Step 2: Customer and Project Setup
meets the following DCAA Requirement:
- Identification and accumulation of direct costs by contract
- Segregation of preproduction costs from production costs
In this article, standard setup of customers and jobs are discussed and a sample setup is created for the most common types of federal contracts. We discuss the definition of direct versus indirect costs with examples relevant to your business. Billing levels are examined and their relationship to contract funding, extensions, option years and modifications. Contract briefs are discussed and an excel template is provided.
Definition of Direct versus Indirect Costs
It is important to understand the concept of direct and indirect costs so that you may properly code transactions in your accounting system. Failure to properly segregate your costs between direct and indirect costs will cause you to fail a DCAA audit.
Direct costs are costs that can be identified to a single contract, regardless of whether the cost is billable or not.
Indirect costs are normally divided into three categories, although there may be more.
- Fringe costs consist of employee benefit insurance, payroll taxes, paid leave and other employee benefit programs.
- Overhead consist of shared contract expense which is shared among two or more contracts.
- G&A expense consists of general and administrative expense incurred to manage and operate the company as whole and is not related to contract performance.
Projects are set up in the Customer Center and the Item screen. Let's first address the Customer Center. There are two basic levels available in the Customer Center; Customer and Job. Up to five levels can be entered in a hierarchy. Give some thought to how you will set up your projects in the Customer Center. Once you start to record customer payments by applying payments to invoices, changes to your set up will become more difficult.
Given that you can set up five hierarchical levels in the Customer Center, you will want to consider several factors. Billing level is your first consideration. At which level will you create an invoice? The second consideration is funding. How is your contract funded? The third consideration is cost collection. Do you need to set up a work breakdown structure (WBS) to collect costs in a certain way to create financial reports? Your final consideration is contract line items (CLINs). Will you track your costs by CLIN at the project level, or at that line item level on an invoice? To summarize, your basic structure in setting up a contract must address:
- Billing level
The Item screen ties your billings to your costs, a DCAA requirement, which requires that you can provide cost data, by unit, for each item that is billed. At a minimum, you'll need to create an Item for each contract CLIN because funding will be entered at the CLIN level. When you record your invoices, you'll select the appropriate Items. When your record your costs, you'll select the Item that you will use when billing. Items are built using a hierarchy, like the Customer Center, which is five levels deep. To some extent the hierarchy will mimic the set up in the Customer Center, but then branch off to provide additional billing and cost collection detail. Considerations include funding, WBS, labor categories, and CLINs.
By combining the power and flexibility of both the Customer Center and Items, you will be able to create a project set up that will meet the requirements for any federal contract that you will encounter. Regardless, project set up can be a complex subject. To address this complexity, we will look at specific types of contracts and recommended set up protocols.
T&M service Contracts
Time and Material (T&M) contracts are utilized to purchase labor services and incidental non-labor expenses. A fixed hourly bill rate is negotiated and the customer is billed this rate for each hour of work that is performed. The "Material" in a T&M contract can be any other non-labor cost, such as travel or other miscellaneous expenses. The "Material" is billed at actual costs. Occasionally, the "Material" price may be marked up with G&A and/or Fee.
The fixed hourly bill rate is set for a specific labor category. For instance, a labor category of "Senior Engineer" will be billed at the contract bill rate. T&M contracts may have multiple labor categories each with their own bill rate. Therefore, it is important to set up the labor categories in Quickbooks.
In this example, we will set up a standard federal contract with a base year and four option years. The T&M contract will have several labor categories with fixed bill rates. Each bill rate will increase in the option years.
Step 1: Set up the Customer Center to include a customer, and then as jobs, a contract, a base year, and four option years, in the hierarchy displayed below.
Step 2: Next, set up the Items in the Item screen. You will follow the same hierarchy as in the Customer Center, but extend the list to include the contract line item number (CLIN), and the labor categories. Include the bill rate and if a staff member is a 1099 or subcontractor, set the COGS account to Direct Subcontractors.
Fixed Price Service Contracts
The most common fixed price contract you'll encounter if you provide services to the federal government is one that allows you to bill a fixed monthly rate for the services you are providing. You will estimate the number of hours of service provided over the length of the contract, multiply the number of hours by the price per hour, and then divide by the number of months that you provide the service, resulting in the price you will bill each month.
Firm fixed price (FFP) service contracts are issued when the level of effort can be easily determined. For instance, the contract may fund one or more full-time equivalents (FTEs) to provide full time support under a certain labor category.
A spin on the fixed price service contract is the fixed price level of effort contract (FP/LOE). This type of contract is typically billed at a fixed monthly rate, but certain minimum levels of hours provided must be met or otherwise a price adjustment is made.
With both fixed priced and fixed price/level of effort contracts, it is wise to track hours by labor category. With FP/LOE this requirement should be obvious since your contract could be adjusted if you do not provide the minimum number of hours. For FFP contracts, the need is not as obvious, but if you were to propose a modification to increase funding, or if the federal agency proposes a modification to decrease funding, you'll need the historical labor data for negotiations. For this reason, it is recommended that you set up your contract in the same manner as a T&M contract. However, when you record your invoice, you will do so at the CLIN level, not the labor category level.
Cost Plus Fixed Fee (CPFF) ContractS
Cost Plus Fixed Fee contracts are the most common type of cost-reimbursable contracts that you'll encounter in federal contracting. You may also come accross Cost Plus Award Fee (CPAF), Cost Plus Incentive Fee (CPIF) and Cost Sharing (CS) contracts, which are all handled in Quickbooks in essentially the same manner.
Step 3: The Customer Center is typically set up in the same manner as in Step 1 above. The Item Screen, however, will be significantly different due to the manner in which cost-reimbursable contracts are invoiced. The Item Screen will need to break out the direct cost elements, the indirect pools, and the fee.
A contract brief is a summary of the contract and accounting data compiled into a short excerpt. The contract brief is required to be submitted to DCAA as part of your Incurred Cost Proposal. It also aids you in contract administration and contract setup, especially in tracking your contract modifications and funding.
Download this free sample of the contract brief: