Phase II is a major step for an SBIR/STTR company.

 

The award is usually larger. The technical work is more complex. The team may need to hire, manage consultants, work with subcontractors, purchase materials, track indirect costs, submit invoices or drawdowns, and prepare for more detailed financial review.

 

That means the accounting system needs to be stronger before the award begins.

 

A setup that worked during Phase I may not be enough for Phase II.

 

Before the award is issued or performance begins, founders should review project costing, timekeeping, labor distribution, indirect rates, unallowable costs, billing support, drawdown records, and documentation.

 

At Peter Witts CPA PC, we help SBIR/STTR companies prepare for Phase II accounting readiness so financial systems, labor records, indirect rates, billing support, and documentation are stronger before award pressure begins.

 

Why Phase II Accounting Readiness Matters

 

Phase II often brings a different level of scrutiny.

 

SBIR.gov explains that SBIR/STTR agencies are generally lenient about accounting systems in Phase I but become more stringent in Phase II. It also notes that Phase II may involve a closer look at documentation, financial stability, accounting systems, indirect rates, and payroll tax deposits when applicable.

 

Phase II readiness matters because the company may need to support:

• Larger award budgets
• More direct labor
• Founder compensation
• New hires
• Consultants
• Subawards or research partners
• Materials and supplies
• Travel or equipment
• Indirect rates
• Drawdowns or invoices
• DCAA or agency review
• Budget-to-actual reporting
• Closeout records

The time to fix accounting gaps is before Phase II begins, not after the first invoice, drawdown, or agency question.

 

Start With the Phase II Award Type

 

Phase II awards are not all the same.

 

Before updating the accounting system, confirm what kind of Phase II funding the company is pursuing or receiving.

 

The award may be:

• A grant
• A cooperative agreement
• A fixed-price contract
• A cost-reimbursable contract
• A cost-plus-fixed-fee contract
• A milestone-based award
• A reimbursement-based award
• A DoD Phase II contract
• An NIH, NSF, DOE, NASA, or other agency award

SBIR.gov notes that the largest hurdle for contractors new to cost-reimbursement contracts, such as DoD Phase II SBIR/STTR contractors, is often passing the pre-award accounting system survey.

 

The award type affects how costs must be tracked, billed, supported, and reviewed.

 

Fix Project Costing First

 

Project costing is one of the first areas founders should fix before Phase II.

 

The accounting system should be able to track costs by award, project, phase, contract, task, or cost objective.

 

At minimum, the system should separate Phase II costs from:

• Phase I costs
• Other federal awards
• Internal R&D
• Commercial product work
• Customer-funded pilots
• Fundraising
• Sales and marketing
• General business activity
• Unallowable costs

SBIR.gov explains that a strong accounting system should differentiate direct costs from indirect costs, isolate unallowable costs, and maintain costs under general ledger control.

If Phase II costs are tracked mostly in spreadsheets, email folders, or manual summaries, the company should strengthen project coding before the award begins.

 

Set Up Phase II Project Codes

 

Phase II should have its own project code.

 

Depending on the accounting system, this may be called a class, job, project, customer, contract, grant, department, tag, or cost center.

 

The project code should allow the company to produce reports showing:

• Direct labor
• Fringe benefits
• Materials and supplies
• Consultants
• Subawards
• Travel
• Equipment
• Other direct costs
• Indirect costs
• Drawdowns or invoices
• Cost transfers
• Remaining budget

If the company has multiple awards or commercial activity, each should have its own code.

 

A single “R&D” code is usually not enough for Phase II readiness.

 

Map the Approved Budget to the Accounting System

 

Founders should not wait until reporting season to realize the books do not match the budget.

 

Before Phase II begins, map the approved or proposed budget categories to the chart of accounts and project reports.

 

Review:

• Direct labor
• Fringe
• Consultants
• Subcontracts or subawards
• Materials
• Supplies
• Travel
• Equipment
• Other direct costs
• Indirect costs
• Fee or profit, if applicable
• TABA, if applicable
• Cost share, if applicable

The company should be able to compare actual costs to the approved budget by category.

 

If that report cannot be produced from the accounting system, the setup should be improved before costs are incurred.

 

Fix Timekeeping Before Labor Begins

 

Timekeeping is one of the most important Phase II controls.

 

Phase II often involves more employees, more technical work, more founder involvement, and more shared activity across federal and commercial projects.

 

SBIR.gov identifies timekeeping as one of the accounting system requirements and explains that timesheets help document time spent across business activities, proposal work, commercialization planning, and other non-client activities.

 

Before Phase II begins, founders should confirm that timekeeping can show:

• Employee name
• Date worked
• Hours worked
• Phase II project code
• Direct award labor
• Indirect labor
• Non-award labor
• Founder time
• Commercialization activity
• Fundraising or investor activity
• Internal R&D
• Supervisor approval
• Corrections or adjustments

The company should not reconstruct time after the fact.

 

Founder Time Needs Clear Coding

 

Founder time often becomes more complex in Phase II.

 

A founder may work on technical development, hiring, investor calls, customer discovery, commercialization, general management, proposal work, and Phase II project management in the same week.

 

Before the award begins, define how founder time will be coded.

 

Separate:

• Direct Phase II technical work
• Phase II project management
• Indirect company management
• Fundraising
• Sales and customer activity
• Commercialization outside the approved scope
• Internal R&D
• General operations

Founder time should be charged to Phase II only when it supports the approved Phase II work and is supported by timekeeping, payroll, labor distribution, and the approved budget.

 

Fix Labor Distribution

 

Payroll records alone are not enough.

 

A Phase II-ready company should be able to show how payroll costs move from timesheets to the general ledger.

 

Labor distribution should connect:

• Timesheets
• Payroll records
• Employee compensation
• Direct labor
• Indirect labor
• Non-award labor
• Fringe benefits
• Project codes
• General ledger accounts
• Indirect rate schedules
• Drawdown or invoice support

SBIR.gov identifies labor distribution as an accounting system requirement that charges direct and indirect labor appropriately.

 

If the company cannot produce labor distribution reports, Phase II labor costs may be difficult to support.

 

Review New Hire Plans

 

Phase II often requires hiring.

 

Before the award starts, founders should review whether hiring plans are realistic and properly budgeted.

 

Ask:

• Which roles are needed?
• When will each person start?
• What salary or wage rate is budgeted?
• What fringe costs apply?
• How will the employee record time?
• Which project codes will be used?
• Will the employee work only on Phase II or across multiple activities?
• What happens if hiring is delayed?
• How will payroll affect cash flow?

If the budget assumes a full-time employee from day one but hiring takes several months, budget-to-actual reports and cash flow forecasts will change.

 

Review Consultant and Subaward Support

 

Phase II may include consultants, subcontractors, universities, labs, or research partners.

 

Before the award begins, review:

• Approved budget
• Scope of work
• Consultant or subaward agreement
• Rate support
• Deliverables
• Invoice detail requirements
• Payment terms
• Period of performance
• Travel costs
• Prior approval requirements
• Closeout documentation

Consultant and subaward costs should not be treated like ordinary vendor bills.

 

The company should have agreements and support files ready before work begins.

 

Build Indirect Rate Support

 

Indirect rates often become more important in Phase II.

 

SBIR.gov explains that indirect rates are company-specific and should be developed from the company’s own accounting system, annual budget, projected cost categories, or other company-specific cost information.

 

Before Phase II begins, review:

• Fringe costs
• Overhead costs
• G&A costs
• Indirect labor
• Direct labor base
• Total direct cost base, if applicable
• Unallowable cost exclusions
• Proposed rates
• Actual rate forecast
• Rate caps or agency limits
• Provisional billing rates, if applicable

If the indirect rate is only a number in the proposal, the company should build the supporting schedule before billing or reporting begins.

 

Review Direct vs. Indirect Cost Treatment

 

Phase II readiness requires consistent cost classification.

 

The company should decide how common costs will be treated before they appear in the accounting system.

 

Review treatment for:

• Founder labor
• Technical staff labor
• Project management
• Accounting support
• Software tools
• Cloud computing
• Lab supplies
• Facility costs
• Insurance
• Travel
• Equipment
• Compliance support
• Proposal costs
• Commercialization activity

The company should not charge a cost directly to Phase II if similar costs are treated as indirect in like circumstances.

 

The policy should be documented and applied consistently.

 

Set Up Unallowable Cost Accounts

 

Unallowable costs should be visible before Phase II begins.

 

SBIR.gov identifies isolation of unallowable costs as part of a strong accounting system.

 

Set up accounts or project codes for costs such as:

• Fundraising
• Investor activity
• Certain lobbying
• Entertainment
• General sales activity
• Non-award commercialization
• Unsupported costs
• Costs outside the period of performance
• Personal or non-business costs
• Costs restricted by the award terms

These costs may still be legitimate business expenses, but they should not be mixed into Phase II award costs.

 

Prepare Billing or Drawdown Support

 

Before Phase II begins, the company should understand how payment will work.

 

Phase II payment may involve:

• PMS drawdowns
• Reimbursement requests
• Contract invoices
• Vouchers
• Milestone payments
• Progress payments
• Cost-reimbursable billing
• Fixed-price payment schedules

For cost-reimbursable or cost-based billing, the company should be ready to support payment requests with accounting records.

 

Support files may include:

• General ledger detail
• Payroll records
• Timesheets
• Labor distribution reports
• Vendor invoices
• Consultant invoices
• Subaward invoices
• Indirect rate schedules
• Budget-to-actual reports
• Prior approvals
• Unallowable cost review

The first payment request should not be the first time the company gathers support.

 

Prepare for DCAA or Agency Review

 

Not every Phase II award receives the same review.

 

But companies pursuing DoD Phase II or cost-reimbursable work should be prepared for DCAA-related questions.

 

DCAA’s pre-award accounting system checklist is used by auditors to understand how a contractor’s system is designed to meet SF 1408 criteria. The checklist is especially relevant for contractors new to government contracting, contractors with cost-reimbursement contracts, or contractors receiving progress payments.

 

DCAA or agency questions may focus on:

• Accounting system design
• Project cost tracking
• Timekeeping
• Labor distribution
• Direct and indirect costs
• Unallowable costs
• Indirect rates
• Interim billing support
• General ledger control
• Financial stability
• Policies and procedures

Founders should not wait for the review request to find out whether the system is ready.

 

NSF Phase II Awardees Should Expect Financial Review

 

NSF says prospective Phase II awardees may undergo an administrative and financial capability review to evaluate financial stability, resources, and risk of waste, fraud, or abuse. NSF also notes that Phase II review may involve significant accounting and administrative documentation and follow-up requests to company leadership.

 

This is a reminder that Phase II readiness is not only a DoD issue.

 

Even when DCAA is not involved, agencies may still review the company’s financial systems, policies, reports, and support.

 

Review Accounting Policies and Procedures

 

Phase II accounting should be supported by written procedures.

 

At minimum, the company should document procedures for:

• Timekeeping
• Labor distribution
• Direct cost classification
• Indirect cost classification
• Unallowable costs
• Purchasing
• Expense approvals
• Consultant invoice review
• Subaward monitoring
• Equipment tracking
• Travel documentation
• Billing or drawdowns
• Cost transfers
• Budget-to-actual reporting
• Record retention

A written procedure manual helps founders, employees, bookkeepers, and outside advisors follow the same process.

 

Fix Documentation Before Work Begins

 

Documentation should be organized before Phase II costs start.

 

Create support folders for:

• Award documents
• Approved budget
• Project reports
• Payroll
• Timekeeping
• Labor distribution
• Vendor invoices
• Consultant files
• Subaward files
• Travel
• Equipment
• Indirect rates
• Drawdowns or invoices
• Prior approvals
• Cost transfers
• Agency correspondence
• Closeout records

If documents are scattered across email, spreadsheets, and accounting software, the company may struggle during review.

 

Review Cash Flow

 

Phase II can create cash pressure.

 

The award may be larger, but payroll, vendors, consultants, subawards, equipment, and materials may need to be paid before reimbursement or payment arrives.

 

Before Phase II begins, review:

• Payroll timing
• Hiring schedule
• Consultant payment terms
• Subaward payment terms
• Vendor invoices
• Equipment purchases
• Travel costs
• Drawdown or invoice timing
• Payment delays
• Indirect cost recovery
• Working capital needs

A Phase II budget can look strong on paper while still creating cash flow stress.

 

Build Monthly Budget-to-Actual Review

 

Phase II should include monthly financial review.

 

The company should review:

• Approved budget
• Actual costs incurred
• Remaining budget
• Labor burn rate
• Consultant and subaward spending
• Travel and equipment
• Indirect costs
• Drawdowns or invoices
• Cash flow
• Cost transfers
• Documentation gaps
• Prior approval questions

Monthly review helps leadership catch issues early instead of discovering them at reporting, billing, or closeout.

 

Review Cost Transfer Controls

 

Cost transfers are common when accounting is weak.

 

Before Phase II begins, establish a process for correcting costs.

 

A cost transfer should document:

• Original charge
• Corrected charge
• Reason for correction
• Why the receiving project benefits
• Date error was discovered
• Date transfer was posted
• Approval
• Impact on drawdowns or invoices
• Prior approval, if required

Transfers should not be used to spend down remaining budget or move costs away from overspent categories.

 

Phase II Readiness Checklist

 

Before Phase II begins, founders should review:

• Award type
• Approved budget
• Project codes
• Chart of accounts mapping
• Direct cost categories
• Indirect cost structure
• Unallowable cost accounts
• Timekeeping system
• Labor distribution process
• Payroll support
• Founder time coding
• New hire plans
• Consultant agreements
• Subaward files
• Travel and equipment procedures
• Billing or drawdown support
• Indirect rate schedules
• Budget-to-actual reports
• Cost transfer policy
• Documentation folders
• Cash flow forecast
• DCAA or agency review readiness

This checklist helps founders identify accounting gaps before Phase II creates pressure.

 

Common Phase II Accounting Readiness Mistakes

 

SBIR/STTR companies often run into trouble when they treat Phase II like a larger version of Phase I.

 

Common mistakes include:

• Waiting until after award to set up project codes
• Tracking Phase II costs manually
• Not implementing timekeeping before work begins
• Charging all founder time to the award
• Processing payroll without labor distribution
• Using unsupported indirect rates
• Not separating direct, indirect, and unallowable costs
• Treating consultants and subawards like ordinary vendor bills
• Submitting drawdowns or invoices without support
• Ignoring cash flow timing
• Not preparing for agency or DCAA questions
• Not maintaining support files monthly
• Waiting until closeout to organize records

These issues are easier to fix before the award begins.

 

Questions to Ask Before Phase II Begins

 

Before Phase II starts, ask:

• Can our accounting system track Phase II costs separately?
• Do our reports match the approved budget categories?
• Is timekeeping ready for employees and founders?
• Does payroll tie to labor distribution?
• Can we support our indirect rate?
• Are unallowable costs separated?
• Are consultants and subawards documented?
• Are billing or drawdown support files ready?
• Do we understand payment timing?
• Are policies and procedures written?
• Are support folders organized?
• Can we answer DCAA or agency questions?
• Do we have enough cash to perform before payment arrives?

If the answer to several of these questions is no, the company should strengthen accounting readiness before Phase II begins.

 

Final Thoughts: Phase II Requires Award-Ready Accounting

 

Phase II is not just a larger funding opportunity.

 

It is a shift into more serious award management.

 

Founders should fix project costing, timekeeping, labor distribution, indirect rates, unallowable cost tracking, billing support, drawdown procedures, policies, documentation, and cash flow planning before the award begins.

 

At Peter Witts CPA PC, we help SBIR/STTR companies prepare for Phase II accounting readiness so financial records are clearer, payment requests are better supported, and agency or DCAA questions are easier to answer.

 

Need Help Preparing for Phase II Accounting Readiness?

 

If your company is preparing for SBIR/STTR Phase II, Peter Witts CPA PC can help review your project costing, accounting system design, timekeeping, labor distribution, indirect rates, unallowable cost tracking, billing or drawdown support, consultant and subaward records, documentation folders, and cash flow planning.

 

Backed by 35+ years of government contract accounting experience and first-hand DCAA knowledge, our team helps innovators strengthen accounting readiness before Phase II begins.

 

Schedule a strategic consultation with Peter Witts CPA PC to prepare for Phase II accounting readiness.