So you have decided to get federal government work.  You may even have a contract already and are doing business.  You are a small business.  You are flying under the radar of the Defense Contract Audit Agency (DCAA).  But are you ready for an audit?  How do you set up your accounting system properly in preparation?  

DCAA is the big brother of government contracting, and they will eventually be in your business just like the Internal Revenue Service (IRS).

DCAA does not recommend any accounting software so you must separate your chart of accounts into three areas:  Direct Costs, Indirect Costs, and Unallowable Costs.  The complete explanation is located in the Far Cost Principles Guide on the DCAA website. 

The decision of whether a cost is direct or indirect is based on the ability to identify the cost associated with the contract, rather than nature of the goods and services specifically.  Indirect costs that cannot be directly tied to the project or ongoing operational expenses are not allowed.  

Expenditures for which it is often impractical to calculate dollar amounts and itemize as direct expenses, because while these expenses are necessary to support a contract, they are also shared across the organization and are therefore not easily identified with a specific contract.

Direct Costs

  • Specifically identifiable to contract
  • Directly related to performance of contract
  • Identified in proposal as direct costs
  • Billable to contract and customer
  • Labor, Subcontractors, Equipment Cost, Materials
  • Travel (Lodging, Mileage, Per Diem, Meals, Rental Car, and Parking)
  • Other Direct Costs

Indirect Costs

  •  Shared costs that apply to multiple contracts or activities
  •  Cannot be identified to specific contract
  •  Fringe, Payroll Taxes, Leave, Benefits
  •  Facility Costs (Internet, Rent, Office Supplies, Postage, Telephone)
  •  Overhead Costs (Labor, Bonuses, Travel, Consultants)
  •  General & Administrative (G&A)
    • Proposal Costs
    • Legal Costs accrued for legal advice on proposals
    • Executive Labor and Bonuses
    • Bank Service Charge
    • Accounting


  • Payroll Expenses, Charitable Contributions, Advertising
  • Interest Expense, Fines, and Penalties
  • Legal Fees, Alcohol, Entertainment, Officer and Owner Insurance
  • Federal Corporate Taxes

The following table is a quick lookup.  Remember I am not an accountant and your best resource is a DCAA familiar accountant.

Cost Description Type
Advertising Advertising, brochures, and displays. Unallowable
Alcoholic Beverages Alcoholic beverages are unallowable as a direct or indirect cost. Unallowable
Bad Debts Losses from uncollectible accounts, collection costs and related legal costs. Unallowable
Books, Journals, and Subscriptions Books, journals and subscriptions to professional and technical> publications. Direct – books, journals, and subscriptions specifically related to a contract. 
Indirect – books, journals, and subscriptions that benefit research in general or the researcher in general.
Charitable Expenses Charitable Expenses Unallowable
Consultant An individual hired to perform professional, short- term services. Direct – if specifically related to a contract Otherwise, indirect.
Delivery Service Overnight delivery service or special shipping services, other than routine postage costs. Direct – shipping of samples, receiving goods for contract use or other delivery of items directly related to the contract work.
Indirect – submitting proposals or other administrative purposes.
Depreciation The cost of an asset (building or equipment) spread over the asset’s useful life. Indirect
Donations and Contributions Includes gifts, memorials and purchase of tables. Unallowable
Entertainment Amusement, social activities, and related costs (tickets, meals, lodging, and gratuities). Unallowable
Equipment Tangible personal property with a useful life of more than two years and a unit cost greater than or equal to $5,000. Direct – if specifically related to a contract. Otherwise, indirect.
Federal Corporate Tax Federal Income Tax Unallowable
Fines and Penalties Costs resulting from violations of laws and regulations. Unallowable unless directly related to compliance with specific provisions of the contract.
Fringe Benefits Medical Insurance, Dental Insurance, Workers’ Compensation, FUTA, SUI/DI ER Expense, SS Tax ER Portion, Med Tax ER Portion, PTO, Holiday Pay Indirect
Goods or Services for Personal Use by Employees Items or services are providing direct personal benefit to employees. Unallowable
Insurance Insurance coverage for normal business purposes, whether provided by an external company or through a self-insurance program. Direct – if specifically related to the contract. Otherwise, indirect.
Interest Interest payments on business loans, credit card balances, or other business debt. Unallowable
Investment Management Costs of investment counsel. Unallowable
Legal Costs of Defense, Prosecution, Claims and Appeals Generally unallowable. Depends on whether the claim is civil, criminal, involves contracts or is against the Federal government. Unallowable
Lobbying Attempts to influence outcomes of elections or other political actions. Unallowable
Losses on Contract Agreements Costs in excess of available funding are unallowable as a direct cost on another contract. Unallowable
Maintenance and Repair Costs Maintenance and Repair Costs to keep the property in efficient operating condition. Not including costs that increase property value. Direct – if specifically related to the contract. Otherwise, indirect.
Meals Meals are allowable if associated with a staff travel, conference or symposium where technical information is presented. Direct – meals directly related to contract performance in the case that per diem rates are not utilized. Otherwise, indirect.
Meeting Refreshments Meeting refreshments, site visit meals and guest meals. Unallowable
Memberships Memberships and dues to belong to a professional or technical> organization. Direct – memberships and dues required exclusively for a particular contract.
Indirect – memberships and dues that benefit the employee, in general, are a professional development cost.
Office Supplies Office supplies are those items usually maintained in a departmental stock for general use by all staff. Such items would include pens, pencils, writing a paper, file folders, departmental letterhead, envelopes, staples, staplers, and rulers. Office supplies generally support multiple activities of contract> personnel. Direct – lab-related office supplies or office supplies purchased for specific contract use. Otherwise, indirect.
Officer and Owner Insurance Insurance expense for officers and owners that exceed a general insurance benefit for rank and file employees. Unallowable
Payroll Expenses The cost of payroll services. Unallowable
Photocopy Photocopying of documents. Direct – photocopying of technical material related to a particular contract.
 Indirect – routine photocopying of a general business nature (employee timesheets, professional materials, proposals).
Postage Routine postage costs. Direct – postage costs for large mailings or surveys related to the contract. Indirect – routine postage costs, including general agency correspondence and mailing of proposals.
Pre-award Costs Costs incurred prior to the effective date of the contract. Unallowable
Professional Services Professional contractual services, consulting and external legal counsel. Retainers require evidence of service. Direct – if specifically related to the contract. Otherwise, indirect.
Proposal Costs Proposal preparation, including typing, copying and mailing costs, for new and renewal applications. Indirect
Public Relations and Marketing Public relations, marketing, and related advertising cost intended to promote the organization or improve community relations. Unallowable
Recruiting Recruiting costs to select a new employee. Indirect.
Rent The cost to lease building space or equipment. Direct – Building rent is a direct cost to the extent if related to contract Equipment – in proportion to use on the contract.
Indirect – administrative equipment rental (fax, copier) are normally indirect costs.
Salaries and Fringe Benefits- Administrative and Clerical Personnel Departmental administration, including professional and clerical staff, and central administration staff are serving the entire organization. Direct – administrative and clerical cost incurred for a technical purpose or related to the contract.
 Indirect – routine, the base level of administrative support provided to all organizational activities.
Salaries and Fringe Benefits- Technical and Programmatic Personnel Personnel performing services related to a contract. Direct – work performed must specifically relate to the contract. The direct cost charge must be based on the percentage of effort devoted bythe employee.
Specialized Service Facilities or Service Center Operating units that use specialized equipment or technical expertise to provide goods or services for a fee. Direct – appropriate billing rates and charging practices must be followed.
Supplies and Materials – Technical Purchased materials and supplies consumed in the performance of the contract. The cost to the contract should be net of credits, discounts, and rebates. Freight costs are part of supply and material costs. Direct – All Cost should be accounted for against a particular contract.
Telephone and Facsimile Equipment and service cost for telephone and fax service. Direct – Long distance telephone, if the charge can be specifically identified with a contract. Indirect – Local telephone and fax service.
Termination Costs Additional costs incurred due to early termination of a contract. Direct
Transportation Freight, express delivery and other transportation related to goods purchased. Direct – if associated with a contract. Otherwise, indirect.
Travel Transportation, lodging, subsistence and related costs for official business, in accordance with organizational policy. Direct – travel expenses directly related to contract performance. Otherwise, indirect.
Tuition The cost of classes at an educational institution for employees. Indirect