health insurance, payroll taxes, retirement contributions, and other employee benefit costs. An Overhead or Facilities pool may include subaccounts for rent, utilities, internet, repairs, and office supplies. A G&A pool may include subaccounts for administrative labor, accounting fees, legal fees, and other general business expenses.
This parent account and subaccount structure helps contractors see how costs accumulate by category and by pool. It also creates a cleaner foundation for tracking direct costs, calculating indirect rates, reviewing contract profitability, and discussing the accounting system with your CPA.
For a broader look at how these pieces fit together, read our article on what your CPA sees when they review your government contracting accounting system.
For a deeper explanation of how the chart of accounts supports DCAA readiness, watch Session 02 of the Wendroff & Associates DCAA Ready webinar series in partnership with WiseCost.
In this webinar, Brian Wendroff, CPA, Managing Partner of Wendroff & Associates, and Sarah Sun, CPA, Tax Manager, explain how small government contractors can structure a QuickBooks Online chart of accounts to separate Direct, Fringe, Overhead, G&A, and Unallowable costs. They also discuss how to classify expenses such as travel and business meals, and how labor distribution maps back into the accounting system.
Fortunately, with QuickBooks Online, you can develop your chart of accounts however you like. However, you will need to customize the chart of accounts for a government contractor. We have included a template you can upload as a sample DCAA-compliant chart of accounts for your government contractor company.
You can see that this chart of accounts has account numbers, parent accounts, and subaccounts. The parent accounts represent broader cost pools, while the subaccounts break out the individual expense categories that roll up into each pool. For example, Office Rent may be listed as a subaccount under the Facilities Expense pool.
Here is a helpful video on how to import the government contractor chart of accounts into QuickBooks Online.
We’re happy to discuss how to set up a chart of accounts for government contractors, as well as any other financial concerns related to government contracting. To set up a free consultation, please click on the button below to schedule a time that works best for you.
