Accounting for government contracts is unique because many of their contracts are cost reimbursable. That is, you are reimbursed based on costs you incur in performing the contract. This requires your accounting to be set up so as to facilitate verification of your costs. The government does this by conducting audits.
Compliance means being able to demonstrate that the costs you claim to have incurred were in fact incurred and that the prices you present in your invoices or cost proposals are based on the actual costs you incurred as appropriate.
The government agency with whom you do the bulk of your business is responsible for conducting compliance audits. The Defense Department uses the Defense Contract Audit Agency, or DCAA for short. Some other departments also use DCAA. Some departments have their own internal agency.
During an audit, the government first asks for reports that display your costs in a format that permits them to be analyzed. Next they do spot checks to insure you have paper back up for the costs on your reports including time sheets, contracts, tax returns, vendor invoices, etc… Last, they look at the internal procedures and controls you employ to insure the integrity of your data.
