To secure government funding for Small Business Innovation Research (SBIR) programs, entrepreneurs must have their accounting in order. 

Small Business Innovation Research (SBIR) funding requires a solid compliant accounting system, no matter which federal agency awards grants or contracts. Small businesses must deliver Direct and Indirect Costs, as well as timesheets, to receive funding. Contracts such as Firm-Fixed Price (FFP) and Cost-Plus Fixed Fee (CPFF) denote the type of funding companies can receive. 

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You’ve done it! After weeks, months, or even years of technically challenging work, you’ve scored an award through the Small Business Innovation Research (SBIR) program from one of the 11 participating federal agencies. 

But now is not the time to rest on your laurels—instead, it’s time to crunch the numbers and adequately manage your funds. 

A fully fleshed-out accounting system ensures you use your SBIR funds correctly, guarding against any sort of government audit. This keeps your small business out of trouble and in the position to receive additional funding down the road. 

In this blog, we’ll blueprint all of the SBIR accounting basics you need—no matter which government agency is delivering your well-deserved funds. 

What is an Acceptable SBIR Accounting System?

Think of it like this: when you receive funds through an SBIR program, you are entering into a business relationship with the U.S. government, which just so happens to be the largest purchaser of goods and services in the world. 

With the sheer volume of business it undertakes, the government boasts a lot of rules—both written and unwritten—in a highly sophisticated system with stiff penalties for any financial transgressions. 

You want to be organized, with all of your government billings and annual incurred cost submissions laid out in detailed job cost reports. Forming the foundation of this information is one easy-to-reference document called a Chart of Accounts (COA), an index of the financial accounts in a company’s general ledger. 

An all-encompassing COA organizes your business’ financial activity into assets, liabilities, income, and expenses. It creates simple, consistent language across your organization so that you can face any government audit with confidence and have the paperwork to back you up.

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What’s the Difference Between Direct, Indirect, and Unallowable Expenses?

At its core, and in the eyes of a government auditor, an acceptable SBIR accounting system demonstrates your ability to segregate the different kinds of expenses listed in your general ledger. These are separated as either Allowable or Unallowable expenses. Breaking it down even further, these expenses (or costs) are organized as:

Let’s define each of these expenses for your SBIR/STTR cost proposal.

Direct Costs

This constitutes the bulk of your government funding and includes the cost of goods and services that are specifically for the benefit of your SBIR project. 

Direct costs constitute expenses incurred by performing specific work on a project, contract, or grant objective. These costs, often engineering or research labor-related, are geared specifically to fulfill a contracted goal. Direct costs also can include materials and equipment, subcontractor costs, and travel expenses directly related to the research project.

Indirect Costs

Indirect Costs are supportive expenses that buoy the success of the project and your organization. Generally speaking, Indirect Costs should not exceed 40 percent of the direct costs. 

These expenses include (but are not limited to) utilities, administrative labor costs, accounting fees, telephone and internet expenses, rent, employer’s portion of payroll taxes, some legal fees, and indirect labor, which refers to vacation, holiday, and sick time. 

Depending on the federal agency, Indirect Costs are often referred to as “Overhead (OH),” “General and Administrative (G&A),” or “Selling, General, and Administrative (SG&A).”

Both Direct Costs and Indirect Costs are considered Allowable under the federal government’s SBIR guidelines. As opposed to …

Unallowable Expenses

There are some expenses the government will absolutely not reimburse, as these components do not bestow any benefits on the federal agencies doling out the funds. Examples of unallowable expenses could include federal income taxes, donations, fines, penalties, and late fees, along with first-class travel and alcohol. 

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What are Indirect Rates?

Part of the accounting process when dealing with government-funded SBIR programs involves calculating your business’ Indirect Cost Rate. Your Indirect Rate determines the amount of money the government will award your entity for any Indirect Costs incurred during your SBIR project. 

Indirect Rates are unique to each small business and startup—this means you should never use another company’s Indirect Rate, and you should also readjust yours frequently. 

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Who is the Principal Investigator?

All ships need a captain, and in the world of SBIR programs, that individual is known as the Principal Investigator (PI). 

Every SBIR proposal must designate a single individual to take on the overall responsibility of the project, including all coordinating and executing efforts. This person must possess the education, work ethic, and project management experience necessary to see the project to the finish line. 

No matter the federal agency awarding the funds, the PI must be primarily employed by the small business in question during the award period. The PI cannot be used full-time anywhere else during the SBIR award process.

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What is Federal Acquisition Regulation (FAR) Part 31 in SBIR Accounting?

Earlier in this article, we discussed the potential for stiff penalties should your SBIR accounting not be in order. All government contractors—that is, for-profit companies that produce goods and services under contract with the government—need to know exactly which costs are reimbursable and how these costs should be accounted for. 

The Federal Acquisition Regulation (FAR) Part 31 (Cost Principles and Procedures) establishes the cost principles and procedures that guide small businesses in SBIR programs and government contractors. This set of protocols works to maintain consistency between the varied accounting methods used by contractors—and all funding applicants must follow these protocols so that federal agencies can swiftly review costs and approve reimbursements of appropriate expenses.

To be considered reimbursable under FAR Part 31, costs have to meet a set of criteria:

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  • Costs must be reasonable. The PI and their team need to ensure that materials and equipment are purchased at a reasonable price.
  • Funds must be appropriately allocated. Expenses are only reimbursable if you can prove that the cost is necessary and beneficial to the project.
  • Costs must be recorded and submitted. Expenses should be duly noted according to Cost Accounting Standards (CAS), a set of 19 government-authored standards.
  • Expenses should adhere to the terms of the contract. Costs that are expressly unallowable should be left out, with no exceptions. However, some questionable expenses are considered circumstantial and are subject to review.

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What are Firm-Fixed Price (FFP) and Cost-Plus Fixed Fee (CPFF) Contracts Under SBIR?

There are two primary forms of contracts used in SBIR programs: Firm-Fixed Price (FFP) and Cost-Plus Fixed Fee (CPFF). These types of contracts are awarded by the Department of Defense and other agencies that focus on construction, as opposed to other agencies like the National Science Foundation, which issues SBIR STTR awards in the form of grants. 

The differences between FFP and CPFF contracts boil down to when they apply (Phase I or Phase II) and how they define the reimbursement process.

Firm-Fixed Price (FFP)

For the most part, Phase I contracts are FFP. Under this contract, the government and the contractor (the small business) agree to a fixed price that cannot be adjusted no matter what costs befall the project. With FFP contracts, the contractor bears all the cost risk and must deliver the product even if it costs more than the amount of the contract. This means that all deliverables must be precisely accounted for.

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Cost-Plus Fixed Fee (CPFF)

Phase II contracts can be either FFP or CPFF, a cost-reimbursement contract. Under a CPFF contract, the federal agency reimburses the contractor for allowable costs, along with a fee. As such, a CPFF sees the government bear the bulk of the risk. However, the contractor must make satisfactory progress and deliver the end product described in the contract to earn the fee. 

There’s generally more government oversight at the completion of a CPFF contract, and an “incurred cost” audit is required before the fees are paid. And to be paid, the contractor must submit an approved invoice. This makes a CPFF contract more complex to administer while attaching more cost regulations for contractors to sort through. Another reason why a competent accounting system is a must!

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What is the Defense Contracting Audit Agency (DCAA), and How Does it Factor Into SBIR?

When a federal agency considers awarding you Phase II funding to continue your research, your company will be subject to an auditing process. Many of 11 federal agencies that dole out SBIR awards—except for the National Institutes of Health (NIH) and the National Science Foundation (NSF)—rely on the Defense Contract Auditing Agency (DCAA) to perform this auditing task. 

The DCAA includes two mandatory components in its evaluation:

  • An assessment of your company’s financial stability.
  • An evaluation of the adequacy of your accounting system. 

There are also two optional components that the DCAA might dig into:

  • An evaluation of the indirect rates you propose to charge on a Phase II project.
  • A confirmation that you are up-to-date on your payroll tax deposits. 

The DCAA offers a guide, Information for Contractors, to give small businesses a window into how these “pre-award surveys” are conducted. Though not specific to SBIR, this guide is helpful to any contractor with a pending government audit.

In terms of your accounting system, there are 10 requirements that you must meet to satisfy DCAA. Those requirements are:

  1. Proper segregation of direct costs from indirect costs.
  2. Identification & accumulation of direct costs by contract.
  3. Logical & consistent method for allocating indirect costs.
  4. Accumulation of costs under general ledger control.
  5. A timekeeping system.
  6. A labor distribution system charging direct and indirect labor appropriately.
  7. Interim determination of costs charged to a contract.
  8. Exclusion of unallowable costs.
  9. Identification of cost by contract line item.
  10. Segregation of pre-production from production costs.
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The one accounting requirement that seems to cause the most heartache among small businesses is #5—the dreaded timekeeping system. So let’s dig into that one a bit more.

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SBIR Agencies and Timesheets

There are horror stories about small businesses being unaware of the timesheet requirement until after the government auditor shows up and asks to evaluate indirect rate charges. Imagine the panic and utter despair of that situation!

Small businesses that receive federal contracts and grants must keep timesheets, with no exceptions. Without timesheets as part of your accounting arsenal, you have no way to prove how much of your employees’ time was spent writing proposals, preparing and updating commercialization plans, and more. And guess what? Your employees’ time is the most significant single indirect cost your small business will incur during the SBIR program.

And timesheets are not only required by agencies such as the Department of Defense (DoD), which issues awards as contracts. Even agencies that award funds in the form of grants, like the NIH and NSF, expect timecards as part of your accounting practices. 

Check out this example of an NIH timesheet to get an idea of what is expected of you and your team as you track your indirect costs.

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What is the Division of Financial Advisory Services (DFAS), and How Does it Relate to SBIR?

The Division of Financial Advisory Services (DFAS) is related to the NIH. Responsible for negotiating and establishing indirect cost rates, DFAS works exclusively with small businesses that receive federal awards from the Department of Health and Human Services (HHS), which deploys the NIH.

More specifically, the DFAS Indirect Cost Branch is responsible for calculating the federal awards from the HHS. The Indirect Cost Branch works with small businesses to zero in on reimbursement rates for contracts and grants, ensuring these figures are based on actual costs and are adjusted according to standards and rules as they are applied to SBIR programs.

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Working With Your SBIR Accountant and CPA

When word comes down that you’re about to receive an SBIR grant or contract, the excitement can overwhelm even the most seasoned innovative minds. After all, this is what you’ve been working toward for months, if not years! But that excitement is tempered when the government auditors come calling. 

There’s one surefire way to prove your SBIR accounting system and ensure that you and your team are entirely audit-ready—partner with an accounting firm with extensive experience in the world of SBIR programs and government contracts and grants. 

Most accounting firms and CPAs are general practitioners graced with a wealth of tax knowledge. However, most do not specialize in government award accounting. 

This means they aren’t well-versed in FAR Part 31 and have never represented a client during a pre-award audit with the DCAA or DFAS. They might also not understand the nuances of different indirect rate structures, nor do they know how to approach a government official when a structural error in an indirect rate is discovered.

Team 80 specializes in government contract and grant accounting. We have represented numerous companies during DCAA, and DFAS audits and know what to look for in negotiating incurred cost rate agreements. And yes, we know what to do when it comes to those ever-present SBIR project timesheets. 

Our systems, deployed and managed by government grant and contract experts, take the accounting specifics off of your desk. This empowers you to focus on the project and increases your chances of securing government funding for your innovative idea.

Team 80 Director of Governmental Accounting Ben Smith

Ben Smith

Director of Governmental Accounting

Ben has worked in and around small businesses for most of his career. But surprisingly, his professional path started in food service as a chef, not accounting. In 2009 he opened his own catering business. The accounting duties for the catering company fell on Ben’s shoulders, and that was when he realized accounting was a much better fit! Ben is passionate about helping small business owners make their companies successful and brings a highly varied set of experiences to the table to help in this pursuit. When he’s not crunching numbers, he can be found hanging out with his wife and their Miniature Pinscher Milo or pursuing his other passions, which include skiing, windsurfing, Brazilian Jiu Jitsu, playing guitar, and riding dirt bikes.

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