This is a fictionalized case study of one company’s experience.

The Road to Compliance

My nanotechnology startup had been soaring with multiple Phase II SBIR awards totaling over $2 million. Recently, we hired a government funding compliance expert to review our business in preparation for our first mandatory audit, which is required because we received and expended more than $1 million in grant funds. I must confess that until I read a few articles on grant compliance, I didn’t realize what I didn’t know. My company was doing basic regular accounting in QuickBooks. When we started the business, we used one of the basic templates for service companies that comes with the software. We made no changes to the template. We did set up some projects as jobs, but that was the extent of our customization.

Consultant’s Initial Findings

After the consultant’s initial review, I knew we were in big trouble. Her findings included:

• Failure to segregate costs, direct, indirect, unallowable, etc.
• Failure to identify costs by project/award/customer.
• False Claims and labor rate inflation in the proposal, with salary amounts at the NIH Salary Cap. The actual salary amounts are about one-third of the budget amounts. Unfortunately, we billed at the budget rates.
• Expenditures by project, exceeding approved funding amounts billed to the government (e.g., travel budget: $5,000, invoice/drawdown amount: $12,000).
• PI is employed full-time at a university and only works for the company 20 hours per week. The level of effort is 100%, so the full salary amount is being charged to the grants.
• Projects showed unallowable costs charged.
• Indirect rate calculations included unallowable costs.
• Grant funds have been used as working capital when the company has experienced cash flow shortages, allowing it to cover its complete payroll and other expenses.
• Inadequate timekeeping, recordkeeping, internal controls, and systems.

We had just started implementing the consultant’s corrective action plan to ensure compliance going forward and to calculate the impact of the incorrect accounting and other mistakes. Unfortunately, we were unable to correct many of our compliance failures. We could, however, repay the funds we had drawn down inappropriately. Our goal was to make that correction with our next invoices. We had our fingers crossed that the dollar amount to credit would not exceed the invoice balances.

Times Up: The Audit That Shattered My World

It was a sunny afternoon. I was feeling good about getting our business compliant. Then the DCAA (Defense Contract Audit Agency) audit notice landed in my inbox, and my heart sank. I didn’t expect to be audited by the DCAA. I knew we had to bring in a qualified, independent audit firm to conduct a Yellow Book audit. On the first day working with our consultant, I recall her explaining the different types of audits, including pre-award, invoice, timekeeping, indirect rates, Yellow Book, program-specific, and others. I guess I didn’t understand that any or all of them could happen.

The auditors arrived and discovered what we had recently learned from the compliance expert. The auditors acknowledged that we were working towards compliance. Unfortunately, that was too little, too late. After completing our analysis and calculation of the excess funds we had drawn due to incorrect rates, allowable costs, and other factors, we found that the amount owed equalled the equivalent of the last three monthly invoices. As a result of our inadequate (non-existent) compliance efforts and systems, the auditors alleged fraud, violations of the False Claims Act, and misuse of funds. Upon receipt of the audit report, all agencies terminated all our grants for cause.

That day, I learned a brutal truth: laziness isn’t an option, and ignorance isn’t a defense. Investing in compliance upfront is the right decision. It would have saved our company and reputation.

The High Price of Careless Accounting

Government grants are game changers for startups. They provide much-needed funds that, if you comply and deliver outcomes, don’t have to be repaid. However, they also require you to invest time, effort, and funds in establishing compliant business systems and processes, training your team on rules, and ensuring you have sufficient non-government funds to keep the business going.

The requirements demand professional business practices and management. The program rules and regulations essentially accelerate the implementation of systems and processes that you would need as your business matures.

My Crash Course in Consequences

When we won that SBIR grant, I was all about the science, not the spreadsheets. I used a generic accounting app, adding expenses without considering justification or accuracy, including $5,000 for “lab stuff,” and logging hours as “miscellaneous.” I didn’t bother learning DCAA-compliant system requirements, such as timekeeping and segregating direct and indirect costs. Why spend time on details? As the director of a local incubator told me, “It’s not rocket science. It’s just math.” She was so wrong.

However, when the audit arrived, we were unable to document project costs, and our non-compliant system raised significant concerns. The awarding agencies didn’t just pull our funding—they flagged us for potential fraud, fines, and a criminal probe that destroyed us. (The audit failure also resulted in investors exercising their rescission rights. They wanted their money back.)

Why Precision and Compliance Matter

Why is careful, compliant accounting non-negotiable? First, it ensures accountability. Agencies require accurate transaction records with specific details—such as date, amount, and purpose—tied to project tasks. Careless entries, like vague categories, fail audits. Second, a compliant accounting system organizes data in a manner that facilitates oversight and audits. Third, compliant systems with robust internal controls mitigate the risk of fraud. Failure to establish the required compliance and systems may be deemed “willful” errors. The terms “willful,” “knowing,” and “intentional” elevate your mistakes into criminal actions. So, laziness and ignorance don’t excuse violations—they amplify them, costing you fines, jail time, or your reputation.

A Simple Grant Accounting System to Stay Compliant

You don’t need to be an expert to get this right. You can hire the expertise and start with a compliant accounting and timekeeping systems. Additionally, it is a straightforward process to maintain records of every transaction, including the date, vendor, project task, and save receipts in a digital folder. You can easily review entries weekly to catch errors. Again, laziness isn’t an option, so build good habits: log transactions daily and attach a digital copy of supporting documentation to the transaction in your accounting system or a cloud-based digital folder.

Overcoming the “It’s Not My Job” Mindset

You might think, “I’m an innovator, not a bookkeeper—accounting’s too tedious!” I felt that, too; it cost me my grant and business. It nearly cost me my freedom. Sloppy records aren’t a shortcut—they’re a trap. Imagine facing a fraud charge because you forgot to keep a receipt. Now imagine the relief of a clean audit, opening doors to bigger grants. Precision isn’t a burden. It’s your ticket to success.

Your First Step to Grant Accounting Compliance

Start now, before it’s too late. Take these steps to move toward compliance.

• Gather supporting documentation for all transactions:
  • Invoices
  • Receipts
  • Contracts and agreements
  • Timesheets
  • Bank and credit card statements
  • Expense reports
  • Other third-party documents.
• Review your existing accounting software to determine if it has project tracking and cost segregation capabilities, and how these features work. Today, most systems offer project/job tracking, class/department/segmentation, customizable chart of accounts, tags, and other features that enable you to meet requirements.
• Compile your company’s written policies and procedures.
• Consult with your bookkeeper, accountant, and other advisors to understand what they know and what they are unsure of.
• Reread your award documents and the program requirements associated with each award and agency.
• Consult a qualified expert to guide you through the compliance process.

From Chaos to Clarity

That audit didn’t just kill my grant and business. It nearly broke me. But it taught me that careful, compliant accounting isn’t a burden—it’s empowerment. When you know you are compliant, your stress level goes down. You don’t need to worry about when the next audit will occur.

Compliance is the discipline that protects your innovation and livelihood. Build your company’s business processes to comply with government funding requirements, as well as securities, tax, and other requirements. One of the most essential aspects of your story is integrity. When you’re known for doing things the right way, you have a competitive advantage in everything you do.