DFARS Business Systems Explained

A rock-solid accounting system is crucial to navigating the rules and regulations associated with DFARS.

The Defense Federal Acquisition Regulation Supplement (DFARS) incorporates accounting prerequisites for any business trying to work with the Department of Defense (DoD). This includes those utilizing the Small Business Innovation Research (SBIR) program and other channels.

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Throughout your journey into the Small Business Innovation Research (SBIR) program, you’ll come across many rules and regulations. After all, this is the federal government; they love their rules and regulations!

Cutting through red tape—not to mention the seemingly impenetrable jungle of legalese—can seem daunting, but fret not! You aren’t the first startup to delve into the world of mandatory government guidelines, and you certainly won’t be the last. As such, there’s plenty of helpful information out there to shine a light on the many mysteries of government contracting. 

This blog can shed some of that light!

One of the most intimidating corners of the government contracting process is the Defense Federal Acquisition Regulation Supplement (DFARS). In this article, we’ll explore DFARS and thoroughly examine each component, explaining all the pertinent information along the way.

First things first.

What Is DFARS?

In order for an organization to conduct business with the Department of Defense (DoD)—or any other federal agency—they must comply with a strict set of prerequisites. These rules and regulations limit who can access certain data, ensure participants have sufficient security education and training to protect the government’s investment with identity and access management, and enlist physical security safeguards in the workplace.

It all comes together in DFARS (Defense Federal Acquisition Regulation Supplement). DFARS represents a set of rules the government uses to oversee the purchase of goods, services, and technology. The requirements and regulations in DFARS guarantee the integrity of sensitive information—also known as Controlled Unclassified Information (CUI)—that belongs to the government.

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What Are DFARS Business Systems?

Beyond coming up with an innovation that fits into the DoD’s various missions, you must also prove to the department that you have proper business systems in place. Without proper business systems, you won’t receive a government contract to take your project from abstract idea to commercialized reality.

There are six mandatory business system requirements documented in the DFARS § 242.70.

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  1. Accounting and Billing
  2. Estimating
  3. Material Management
  4. Purchasing
  5. Government Property
  6. Earned Value

Contractors need to declare that their business systems can adequately respond to requests for proposal for cost-reimbursement, incentive type, and time-and-material and labor-hour contracts.

One of the most important business systems to have in place is a reliable, all-encompassing accounting system that clearly outlines all allowable expenses associated with your SBIR project.
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What Is the Difference Between FAR and DFARS?

Federal Acquisition Regulation (FAR) is another set of government compliance standards, but it focuses on the way contractors can charge the government. FAR is all about “allowability.”

Essentially, it states what you can charge the government for in a contract and what you cannot.

FAR safeguards government contracts with a set of uniform policies and procedures within the acquisition process. It’s a set of accounting standards that defines when costs can be recovered under a federal contract.

DFARS is simply the official DoD regulatory supplement to FAR.

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What Does It Mean To Be DFARS Compliant?


A DFARS compliant business system meets all of the expectations put forth by the DoD. All applicants seeking contract work with the DoD and other federal agencies must be DFARS compliant. This goes for small businesses and large defense contractors. 

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There are 14 critical areas of DFARS compliance:


  • Audit and Accountability
  • Awareness and Training
  • Access Controls
  • Incident Response
  • Identification and Authentication
  • Configuration Management
  • Media Protection
  • Maintenance
  • Personnel Security
  • Physical Protection
  • Security Assessment
  • Risk Assessment
  • System and Information Integrity
  • System and Communications Protection

DFARS compliance begins with a comprehensive security assessment. If you have contract work with the DoD, you should create a compliance team to monitor CUI and identify sensitive information, security shortfalls, and improvements that can be implemented.

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How Many DFARS Clauses Are There?

There are many different sections and subsections to DFARS, and each one covers different topics such as Acquisition Planning, Competition Requirements, Contractor Qualifications, Types of Contracts, and so much more. For a full list of sections, visit the DFARS page of Acquisition.gov.

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What Is DFARS 252.242-7006(a)(1)?

DFARS 252.242-7006(a)(1) is related specifically to Accounting System AdministrationThe DoD implemented this clause as a regulation to dictate that all accounting systems must meet certain standards. This clause marked the first time the federal government relayed official, universal requirements for accounting systems and outlined penalties should businesses fall short of such requirements. 

This clause applies to cost reimbursement, incentive type, and time and materials, along with labor hour contracts or contracts with progress payments based on costs or progress payments based on stage of completion.

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What is Required for a DCAA Acceptable Accounting System?

Federal agencies rely on the Defense Contract Auditing Agency (DCAA) to perform the in-depth auditing process for any small business conducting research through the SBIR.

accountant reviewing financial stability

DCAA auditing components typically include:

  • Review of your company’s financial stability
  • Review of your company’s overall accounting system
  • Evaluation of your company’s proposed indirect rates 
  • Confirmation of your company’s payroll tax deposits

The DCAA offers a guide—Information for Contractors—to assist with the DCAA auditing process. Though not specific to SBIR, this guide is a helpful resource for any contractor with a pending government audit. 

In order to satisfy the DCAA’s auditing process, you must meet the standards set in the following 18 criteria. Your company must have:

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  1. A sound internal control environment, accounting framework, and organizational structure. 
  2. Proper segregation of direct costs from indirect costs. 
  3. Identification and accumulation of direct costs by contract. 
  4. A logical and consistent method for the accumulation and allocation of indirect costs to intermediate and final cost objectives. 
  5. Accumulation of costs under general ledger control. 
  6. Reconciliation of subsidiary cost ledgers and cost objectives to general ledger. 
  7. Approval and documentation of adjusting entries. 
  8. Management reviews or internal audits of the system to ensure compliance with the Contractor’s established policies, procedures, and accounting practices. 
  9. A timekeeping system that identifies employees’ labor by intermediate or final cost objectives. 
  10. A labor distribution system that charges direct and indirect labor to the appropriate cost objectives. 
  11. Interim (at least monthly) determination of costs charged to a contract through routine posting of books of account. 

  1. Exclusion from costs charged to government contracts of amounts which are not allowable in terms of FAR part 31, Contract Cost Principles and Procedures, and other contract provisions. 
  2.  Identification of costs by contract line item and by units (as if each unit or line item were a separate contract), if required by the contract. 
  3. Segregation of preproduction costs from production costs, as applicable. 
  4. Cost accounting information, as required.
    a. By contract clauses concerning limitation of cost (FAR 52.232-20), limitation of funds (FAR 52.232-22), or allowable cost and payment (FAR 52.216-7);
    b. To readily calculate indirect cost rates from the books of accounts.
  5. Billings that can be reconciled to the cost accounts for both current and cumulative amounts claimed and comply with contract terms. 
  6. Adequate, reliable data for use in pricing follow-on acquisitions. 
  7. Accounting practices in accordance with standards promulgated by the Cost Accounting Standards Board, if applicable, otherwise, Generally Accepted Accounting Principles.


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What Are the Significant Deficiencies of DFARS?

Significant deficiencies are any shortfalls deemed “significant enough” to cause the government to withhold payment of contracts. A “significant deficiency” is defined as a single weakness or a combination of weaknesses in the internal controls associated with financial reporting. It could be less severe than a material control weakness but sufficient enough to merit government scrutiny of your accounting system.

It doesn’t necessarily mean you made an egregious misstatement on your finances, but it indicates the potential for it to happen in the future. Government auditors will make your team aware of any significant deficiencies it finds.

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What Happens if an Inadequacy Is Identified by DCAA Audit?

If an accounting inadequacy is found through a DCAA audit, auditors will take three main steps:

3 Steps

  1. The Contracting Officer will provide an initial determination in writing on any significant deficiencies. The initial determination will describe the deficiency in sufficient detail.
  2. The Contractor shall respond within 30 days to a written initial determination from the Contracting Officer that identifies significant deficiencies in the Contractor’s accounting system. If the Contractor disagrees with the initial determination, the Contractor shall state, in writing, its rationale for their disagreement.
  3. The Contracting Officer will evaluate the Contractor’s response and notify the Contractor, in writing, of the Contracting Officer’s final determination concerning:
    a. Remaining significant deficiencies
    b. The adequacy of any proposed or completed corrective action; and
    c. System disapproval, if the Contracting Officer determines that one or more significant deficiencies remain.

*If the Contractor receives the Contracting Officer’s final determination of significant deficiencies, the Contractor shall, within 45 days of receipt of the final determination, either correct the significant deficiencies or submit an acceptable corrective action plan showing milestones and actions to eliminate the significant deficiencies.

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What Is the Penalty for a Non-Compliant Accounting System?

Should the DoD find that your company presented a non-compliant accounting system related to any DFARS requirements, you will likely receive a stop-work order. This means any right you had to conduct work on behalf of the DoD will be revoked, and your contract will be suspended until corrective measures are implemented and full compliance is reached. 

In worst-case scenarios, the DoD could seek damages for any false claims or breach of contract. This could lead to the ultimate disaster: the department terminates your contract and administers a lifetime ban on you ever working with the DoD again. While this only occurs in extreme cases, it’s reason enough to make sure your accounting system meets all requirements!

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What Are the Record Retention Requirements for Government Contractors?

Government contractors are required to adhere to a set of standards regarding maintenance of any record related to procurements and assistance awards. The requirements are different whether you are an agency, a contractor, or the recipient of a grant or cooperative agreement. For federal contractors, the best course of action is to adhere to the regulations set forth in FAR Subpart 4.7.

This general rule states that “contractors shall make available records, which includes books, documents, accounting procedures and practices, and other data, regardless of type and regardless of whether such items are in written form, in the form of computer data, or in any other form, and other supporting evidence to satisfy contract negotiation, administration, and audit requirements of the contracting agencies and the Comptroller General for three years after final payment on the contract.”

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What Are the DCAA’s Two Audit Programs?

DCAA has a number of audits, all of which have implications concerning the adequacy of a contractor’s accounting system. Among others, these audits include the pre-award (accounting system design) and the post-award accounting system audit. 

Digging a bit deeper, there are two specific audit programs we should mention: 

Major (Audit Code 11070) Purpose and Scope:

This audit ensures you are in line with 252.242.7006 and is conducted to examine contractor compliance with all system criteria. As part of the audit, officials will:

  • Obtain an understanding of the contractor’s compliance with DFARS 252.242-7006.
  • Determine if the contractor is compliant with the accounting system criteria prescribed DFARS 252.242-7006.
  • Report both significant deficiencies and less severe significant deficiencies in compliance with the DFARS criteria.

Non-Major (Audit Code 17741) Purpose and Scope:

This is a post-award accounting system audit conducted to examine a non-major contractor’s compliance with all system criteria outlined in DFARS 252.242-7006. As part of the examination, auditors will:

  • Obtain an understanding of the contractor’s compliance with DFARS 252.242-7006.
  • Determine if the contractor is compliant with the accounting system criteria prescribed in DFARS 252.242-7006.
  • Report both significant deficiencies and less severe significant deficiencies in compliance with the DFARS criteria.

Both audits are based on the previously mentioned 18 accounting system criteria. 

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What Is the SF1408?

SF1408 stands for “Standard Form 1408” and is a pre-award accounting system survey— considered a “pre-award audit”—necessary for an award in a government contract. While the results of this survey could deem your accounting system as “acceptable,” it is not considered a “true audit” in the eyes of DCAA auditors because it doesn’t examine any actual costs. Instead, it measures the capability of your system to handle an audit. It functions more as a review of your business accounting system than an audit.

Questions on the SF1408 survey include:

  • Is the accounting system in accordance with Generally Accepted Accounting Principles (GAAP)?
  • Does the accounting system provide for:
    • Proper segregation of direct and indirect costs
    • Identification and accumulation of direct costs by contract
    • Method for allocation of indirect costs
    • A Proper Timekeeping System
    • Labor distribution
    • Segregation of unallowable costs
    • Accumulation of costs under General Ledger Control
  • Is the accounting system designed to have reliable and accurate data?
  • Is the accounting system fully operable?

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How Team 80 Helps with DFARS

No one likes a government audit, but Team 80 has extensive experience working with small businesses trying to score a federal contract.

We deliver the full spectrum of DCAA audit services, along with an extensive knowledge of DFARS, FARS, and every other scary federal acronym you can imagine.

Our services include:

  • Accounting
  • Financial Statement Reporting
  • Regulatory Compliance
  • Indirect Costs, Direct Costs, Rates, Pricing
    Business Systems
  • Pre- and Post-Transaction Integration
  • Services
  • And more!

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Get A Free Consultation for Your DFARS Accounting Services
Team 80 CEO Sarah Sinicki

Sarah Sinicki

Team 80 CEO

Sarah is a leader focused on serving small businesses in various industries. She has worked with a multitude of companies over the last 25 years and loves helping business owners find success. Sarah is genuinely committed to unburdening Team 80 clients so that they have the freedom to focus on their business. In her free time, you can find her spending time with her husband, two kids, and her Yorkies, Marley and Ziggy. When she is not helping business owners, you can find her in a Reb3l Groove class dancing it out. Sarah is also an avid Colorado Avalanche fan, so if you ever want to talk about hockey, she’s your gal.

Stressed out man and women business workers at table in front of laptop

Overcoming Innovation Sabotage: 4 Common SBIR Accounting Mistakes to Avoid

The price of non-compliance can cost you an SBIR award. Are you making any of these easily preventable mistakes?

Government contracting can be a challenge; when you’ve cleared one hurdle, another one awaits, like finding a government-approved accounting system.

When COVID-19 hit, North Carolina’s BioMedomics made a tremendous impact on the world by introducing their groundbreaking COVID-19 rapid test.

From their experience developing a rapid test to diagnose sickle cell disease through the SBIR program, BioMedomics was able to help combat the pandemic by slowing down the spread of contagion with their rapid COVID tests.

Now, we want you to picture a scenario where these rapid COVID tests didn’t exist because of an oversight. What if the folks at BioMedomics failed to seize the federal seed funding needed for their initial research and development? And what if it was all because of something as simple as having an inadequate accounting system?

If BioMedomics didn’t have their ducks in a row when they started their SBIR journey, this could have been the outcome. There are many pitfalls in traversing the SBIR program, and so many of them are easily avoidable.

4 SBIR Accounting Mistakes

Mistake 1: Not having an acceptable and compliant accounting system.

Mistake 2: Proposing too low F&A or indirect rates.

Mistake 3: Improper timekeeping and uncompensated overtime issues.

Mistake 4: Thinking you can do the books yourself.

Doctor Holding BioMedomics COVID-19 rapid test

There’s a good chance you’re reading this blog because you have a solution to today’s most pressing technological and scientific needs, and you don’t want to jeopardize your idea over something as trivial as accounting.

Let’s look at some of the most common mistakes SBIR awardees make to sabotage their hard work.

Mistake 1: Not Having an Acceptable and Compliant Accounting System.

If it feels like we’re constantly going on about the importance of government-approved accounting systems and Federal Acquisition Regulation (FAR) compliance, it’s because we are. And that’s for good reason.

Too often, we see dreams dashed because a small business owner’s accounting system wasn’t adequate. Unfortunately, oversight agencies, like the Defense Contract Audit Agency (DCAA) or the Defense Contract Management Agency (DCMA), aren’t forgiving for non-compliance among government contractors.

auditor working with SBIR financial statements

The real shame is how easily avoidable these failures are.

Having a FAR-compliant accounting system means you are following the BEST accounting practices. And practicing excellent accounting should be second nature.

Awarded SBIR grants are cost-reimbursable, but your accounting system must be compliant with FAR Part 31. This particular regulation establishes cost principles and procedures and helps you determine which costs are reimbursable, and you’ve accounted for them.

Typically, the first phase of the SBIR program is a firm-fixed-price (FFP) contract which is not subject to any adjustments, so your chances of having the DCAA breathing down your neck about compliance are relatively slim.

However, this doesn’t mean you should wait until the last minute to ensure everything is in line with FAR requirements. These government watchdogs will check your accounting system before Phase II, and you can still lose an award for non-compliance no matter how much work you put into Phase I.

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Mistake 2: Proposing Too Low F&A or Indirect Rates.

You may think proposing a low, conservative estimate of your Facilities and Administrative (F&A) costs might give you a leg up when it comes to winning over the government. But, this kind of thinking could land you in hot water.

F&A, or indirect costs in a grant, can include electricity, internet, rent, and administrative services (and more). Unfortunately, we often watch small business owners create SBIR proposals with inaccurate indirect costs.

Incorrectly projecting indirect costs can lead to all sorts of cash flow nightmares. For example, if the amount you spend on indirect costs winds up exceeding the amount you projected, you’ll be responsible for paying the remainder out of pocket.

Pen checking box of Indirect Costs: Increase

Not everyone has thousands of dollars lying around, which means grantees may have to tap into their bank accounts or take out a second mortgage. This, of course, can have devastating effects on your business.

On the flip side, if your rate is much lower than what you projected, you run the genuine risk of committing inadvertent fraud by overbilling the government.

Estimating indirect rates can be an uphill battle, but it is your responsibility to project these costs in your proposal accurately. You’ll need to know all of your company’s expenses (direct and indirect) and understand how to charge costs in your accounting system appropriately.

Here’s a great place to start: list all of your company’s costs (don’t worry about whether they’re direct or indirect at this point.); your profit/loss statement or your income statement can help.

Not only do you need to understand the differences between direct costs, indirect costs, and even unallowable costs, but you must also thoroughly track your indirect rates to avoid any nasty surprises that could spell financial ruin.

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Mistake 3: Improper timekeeping and uncompensated overtime issues.


Close-up Of A Businesswoman Filling Weekly Time Sheet On Laptop In Office

Sometimes, the idea of having to fill out a timesheet can feel too micromanaging. You or your employees might find punching in for the workday an unnecessary task better suited for people working menial jobs. But this is far from the truth.

Timekeeping is a vital cog in the accounting machine. Payroll is one of your most significant expenses, and keeping track of the hours worked is crucial. By documenting the actual amount paid to you and your employees, you can allocate these costs to the various billable and non-billable tasks performed in your project.

Every cost-reimbursable government award must be FAR and DCAA compliant, and this includes timekeeping. FAR 31.201-2(d) states:

“A contractor is responsible for accounting for costs appropriately and for maintaining records, including supporting documentation, adequate to demonstrate that costs claimed have been incurred, are allocable to the contract, and comply with applicable cost principles in this subpart and agency supplements. The contracting officer may disallow all or part of a claimed cost that is inadequately supported.”

Yes, once again, we stress the importance of being FAR compliant. And yes, once again, this means employing BEST practices.

An audit will heavily scrutinize your timekeeping procedures. To ensure things go smoothly, make sure your company has documented policies and procedures, a labor charging system for hourly time, specific accounting and billing system properties, and a staff trained in DCAA compliance.

Two Accountants Analyzing Time Sheet Chart On Laptop

Here is what you’ll need to do to get your timekeeping system up to speed:

  • Create a policy detailing the timekeeping requirements for ALL employees
  • Record EVERY hour of the workday, including leave
  • Have every employee track their time DAILY
  • Make sure you sign off and approve employee timesheets
  • Keep all timesheets (including timesheet corrections) for at least two years

Having a transparent, organized timekeeping system is one way to ensure you won’t lose that hard-fought SBIR award. It will also ensure you don’t run into the costly issue of uncompensated overtime. Uncompensated overtime is the excess hours worked by employees exempt from the Fair Labor Standards Act (FSLA) (salaried employees) in a 40-hour week without additional compensation, and it is an oversight that can cost you dearly.

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Mistake 4: Thinking you can do the books yourself.

The SBIR program is aggressively competitive, and the government’s expectations can seem insurmountable.

Having a detailed Excel spreadsheet and QuickBooks is beneficial, but there is only so much those tools can do. For example, they can’t cover things like rates, labor distribution, and accurate timekeeping.

Frustrated Businessman doing his own SBIR accounting and looking at laptop

You probably think you can’t afford the costs of accounting services to bring you into compliance. It’s understandable. But what are your innovations and ideas worth? You can’t afford to have your solutions shelved because of flimsy and inadequate accounting.

FAR-compliant accounting systems are complex and unique. Your time is best spent focusing on the research and development of your project. Not tracking indirect expenses, reconciling books, monitoring job costs reports, developing timekeeping procedures, and keeping checks and balances.

Team 80 is on a mission to help innovators like you succeed. We’re also on a mission to eliminate SBIR failures. We understand the nuances of government-approved accounting and FAR requirements, and our outsourced accounting solutions are affordable so that you won’t be breaking the bank.

Why are you waiting? Let us take over the accounting aspects so you can focus on turning your vision into a reality!

Team 80 CEO Sarah Sinicki

Sarah Sinicki

Team 80 CEO

Sarah is a leader focused on serving small businesses in various industries. She has worked with a multitude of companies over the last 25 years and loves helping business owners find success. Sarah is genuinely committed to unburdening Team 80 clients so that they have the freedom to focus on their business. In her free time, you can find her spending time with her husband, two kids, and her Yorkies, Marley and Ziggy. When she is not helping business owners, you can find her in a Reb3l Groove class dancing it out. Sarah is also an avid Colorado Avalanche fan, so if you ever want to talk about hockey, she’s your gal.