Step 8: Month-end Close

MEETS THE FOLLOWING DCAA REQUIREMENTS

Interim (at least monthly) determination of contract costs posted to a book of accounts
Accounting system in accordance with GAAP

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Synopsis

We discuss why DCAA insists that you close your books on a monthly basis. The difference between cash basis accounting and accrual basis accounting is discussed. We provide a sample closing checklist and highlight important reconciliations that are required for DCAA compliance.

Monthly Closes

What does it mean to "close your books"? In the days before computerized accounting systems, accountants wrote their entries into actual books. At the end of the month, after all entries were made, the books for the month were physically closed, shut tight, even locked away by the controller, to prevent any further entries. A new set of books were then opened for the new month.

Why was it (and still is) so important to prevent changes to the previous month's books? Once financial statement were produced and published, the supporting documentation for those statements was the set of physical books, which had been closed and locked away in the controller's office. Later, during the company's audit, the books would be re-opened and examined. To pass the audit, the numbers in the books needed to match the numbers on the financial statements.

Today's computerized accounting systems have eliminated much of the tediousness of keeping accounting records. But this same technology has also made it almost too easy to change data in previously closed periods. Fortunately, Quickbooks has a feature that allows you to "close" the books to prevent accidental changes to previous months. You are able to set a "closing date" and password protect transactions that are dated on or prior to the closing date.

To set the closing date in Quickbooks, navigate to "Preferences" and select the "Accounting" screen.

Why It Matters to DCAA

Why does it matter to DCAA that you close your books on a monthly basis? After all, many small businesses close their books only once a year, at the end of the year, to prepare taxes.

Accuracy. Your books will be more accurate with monthly closes. Accounting errors will be discovered and corrected more quickly.
Period of Performance. Government contracts can start and stop on any day of the year. To bill your government contracts accurately, you'll need to record and reconcile your accounting data for each billing period. Fortunately, most government contracts are billed on a monthly basis, so at a minimum DCAA requires a monthly close.
Indirect Rates. You'll need to monitor your indirect rates on a monthly basis. If you have a Cost Plus type contract and bill your indirect rates, any large variance in your actual rates compared to your provisional rates will need to be reported to your contracting officer and possibly adjusted.

Cash Basis vs. Accrual Basis Accounting

Most small businesses maintain their books on a cash basis, because most small businesses file their taxes on a cash basis. Maintaining their books on a cash basis makes sense for a lot of small businesses because there is no need to convert their books from accrual basis to cash basis at year end in order to prepare taxes.

DCAA, however, requires that your books are kept on an accrual basis. What is accrual basis accounting, and why does DCAA require accrual basis accounting?

Accrual basis accounting differs from cash basis accounting in that transactions are recorded when they have an economic impact on the company, regardless of the timing of cash receipts or expenditures. The concept behind accrual basis accounting is to have financial statements represent the true economic value of the enterprise regardless of cash flow timing.

Here are a few examples. In accrual basis accounting, you recognize revenue when you earn it, which can occur before or after you invoice your customer or collect cash. In cash basis accounting, you recognize revenue when you receive the payment from your customer. As another example, in accrual basis accounting, you recognize an expense when you incur it, which again occur before or after you actually pay for the expense. In cash basis accounting, you recognize and expense when you actually pay for the expense.

Accrual basis accounting is concerned with the "matching principle". The idea is that you "match" expenses to revenue in the same period, usually a monthly period. In other words, if you have recognized revenue in a given month for a particular contract, the expenses that relate to that contract revenue must be identified and recorded in the same period. In this way, the income earned (revenue minus expense) will be accurately reflected on the income statement.

So, why does DCAA care? DCAA requires accrual basis accounting to ensure that the invoices you submit to the government include all the revenue and expenses incurred, regardless of the timing of when you pay your bills or receive payments. Your contracts will have a funding limit or ceiling against which you can bill but you should not be bill in excess of funding. The government wants to know as soon as possible what your total billings will be so that you do not bill over the funding ceiling, and accrual basis accounting provides a more accurate method of accounting for all of your expenses and creating accurate invoices than does cash basis accounting.

Another reason why DCAA cares about accrual basis accounting is that your indirect rates are calculated based on your fiscal year, which is typically the calendar year. To accurately calculate your indirect rates at year end, accrual basis accounting provides a higher level of precision because the amount of expense that is recognized is not determined by cash flow.

Important Month-end Reconciliations

When closing the books for a typical commercial enterprise using the cash basis method of accounting, the month-end reconciliations may be limited to reconciling the bank and credit card accounts, which is a fairly straight forward and simple process. However, for a government contractor, additional reconciliations need to be performed to meet DCAA compliance.

Unbilled receivables. If you are not able to bill out all of your revenue in a given month, you may need to record the unbilled portion of revenue as unbilled receivables. When the revenue is eventually billed, you'll need to credit the unbilled receivable and maintain a reconciliation schedule.
Prepaid and accrued expenses. Since you will be recognizing expenses as they are incurred, rather than when they are paid, you may need to record expenses in either a prepaid account or an accrued expense account. Reconciliation schedules should be maintained for these accounts.
Payroll and labor distribution. You will be recording your payroll expense in your accounting system to various billable jobs, paid leave, and indirect functions such as overhead and G&A. Each month you will need to reconcile your payroll to this labor distribution.
Job ledger. Since you are required to record your expense by contract, you'll need to reconcile your job ledger to your general ledger each month to ensure that all job costs have been recorded.
Items. Your requirement to track funding, billing and costs by contract line item (CLIN) and labor category will be achieved through the use of the Item feature in Quickbooks. The Items will then need to be reconciled to your job ledger to ensure accuracy.
Booked vs. Billed. Each month you will need to analyze all billings to the government and compare the billings to the cost and hours recorded in Quickbooks to prevent overbilling or underbilling the government.

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