A government contract can be a major win in the aerospace and defense sector, but many companies jump in without realizing how complex the rules and requirements can be. From understanding the nuances of the Federal Acquisition Regulation (FAR) and relevant Cost Accounting Standards (CAS), to the standards set forth by numerous federal and state-level regulating agencies, the journey into government contracting demands strategic foresight, operational readiness, and expert guidance.
Before pursuing government contracts, it’s important to understand key compliance requirements to avoid costly setbacks.
Navigating FAR rules for cost reimbursement and contract terms
The FAR is a comprehensive set of rules issued and maintained by various federal agencies to govern the federal government’s purchasing process, ensuring that procurement procedures are standardized, consistent, and impartial. It provides a framework for determining which costs incurred by companies are reimbursable, particularly in cost-reimbursable contracts, where identifying and segregating unallowable costs is essential for compliance. To adhere to FAR requirements, your company must closely review contract provisions that reference the regulation, especially those concerning changes in scope, contract termination, payment terms, and the inspection, testing, and acceptance of goods and services. Resources for understanding and navigating the FAR are available through the Small Business Administration (SBA) and the acquisition.gov website, offering valuable guidance for federal contracting.
Cost accounting standards in federal contracts
CAS rules apply to negotiated federal contracts and subcontracts. It requires your company to determine whether full or modified CAS coverage is necessary — a process that can be complex. Modified CAS mandates compliance with four specific standards, while full CAS coverage involves adherence to 19 standards. To ensure transparency and accountability in cost reporting companies with federal contracts must submit overhead rate calculations using the Incurred Cost Electronically (ICE) form to the Defense Contract Audit Agency (DCAA) within six months after the end of their fiscal year.
DCAA audits and financial advisory services
The DCAA, operating under the Secretary of Defense Comptroller/CFO, provides audit and financial advisory services to the Department of Defense (DoD) and other federal entities involved in acquisition and contract administration. Using the FAR as its primary guideline, the DCAA conducts essential audits, including annual incurred cost and overhead rate audits, as well as pre-award accounting system audits, to assess a contractor’s financial practices and system reliability. In 2024 alone, the agency reviewed over $262 billion in defense contractor costs and issued more than 2,400 audit reports. When considering federal bids, your company should become familiar with the DCAA’s expectations and resources, including the DCAA Manual released in November 2023 and other guidance available on the agency’s website. Building a collaborative relationship with the DCAA is recommended, though you should also be prepared to challenge audit findings when appropriate.
State-level compliance
If you’re considering state contracts, it’s important to recognize that each state has its own agency, similar to the DCAA, that’s responsible for overseeing contract compliance. For example, Colorado’s Office of the State Controller includes the Central Contracts Unit, which collaborates with other agencies within the state to ensure contracts align with applicable laws, rules, and regulations. This office handles contract processing, develops model contracts and purchase order terms, monitors performance, and offers training and vendor support, with resources and bidding solicitations available on its website. If you’ll be operating in multiple states, each state will have distinct regulations and specific requirements. In addition to state websites, the SBA also provides helpful resources for identifying and navigating these agencies.
Yellow Book standards for audits
The Government Auditing Standards — commonly known as the Yellow Book due to its distinctive cover — is issued by the Comptroller General of the United States through the Government Accountability Office (GAO). It outlines Generally Accepted Government Auditing Standards, which guide auditors in conducting ethical and effective audits that serve the public interest. These standards cover three main types of audits: performance, financial, and attestation, and instruct auditors to report findings such as internal control deficiencies, noncompliance, fraud, and abuse. Whether a Yellow Book audit will be required depends on the specific contract and any applicable laws or regulations; for example, the Department of Energy mandates Yellow Book performance audits on its contracts when annual expenditures exceed $1 million for fiscal years beginning on or after Oct. 1, 2024. You should understand what auditors will examine. You can find the most recent version of the Yellow Book, updated in February 2024, on the GAO website.
Know your starting point
When considering government contracting your first step should be to undertake a candid assessment of your internal capabilities. Do you have personnel familiar with government financial reporting or operational compliance? Are your financial reporting systems equipped to handle federal and/or state requirements? Establishing this baseline helps you determine the level of support and system upgrades you’ll need. The government entity and nature of the contract you’re seeking will influence the complexity and unique requirements. Consult with professionals who work regularly in your area of focus to ensure you get all of the requirements covered.
Contract types matter
The type of government contract you pursue can significantly influence your compliance obligations. For example, a cost-reimbursable contract allows for reimbursement of allowable project costs but requires rigorous audits of overhead rates and strict adherence to the FAR and CAS due to the government assuming more risk. If you’re contracting under this model, you must maintain robust accounting systems to ensure compliance. In contrast, firm-fixed-price contracts establish a set price for goods or services regardless of actual costs incurred. This shifts most of the risk to you, incentivizing cost control and operational efficiency. While potentially offering more predictability to the government, fixed price contracts still require compliance with relevant procurement regulations, including applicable sections of the FAR.
Pre-award surveys: Your first compliance test
Before a contract is awarded, your company may be required to undergo a pre-award survey, which is a government review of your accounting systems, policies, and procedures. The survey typically includes evaluating purchasing systems, timekeeping protocols, and disclosure statements describing how transactions are processed. Many companies are unaware of these prerequisites, so prepare early and bring in the necessary expert advisory support.
Regulatory ambiguity: A hidden challenge
Unlike other accounting standards, the FAR and CAS often lack specificity. FAR Part 31, that governs cost allowability, is often misunderstood; its brevity and ambiguity leave room for interpretation, often complicating compliance. When working through these issues, be prepared to consult with experienced advisors to help guide your decision-making. Likewise, understanding what cost accounting standards apply to your contract is essential. For example, most aerospace contractors fall under modified CAS, which is less burdensome, but still requires thorough documentation and system alignment. If you’re new to government contracts, identifying gaps and implementing the necessary controls is a vital step.
A culture of compliance is essential
The importance of FAR and CAS compliance can’t be overstated. Failure to comply can result in payment withholdings, contract cancellations, or demands for repayment of disallowed costs. These consequences can disrupt cash flow and jeopardize business continuity.
Organizational buy-in to an environment of compliance is crucial. Those who oversee compliance must have full support from leadership and all operational teams to ensure protocols are enforced across the organization. Setting the tone at the top has never been more important.
Given the potential severity of potential penalties, continuous monitoring is essential. Implement rigorous internal compliance programs, ideally staffed by professionals with government certifications or experience. Where resources are limited, CFOs or controllers may assume this role, preferably with strong outside support. Key areas of focus include:
- Segregating allowable vs. unallowable costs.
- Differentiating direct vs. indirect expenses.
- Ensuring proper timekeeping and expense recognition controls.
Leverage government experience, where possible
Given the potential pitfalls described above, companies employing former government employees or veterans on staff often have a meaningful advantage in this space. Their familiarity with federal processes and expectations is invaluable. Even if you don’t have this expertise within your full-time staff, bringing in these insights as contract advisors can help you navigate proposals and compliance successfully. Likewise, specialized firms can assist with RFPs and system navigation. Regardless of how you meet your personnel needs, it’s essential that your internal staff fully understands the contract requirements.
From readiness to results: Thriving in government contracts
Government contracting offers immense opportunities, but only for those prepared to meet its demands. By understanding the regulatory framework, investing in the right systems and people, and fostering a culture of compliance, your company can position itself for long-term success in the government marketplace.
