The Taxpayer Times

SF 1408 Explained: What an “Adequate Accounting System” Really Means

In the earlier articles in this series, I introduced what a DCAA audit is and what the government actually reviews. At this point, many contractors start hearing a specific phrase that feels more intimidating than it needs to be:

“Do you have an adequate accounting system?”

That question is commonly tied to SF 1408, a form used by the government to evaluate whether a contractor’s accounting system is capable of handling certain types of federal contracts.

This article explains what SF 1408 really represents, when it comes into play, and what “adequate” actually looks like for small and growing government contractors.

What Is SF 1408?

SF 1408 is a pre-award accounting system evaluation tool. It is often used when the government or a prime contractor acting on the government’s behalf needs assurance that a contractor can properly track and support costs before awarding certain contracts.

The form itself is not the goal. The system behind it is what matters.

At its core, SF 1408 asks one question:

Can this contractor’s accounting system reliably track, classify, and support costs charged to the government?

This evaluation is commonly associated with the Defense Contract Audit Agency, but the underlying concepts are used broadly across federal contracting when cost visibility matters.

When SF 1408 Typically Comes Up

Not every contractor will face an SF 1408 review immediately. It most often appears when:

• A contract involves cost-reimbursement, time-and-materials, or labor-hour pricing
• The government wants assurance that the billed costs can be supported
• A prime contractor is vetting a subcontractor’s system
• A contractor is transitioning from commercial work into government contracts

For small contractors, this can feel sudden. One day, you are focused on proposals and capability statements. Next, you are asked whether your accounting system is “adequate.”

Understanding what that means ahead of time removes much of the anxiety.

What “Adequate” Really Means (In Practical Terms)

An “adequate” accounting system does not mean:

• Expensive software
• A large accounting department
• Complex processes designed for large defense contractors

It means the system can do certain fundamental things consistently.

Below are the core capabilities the government is looking for:

1. Separating Direct and Indirect Costs

The system must clearly distinguish:

• Direct costs: expenses that can be tied to a specific contract or project
• Indirect costs: general business expenses that support multiple activities

The issue is not how many cost categories you use. The issue is whether similar costs are treated the same way every time.

Problems often arise when costs shift between direct and indirect, depending on convenience rather than policy.

2. Accumulating Costs by Contract or Job

Your accounting system must be able to answer a simple question:

How much did this specific contract cost us?

That means:

• Costs are tracked by job or contract
• Labor, materials, and other expenses are assigned correctly
• Reports can be generated without reconstructing history

Even small contractors need job-cost visibility once government funds are involved.

3. Tracking Labor Through Timekeeping

Labor is often the largest cost component in government contracts.

An adequate system must show:

• Hours worked
• Where those hours were charged
• That time was recorded consistently and timely

The concern is not how many hours were worked. The question is whether labor costs can be traced from timesheets to payroll to the accounting records.

4. Recording Costs Accurately and Timely

Timing matters.

Costs should be:

• Recorded in the correct period
• Posted regularly, not months later
• Supported by source documentation

Delays and after-the-fact corrections create gaps that are difficult to explain during reviews.

5. Supporting Government Billing Requirements

Even if you are not billing the government yet, the system must be capable of:

• Producing reliable cost data
• Supporting future invoices
• Withstanding review after costs are incurred

An accounting system that only works for tax filing purposes often needs adjustments before it can support government billing.

What SF 1408 Is Not

Understanding what SF 1408 is not helps contractors avoid unnecessary stress.

It is not:

• A judgment of business success
• A test of profitability
• A requirement to mirror large defense contractor systems

It is simply a structured way for the government to confirm that costs can be trusted.

Where Small Contractors Commonly Struggle

Most SF 1408-related issues arise from habits formed before government work begins.

Common challenges include:

• Mixing personal and business transactions
• Inconsistent cost classification
• Informal timekeeping practices
• Systems designed only for tax compliance
• Documentation that exists but is not organized

None of these issues implies bad intent. They usually reflect growth outpacing structure.

Preparing Early Makes Everything Easier

Contractors who prepare early often find that SF 1408 reviews are far less disruptive than expected.

Early preparation allows you to:

• Address gaps calmly
• Build systems intentionally
• Avoid last-minute fixes under proposal pressure

Most importantly, it shifts readiness from a reactive scramble to a controlled process.

Looking Ahead in the Series

SF 1408 touches multiple areas, but each deserves its own discussion. In the upcoming articles, we’ll take a closer look at:

• Timekeeping systems and common pitfalls
• Direct vs. indirect cost treatment in practice
• Internal controls that make sense for small businesses
• How systems break down as contractors grow

Each topic will build forward, no backtracking, no repetition, so that contractors can develop understanding step by step.

Key takeaway:

SF 1408 is not about perfection. It is about whether your accounting system can consistently support the story your numbers are telling. When the structure is there, everything else becomes easier to manage.