Understand the Hidden Risks When Changing Accounting Systems

Important Considerations Regarding Data Migration and Archiving
Many government contractors are moving to cloud-based ERP/Accounting solutions as these systems offer a broad array of benefits. Government contractors must be keenly aware of the impact changing accounting systems may have on their accounting practices, procedures and compliance with government regulatory requirements. This article will frame the situation and the issues you should consider if you are planning to change accounting systems.

Accurate, Complete and Reliable
Government contractors are subject to specific regulations surrounding their accounting system’s capability to provide adequate, reliable data for supporting historical costs and pricing of follow-on acquisitions. As requested (normally) by a Contracting Officer (CO), the Defense Contract Audit Agency (DCAA) will examine a government contractor’s accounting system to determine whether capabilities exist and whether the Government may rely upon it.  The Defense Federal Acquisition Regulation Supplement (DFARS) stipulates 18 criteria that the system must provide (DFARS 252.244-7006) to be deemed adequate, which is used to evaluate both Department of Defense (DoD) and non-DoD contractors’ systems.  We summarized these 18 criteria into five major capabilities:

  1. Internal control environment over approval, structure, access, monitoring and policies
  2. Segregation of direct and indirect costs on a monthly basis for allocation to projects
  3. Reporting costs under general ledger control, subsidiary cost ledger and transactional details
  4. Timekeeping and labor distribution of direct and indirect labor costs
  5. Compliance with contract terms, conditions, regulations and other laws

If the accounting system can perform these operations satisfactorily, DCAA will issue a report to the administrative CO stating that the accounting system is adequate. With the auditor’s opinion, the CO will make a final determination and notify the contractor in writing. Contractors with this determination/approval can substantiate their claimed costs to seek reimbursement, plus indicate their systems’ approved status in response to requests for proposal (RFP).

Unknown (And Costly) Risks
If a government contractor migrates to a new accounting system and the data from the old system has not been properly archived and transferred, the “deemed adequate” status as described above is no longer valid.  The contractor is no longer using the same accounting software that was in place during the audit of the internal controls over the identification, capture, allocation and reporting of those costs.  An accounting system is intertwined and codependent on the information system’s controls to classify, accumulate and report incurred costs. CO’s run great risk by accepting outdated audit reports of accounting systems, when the accounting software, which is an integral part of the overall system’s control mechanism, has changed.

Contractors must either have the system re-audited or face the risk of the new accounting system’s status being regarded as “not evaluated” in contract business analysis repository (CBAR) [DCMA-INST 131 (IPC-1), Dec 1, 2015)]. A “not evaluated” accounting system factors into whether a CO may award contracts which are awarded based on costs. This includes cost-plus fixed fee; cost plus award fee; cost sharing; Time & materials with a cost reimbursable component; fixed price with progress payments based on costs and fixed price incentive fee contracts.

Movement to Cloud-Based Accounting
Up until recently, most software was acquired via a perpetual license, where the company owned the software (license).  When the software resided on company servers, there was no problem archiving the data if they moved to a new software application because they owned that software license. Today, an increasing number of companies are moving to the cloud where they lease the software via a subscription.  Therefore, in a cloud-based model, companies do not own the software license.

When migrating from an “on premise” (owned) application to a “cloud-based” (leased) application, companies must consider (1) how to archive their legacy system’s data, and (2) whether to migrate some or all of their historical data to the new accounting system.  Either way, source documents must be preserved to confirm the costs that have previously been billed to the government. Keep in mind that the legacy system is still the system of record and DCAA auditors will perform their audit procedures against this data regardless of whether historical data was migrated to new accounting system.

If contractors change accounting systems, they might not have the actual source documents or the initial transactions that occurred because of the change. Contractors must ensure they have access to that information so that if audited, the supporting source documents are readily available.  If supporting documents are not provided, and the DCAA questions those costs, contractors might not be reimbursed for and, thus, lose money that would otherwise be allowable and reimbursable.

Record Retention Requirements
Federal Acquisition Regulations 4.703 (FAR) requires contractors to make available records and other supporting evidence to satisfy contract negotiation, administration and audit requirements for three years after final payment, or the period specified in FAR 4.705-4.705.3, whichever period expires first.  However, contractors may be required to make records available for a longer period if, required by contract or if the contractor did not file their incurred cost submission in a timely manner.

Consultative Wisdom and Direction
While selecting a new accounting system and developing an implementation plan presents numerous inherent challenges, government contractors must also:

  • Evaluate continued adherence to regulatory requirements
  • Determine how to handle the loss of approval of their accounting system
  • Determine if an accounting practice change will occur
  • Determine how to access historical data

Reach out to WiJiT before you consider a move to a new accounting system.  We can walk you through the process and insure you consider all areas that can impact the business of a government contractor. WiJiT has deep government contracting experience and has guided many contractors through the inherent risks of moving to a new accounting system.

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