AASHTO
Uniform Audit & Accounting Guide – 2010 Edition
Reference
to Topics Covered in Former ODOT Contract Audit Circulars
(click
on links below to go to specific sections of the document)
Topic |
Prior ODOT Guidance |
AASHTO Guide Reference |
Preparing Overhead Rates, Generally
|
Circular No. 1
|
Discussed throughout Guide. Key discussion areas
include: Chapter 2, Chapter
4, Chapter 5, Chapter
8, & Chapter 11. Sample overhead schedules appear in Chapter 5: (1) Corporate/Blended
Rate; (2) Home Office and Field Rates. |
Labor Charging Systems & Compensation
|
Circular No. 2
|
- A Labor-Charging Checklist appears in Section 6.5, Table 6-1. - Executive Compensation is discussed specifically
in Section 7.5. |
Professional and Consultant Service Fees |
Circular No. 3
|
|
Advertising
& Selling |
Circular No. 4
|
|
Vehicle Costs |
Circular No. 5
|
Sections 5.4.E.2, 5.5, 8.4, 8.26.D, Table 8-1, 10.4.B,
11.4.D, 11.4.G |
Rent and Common Control |
Circular No. 6 |
Sections 8.23.B and 11.4.G,
Example 11-8 |
Overtime Premium
|
Circular No. 7
|
|
Meals and Lodging |
Circular No. 8 |
Section 8.26 |
Meetings, Conferences, & Retreats |
Circular No. 9 |
|
Interest and FCCM
|
Circular No. 10 |
|
Employee Welfare
|
Circular No. 11 |
Guide Section 8.8 |
AASHTO
Uniform Audit & Accounting Guide – 2010 Edition – Chapters 1 through 12
TABLE OF
CONTENTS (click on links below to go to
specific sections of the document)
Chapter 1 – Organization of this
Guide and Defined Terms
1.1 –
Organization of This Guide
Chapter 2 – Adequacy of Accounting
Records
B. Facilities Capital Cost of Money
and Other Items
C. Disclosure of Field Office Rates
2.4 –
Management Representations
2.5 –
Management and CPA’s Roles and Responsibilities
A. Management Responsibilities
B. The CPA Auditor’s
Responsibilities
2. The CPA’s Responsibilities for
Fraud Detection
C. Selection of CPA Firm as Overhead
Auditor
Chapter 3 – Standards for
Attestations and Audits
A. Review of Indirect Cost Rates for
Costs Incurred
B. Indirect Cost Rate (Forward
Pricing) Review
A. Government Auditing Standards
(“Yellow Book” or “GAGAS” Standards)
3.4 –
Opinion on Internal Control
4.1 –
Overview of Federal Acquisition Regulation Part 31
4.2 –
Reasonableness and Allowability
B. Requirements of FAR 31.201-2 and
FAR 31.201-3
C. Methodologies for Applying FAR
31.201-3
1. Determining Ordinary Cost Through
Quantitative Analysis
2. Determining Reasonableness:
Common Cost Categories
4.5 –
Direct and Indirect Costs
4.6 –
Applicability of Cost Accounting Standards
4.7 –
Allocation Bases for Indirect Costs
5.1 –
Allocation Bases, Generally
C. Total Labor Hours (Total Hours
Worked)
5.2 –
Accounting for Unallowable Costs in Allocation Bases
B. Subsidiaries, Affiliates,
Divisions, and Geographic Locations
D. General and Administrative
(G&A)
E. Internally-Allocated Costs
(Company-Owned Assets)
4. Printing/Copying/Plan
Reproduction
2. Uncompensated Overtime for
Salaried Employees
5. Potential Areas of Risk Regarding
Internal Labor
6. Sole Proprietors’ and Partners’
Salaries
G. Contract Labor/ Purchased Labor
5.5 – Other
Direct Costs-Outside Vendors/Employee Expense Reports
C. Cost Accounting Considerations
2. Field Office Indirect Costs
3. Other Considerations Regarding
Indirect Cost Allocations
Chapter 6 – Labor-Charging Systems
and Other Considerations
6.3 –
Allowability and Reasonableness of Indirect Labor
A. Bid and Proposal Costs (B&P)
2. Identification and Accumulation
of B&P
3. Efforts Sponsored by Grant or
Required by Contract
B. Selling Effort and Activities
2. Brokerage Fees, Commissions, and
Similar Costs
3. Other Cost Principles Related to
Selling Efforts
A. Accounting System Internal
Control
B. Labor Charging System Internal
Control
7.2 –
Allowability of Compensation
7.3 –
Reasonableness of Compensation
7.4 – Statutory
Compensation Limit: The Benchmark Compensation Amount (BCA)
7.5 –
Determining the Reasonableness of Executive Compensation
B. Procedures for Determining
Reasonableness
7.6 –
Criteria for Demonstrating Superior Performance
B. Procedure for Establishing
Compensation Amounts in Excess of Survey Medians
7.7 –
National Compensation Matrix (NCM)
7.8 –
Application of the National Compensation Matrix (NCM)
B. State DOT Contracting Terms
7.9 –
Executive Compensation—Required Supporting Documentation
7.10 –
Additional Procedures – Related Parties
7.11 –
Special Consideration for Closely-Held Firms
7.12 –
Bonus and Incentive Pay Plans
C. Documentation of Bonus and
Profit-Distribution Plans
A. Deferred Compensation, Generally
C. Employee Stock Ownership Plans
(ESOPs)
A. Supplemental Executive Retirement
Plans (SERPs)
B. Long-Term Incentive (LTI) Plans
Chapter 8 – Selected Areas of Cost
8.2 – Advertising
and Public Relations
B. Trade Show Expenses and Labor
D. Bad Debts and Collection Costs
8.4 –
Personal Use of Company Vehicles
8.5 –
Contributions or Donations
8.6 –
Facilities Capital Cost of Money (Cost of Money)
A. Depreciation Expense Presented Is
Same for Both Financial and Income Tax Purposes
B. Depreciation Expense Presented For Financial
Purposes Differs From Income Tax Purposes
8.8 –
Employee Morale, Health, and Welfare
8.11 –
Gains and Losses on Depreciable Property
8.12 – Idle
Facilities and Idle Capacity Costs
A. Insurance on Lives of Key
Personnel
B. Professional Liability Insurance
C. Losses and Insurance Deductibles
8.18 –
Losses on Other Contracts
8.19 –
Organization and Reorganization Costs.
B. Substantiation of Travel Costs
8.28 –
Goodwill and Business Combination Costs
8.30 –
Listing of Common Unallowable Costs
Chapter 9 – General Audit
Considerations
B. COSO Internal Control Framework
4. Information and Communication
9.4 –
Estimating and Proposal Systems
9.6 –
Understanding the Engineering Consultant’s Business
9.7 –Other
Audits as a Resource
9.8 –
Computerized Accounting Information Systems
9.9 – Audit
Risk and Materiality
9.10 – Type
and Volume of Contracts
Chapter 10 – Guidance for Developing
Audit Procedures
10.1 –
Planning and General Procedures
A. Audit Objectives and Sampling
Methods
B. Sampling for Attributes and
Sampling for Variables
B. Recommended Testing Procedures
B. Baseline for Determining Risk
10.6 –
Other Direct Costs (ODCs)
10.7 –
Failure to Meet Minimum Audit Procedures
Chapter 11 – Audit Reports and
Minimum Disclosures
11.2 –
Sample Audit Report on Overhead Schedule
11.3 –
Sample Report on Internal Control and Compliance
11.4 –
Minimum Audit Report Disclosures
C. Description of Accounting
Policies
D. Description of Overhead Rate
Structure
E. Description of Labor-Related
Costs
F. Description of Depreciation and
Leasing Policies
G. Description of Related Party
Transactions
H. Facilities Capital Cost of Money
(FCCM)
I. List of Direct Cost Accounts
Chapter 12 – Cognizance and
Oversight
12.1 –
National Highway System Designation Act Section 307
12.2 –
Section 174 of the 2006 Transportation Appropriations Act
12.3 – What
Is a Cognizant Agency?
12.4 – How Is a Cognizant Approved Indirect
Cost Rate Established?
12.5 – Guidelines
for Reviewing CPA Indirect Cost Audits
12.6 –
Attestations Engagements
12.7 – Risk
Analysis: Accepting Overhead Rates Without a Workpaper Review
12.8 –
Questions and Answers Regarding Cognizance
This Uniform Auditing and Accounting Guide is
organized in chapters. Chapters are subdivided into sections, subsections, and
paragraphs. For the sake of brevity, internal references to this Guide most
commonly follow the “short reference” format as illustrated in the following
examples:
Short Reference |
Full Reference |
Section 2.4 |
Chapter 2, section 4 |
Section 3.2.D |
Chapter 3, section 2,
subsection D |
Section 5.6.A.2 |
Chapter 5, section 6,
subsection A, paragraph 2 |
In this Guide, words not defined shall be given
their plain meaning. The following defined words and terms are used throughout
this Guide—
·
“AASHTO” refers to the American Association of State Highway and
Transportation Officials.
·
The terms “A/E firm,” “engineering consultant,” “consultant,”
“contractor,” or “firm” refer to Architectural and Engineering design companies
that perform work on Government contracts.
·
“AICPA” refers to the American Institute of Certified Public
Accountants, the national, professional organization for all Certified Public
Accountants.
·
The terms “the CPA auditor,” or “the CPA” refer to independent CPA
firms that perform audits, reviews, or other types of attestation engagements
for A/E firms.
·
The “Code
of Federal Regulations”
(CFR) is the
codification of the general and permanent rules published in the Federal Register by the executive departments and agencies of
the Federal Government. The CFR is divided into 50 titles that represent broad
areas subject to Federal regulation. 48
CFR Chapter 12 sets forth the general guidelines used by State DOTs.
·
The “Cost
Accounting Standards,” or “CAS,” are issued by the Cost Accounting
Standards Board (CASB), a section of the
Office of Federal Procurement Policy within the U.S. Office of Management and
Budget. The
·
The “DCAA
Contract Audit Manual” (CAM or DCAA Manual 7640.1) is an official
publication of the Defense Contract Audit Agency (DCAA). The CAM prescribes
auditing policies and procedures and furnishes guidance in auditing techniques
for personnel engaged in performing audits in compliance with FAR Part 31 and
related laws and regulations. The CAM is published semiannually by the DCAA.
·
The “Federal Acquisition
Regulation, Part 31” (FAR). The FAR is
codified at 48 CFR Part 31. The FAR is the primary regulation governing the acquisition of
supplies and services with Federal funds. 48 CFR Part 31 sets the criteria for
determining costs eligible for reimbursement on Federally funded agreements and
also may be used to determine allowable costs for contracts funded solely by
State funds.
·
The “Federal
Travel Regulation” (
·
“GAAP” refers to the Generally Accepted Accounting Principles, a widely accepted set
of rules,
conventions,
standards,
and procedures
for reporting financial
information,
as established by the Financial
Accounting Standards Board (FASB).
·
“Generally
Accepted Auditing Standards” (GAAS) are published by the American Institute
of Certified Public Accountants (AICPA). GAAS apply to financial statement
audits and contain guidance regarding auditors’ professional qualifications,
the quality of audit effort, and the characteristics of professional and
meaningful audit reports.
·
The “Government Auditing Standards,” also known as “Generally
Accepted Government Auditing Standards” (GAGAS) or “Yellow Book” standards, are issued by the U.S. Government Accountability Office
(GAO).[1] GAGAS prescribe general
procedures and professional standards that examiners must apply when performing
audits or attestation engagements of firms that conduct business with
governmental entities. GAGAS standards also incorporate the Generally Accepted
Auditing Standards specific to financial-related audits.
·
“Management” refers to A/E firm owners, officers, and/or others
responsible for the formulation and execution of the firm’s policies and
procedures, including, but not limited to, internal controls, personnel
policies, compensation policies, and labor-charging practices.
·
“Overhead” or “indirect cost” refers to any cost that is not directly identified with a single
final cost objective, but is identified with two or more final cost objectives
or with at least one intermediate cost objective. Engineering consultants
charge their indirect costs by applying an overhead rate to an allocation base
(e.g., direct labor cost).
·
“Overhead rate” refers to a factor/ratio computed by adding together
all of a firm’s costs that cannot be associated with a single cost objective
(e.g., general and administrative costs and fringe benefit costs),
then dividing by a base value (usually direct labor cost) to determine a rate. This
rate is applied to direct labor, as incurred on projects, to allow a firm to recover the
appropriate share of indirect costs allowable per the terms of specific agreements. In this document, the
terms “indirect cost rate” and “overhead rate” are used synonymously.
·
“Overhead schedule” refers to the primary document
used by engineering consultants to compute indirect cost rates (overhead rates)
used for billings on Government projects. An overhead schedule is based on
amounts obtained from the engineering consultant’s general ledger (after the
adjusting entries have been posted to the accounts), as well as from amounts in
the engineering consultant’s cost accounting system. This schedule must be in
agreement with, or must be reconciled to, amounts from the engineering
consultant’s general ledger or post-closing trial balance. An overhead schedule
also is commonly referred as a “schedule of indirect costs” or “Statement of
Direct Labor, Fringe Benefits, and General Overhead.”
·
“State DOT” or “DOT” refers to a State department of transportation or
other State transportation agency.
·
“Statements on Auditing Standards” or “SASs” are interpretations of
U.S. Generally Accepted Auditing Standards as issued by the Auditing Standards
Board (ASB), the senior technical committee of the AICPA designated to issue
auditing, attestation, and quality control standards and guidance.
Amounts
determined on the basis of costs incurred. Actual costs are supported by
original source documentation, such as invoices, receipts, and cancelled
checks. Actual costs generally are not determined based on forecasts or
historical averages.
Costs
reimbursed under an Actual Cost Agreement are limited to the specified criteria
(actual allowable costs) described in the agreement. These limitations are
based on the Cost Principles found in FAR Subpart 31.2 and may include
additional restrictions mandated by the laws of specific State DOTs. Direct and
indirect costs billed against Actual Cost Agreements must exclude all unallowable
costs, including certain costs that may be fully or partially deductible for
the purpose of computing income taxes (e.g., interest, entertainment, and bad debts).
Contract
language that specifies the treatment of special or unusual costs. For example,
the use of statistical sampling methods for identifying and
segregating unallowable costs should be the subject of an advance agreement
under the provisions of FAR 31.109
between the engineering
consultant and the cognizant audit agency. The advance
agreement should specify the basic characteristics of the sampling process. FAR 31.109 provides that advance agreements must be “in
writing, executed by both the contracting parties, and incorporated into
applicable current and future contracts. An advance agreement shall contain a
statement of its applicability and duration.”
A
contract between a State DOT and an A/E firm. An Agreement is a binding, legal
document that identifies the deliverable goods/services to be provided, under
what conditions, and the method of reimbursement for such goods/services. An
Agreement may include both Federal and State requirements that must be met by
the State DOT and the engineering consultant. Agreements usually indicate start
and finish dates, record retention requirements, and other pertinent
information relative to the work to be performed.
A
contract using a provisional hourly billing rate based on a firm’s estimated
direct labor and overhead costs, plus a negotiated profit
margin. Generally, provisional hourly rates are temporary and are adjusted
during the audit process. Negotiated hourly rates may be used for the life of
an Agreement or instead may be adjusted periodically based on the provisions of
the agreement.
FAR 31.201-4 provides that a cost is allocable to a Government contract if the
cost—
(a) Is incurred specifically for
the contract;
(b) Benefits both the contract and
other work, and can be distributed to them in reasonable proportion to the
benefits received; or
(c) Is necessary to the overall
operation of the business, although a direct relationship to any particular
cost objective cannot be shown.
Depending on the nature of specific cost
items, allowable costs may either be billed directly to contracts or included
as overhead costs; however, FAR 31.201-2 provides that a cost is an allowable charge to a Government
contract only if the cost is—
·
reasonable in amount,
·
allocable to Government contracts,
·
compliant with Generally Accepted Accounting Principles and standards
promulgated by the Cost Accounting Standards Board (when applicable),
·
compliant with the terms of the contract, and
·
not prohibited by any of the FAR Subpart 31.2 cost principles.
A
formal examination, in accordance with professional standards, of accounting
systems, incurred cost records, and other cost presentations to verify their
reasonableness, allowability, and allocability for negotiating agreement fees and for determining
allowable costs to be charged against Government contracts. Audits include an
evaluation of an engineering consultant’s policies, procedures, controls, and
actual performance. Audit objectives include the identification and evaluation
of all activities that contribute to, or have an impact on, proposed or
incurred costs related to Government contracts.
The
series of steps that auditors perform in completing an audit engagement. The
procedures performed may vary somewhat, but the Audit Cycle generally includes
audit planning, review of the auditee’s permanent
file, preliminary analytical review, audit fieldwork (including entrance and
exit conferences), submittal of the draft audit report to the auditee for
review and comment, and the issuance of the final audit report.
The
process that State DOTs and the auditee engage in to resolve audit findings.
This process may include the negotiation of a settlement and/or may involve
legal counsel and court procedures.
A
record of transactions in an accounting system that provides verification of
the activity of the system. A complete audit trail allows auditors to trace
transactions in a firm’s accounting records from original source documents into
subsidiary ledgers through the general ledger and into general purpose
financial statements and billings/invoices prepared and submitted by the
engineering consultant.
Generally
refers to the hourly labor rates charged by an engineering
consultant for work performed on an agreement. For a cost plus fixed fee
agreement (the most common type of agreement), billing rates are determined
based on employees’ actual payroll rates. By contrast, for an all-inclusive
hourly rate agreement, billing rates are determined based on actual payroll
rates with additional amounts included for overhead and net fee (profit).
A
position title used in FAR Part 31 to identify a person with the authority to
bind a State or Federal agency to a contract. Within
State DOTs, contracting officers are the individuals who enter into,
administer, and/or terminate contracts and make related determinations and
findings. In State DOTs, auditors generally act at the request of, and on
behalf of, contracting officers.
A
business structure where stock is made available for purchase. A corporation
typically has a president, numerous vice presidents, a chief financial officer
and/or treasurer, and a secretary. Corporate employees usually are paid based
on an hourly wage rate or annual salary. The liability of individual
stockholders (owners) is limited to their investments in the corporation’s
stock.
Depending
on how a corporation is formed, it will be taxed under either Subchapter C or
Subchapter S of Chapter 1 of the Internal Revenue Code. A C-Corporation is
taxed on its income at the corporate level, and stockholders pay a second layer
of tax on the dividends they receive from the corporation. By contrast,
S-Corporations are not taxed at the corporate level; instead, the
S-Corporation’s income or losses are passed through to its shareholders, who
then report the income or loss on their individual tax returns.
A
non-revenue-producing element of a business organization. Cost centers are used
to accumulate and segregate costs.
An
agreement/contract, function or organizational subdivision, or other work unit
for which the costs of processes, products, jobs, or projects are accumulated
and measured. An “intermediate cost objective” is a cost objective used to
accumulate costs that are subsequently allocated to one or more indirect cost pools and/or final cost
objectives.
This
concept was developed to assign primary responsibility for an audit to a single
entity (the “cognizant agency”) to avoid the duplication of audit work performed
in accordance with Government Auditing Standards to obtain reasonable assurance
that claimed costs are accordance with the FAR Subpart 31.2 cost principles. Such audit work may be performed by home-State auditors, a Federal
audit agency, a CPA firm, or a non-home State auditor designated by the
home-State auditor.
Exists
in related-party transactions when business is conducted at less than arm’s
length between businesses and/or persons that have a family or business
relationship. Examples are transactions between family members, transactions
between subsidiaries of the same parent company, or transactions between
companies owned by the same person or persons. Common control exists when a related
party has effective control over the
operating and financial policies of the related entity. Effective control may
exist even if the related party owns less than 50 percent of the related
entity.
An
agreement in which all the cost factors, except the fixed fee, are based on the
engineering consultant’s actual allowable costs. The fixed fee is a specific,
predetermined amount, as identified in the agreement.
Although interest costs
associated with the financing of capital are unallowable, some costs associated
with the engineering
consultant’s investment in fixed assets are allowable. Specifically,
Cost of Money is an imputed cost determined by applying a charge rate to the
facilities capital employed in contract performance. (See further discussion in
Section 8.6.)
Cost of Money is not required to be
recorded in the engineering
consultant’s formal accounting records; instead, Cost of Money is
computed as a charge rate based on the following factors:
·
The average annual net book value of the engineering consultant’s
investments in the fixed assets used for allowable business activities (in
accordance with the cost principles of FAR Subpart 31.2),
·
The prorated average Prompt Payment Act Interest Rate determined by the
U.S. Secretary of the Treasury for the accounting period in question, and
·
The engineering consultant’s direct labor base used to determine
overhead rates.
These
principles establish the framework for determining allowable and unallowable
charges against Federal-aid contracts. FAR Subpart 31.2 lists expressly
unallowable costs and establishes criteria for determining the allocability and
reasonableness of cost items.
Refers
to a cost generated solely as a result of the incurrence of another cost, and
which would not have been incurred had the other cost not also been incurred
(see FAR 31.001 and FAR 31.201-6(a)). If a cost is determined to be unallowable, then its directly
associated costs also must be disallowed.
Any
cost that is identified specifically with a particular final cost objective.
Direct costs are not limited to items that are incorporated in the end product
as material or labor. Costs identified specifically with a contract are direct costs of that contract. All costs identified specifically with other final
cost objectives of the contractor are direct costs of those cost objectives.
Direct
costs include labor, materials, and reimbursable expenses incurred specifically
for an agreement. All direct labor costs allocable to design and
engineering contracts (regardless of the contract type,
e.g., lump-sum
versus actual cost) must be included in the direct labor base regardless of
whether the costs are billable to a client.
A
meeting between the auditor and the auditee during which the purpose and scope
of the audit are discussed.
A
meeting held after the completion of audit field work. The exit conference
generally focuses on a discussion of the preliminary audit findings, which are
subject to change based on further audit testing, supervisory review, and
additional information submitted by the auditee.
Refers
to agreements for the acquisition of supplies and services that are partially-
or fully-funded from Federal sources. “Government contracts” is a more
encompassing term, as it includes Federal-aid contracts and all other contracts
with governmental entities, including contracts that are fully funded by State
or municipal governments.
A
field office is a facility that the engineering consultant specifically
establishes, or has furnished to it, at or near the project site. The field
office must be used exclusively for project purposes. The use of a field office
allows for the computation of a field office overhead rate, which is designed
to reimburse the engineering consultant for the fringe benefits of the field
personnel and the home office support that is provided to them. Field offices
may exist in several forms. For example, an engineering consultant’s employees
may work for a period of time in an on-site office maintained by a State DOT.
Since the engineering consultant’s employees do not work out of their own
offices and do not receive office support in their daily activities, the hours
billed for these employees may not qualify for the engineering consultant’s
full overhead rate. Instead, a field rate may need to be established to
allocate a reasonable portion of the engineering consultant’s indirect costs to
a field office.
Financial
statements are formal records that summarize a firm’s business activities. Financial
statements usually are compiled on a quarterly and annual basis. In this Guide,
the term “General Purpose Financial Statements” is used to refer to the basic
financial statements, which include an Income Statement, Balance Sheet, and
Statement of Cash Flows. This Guide also makes reference to an overhead
schedule, which is a Special Purpose Financial Statement used to report
specific financial information to governmental agencies such as State
Departments of Transportation and the U.S. Department of Defense.
An
audit finding may result from an engineering consultant’s deficiencies in
internal control, fraud, illegal acts, the violation of contract or grant
provisions, and/or abuse. When auditors identify deficiencies, they should plan
and perform procedures to develop the elements of the findings that are
relevant and necessary to achieve the audit objectives. In accordance with
GAGAS, when documenting a finding, the auditor should include the condition,
criteria, cause, effect, and a recommendation for correction. See GAGAS
Chapters 4.14 to 4.18 for more details.
Costs
of operating a company that are incurred by, or allocated to, a business unit
and are not directly linked to the company’s products or services.
An
audit conducted during the life of an agreement and designed to determine the
actual allowable costs as of the audit date, including costs charged by the
prime engineering consultant and any subconsultants.
During an interim audit, auditors typically adjust the engineering consultant’s
billed costs (including direct labor, overhead, and other direct costs) to the
allowable costs actually incurred. Interim audits generally involve the use of
a standard audit program, although the procedures used may vary somewhat
depending on the agency performing the audit.
Include
the plan of organization and the methods and procedures adopted by management
to ensure that the firm’s goals and objectives are met; that resources are used
consistent with laws, regulations, and
policies; that resources are safeguarded against waste, loss, and misuse; and
that reliable data are obtained, maintained, and fairly disclosed in reports.
Business
entities in which the members (owners) generally are liable only to the extent
of their invested capital. LLCs and LLPs usually are taxed as partnerships (no
taxation at the corporate level); although some LLCs elect to be taxed like
C-Corporations (taxation applies at the corporate level, before the
distribution of dividends).
An
agreement in which the method of payment for delivered goods and/or services is a fixed amount that
includes salaries, overhead, and profit. Once the lump-sum amount is determined, the goods and/or
services must be provided regardless of the engineering consultant’s actual
costs. No adjustments are permitted to compensate the engineering consultant
for costs in excess of the contract’s fixed amount unless there is a
significant change in the scope of work that results in an approved change
order.
An
agreement in which hourly billing rates (including labor, overhead, and net fee) are negotiated in advance and are listed for a period of
one year or more.
Compensation
paid to employees who work more than 40 hours per week. Overtime pay rates may
be based on employees’ normal hourly rates or may include “premium overtime”
such as time and a half or double time. In accordance with the Fair Labor
Standards Act (FLSA), premium overtime pay generally is required for hourly
workers but is optional for certain salaried employees (exempt employees).
A
business with two or more co-owners, who may or may not have established
salaries. Generally, partners are jointly responsible for the firm’s debts and
other liabilities, and this liability exposure is not limited to the partners’
individual investments in the firm. When establishing hourly pay rates that may
be charged against Government contracts, partners may be treated the same as
sole proprietors.
An
audit done after an engineering consultant completes all scheduled work on a
project. The scope of a post audit may include all costs billed to the project,
including direct costs, overhead costs, and costs for subconsultants. Post audits generally involve the use of a
standard audit program, although the procedures used may vary somewhat depending
on the agency performing the audit.
An
examination conducted on behalf of State DOT management for the purpose of
verifying financial information supplied by an engineering consultant. The
examination may involve a desk review performed at the audit office and/or
fieldwork at the engineering consultant’s place of business. Upon completion,
the audit results are provided to the State DOT contracting officer for use
during contract negotiations.
An
agreement in which hourly billing rates, including labor, overhead, and net fee, are negotiated in advance but are subject to adjustment
after actual labor and overhead costs are determined through an audit.
A
cost is reasonable, if, in its nature and amount, it does not exceed that which
would be incurred by a prudent person in the conduct of competitive business.
See Section 4.2 for additional discussion.
A
business with only one owner. Sole proprietors commonly do not have established
salaries, but instead may rely on draws from the firm’s profits to obtain
payment for their services.
Original
documents that support the costs recorded in an engineering consultant’s
accounting records, including general and subsidiary ledgers. Source documents
include, but are not limited to, time sheets, payroll registers, invoices, hotel
receipts, rental slips, gasoline tickets, cancelled checks, tax returns,
insurance policies, and minutes of corporate meetings.
An
agreement that specifies a time period for performance but does not include a
complete description of all the work to be completed under the agreement. Tasks
that require the engineering consultant’s expertise are assigned as needed, and
each task has its own maximum payable amount. The total amount paid on all the
tasks may not exceed the total amount of the agreement.
A
total-hour accounting system records all hours worked by all employees,
regardless of whether the employees are exempt from overtime pay or whether all
direct labor hours are billed to specific
contracts. All engineering consultants that receive compensation under actual
cost agreements must maintain a total-hour accounting system. See DCAAP 7641.90 Chapter 2-302.1(5) for details.
The DCAAP is available at http://www.dcaa.mil/dcaap7641.90.pdf.
An
item of cost that is ineligible for cost reimbursement. Unallowable costs must
not be billed to Government contracts either directly or through the
application of an overhead rate. When an unallowable cost
is incurred, its directly associated costs also are unallowable.
FAR
52.237-10 defines uncompensated overtime as “hours worked without additional
compensation in excess of an average of 40 hours per week by direct charge
employees who are exempt from the Fair Labor Standards Act. Compensated
personal absences such as holidays, vacations, and sick leave must be included
in the normal work week for purposes of computing uncompensated overtime
hours.”
Management must maintain
accurate financial information and must submit timely financial reports to
governmental agencies, including Federal agencies, State DOTs, and/or municipal
entities. These financial reports include general purpose financial statements,
overhead schedules, and other schedules required to demonstrate an engineering
consultant’s compliance with Federal procurement regulations and State DOT
laws. In most cases, special schedules and disclosures will be required to be
submitted to State DOTs in addition to the annual general purpose financial
statements prepared for stockholders, lending institutions, and management.
Note: In
cases where a CPA performs an engagement to determine the engineering
consultant’s compliance with the cost principles of FAR Part 31.2, management
also must ensure that Federal and/or State DOT auditors are granted full access
to the CPA’s workpapers.
An overhead schedule is the primary document used to show the
calculation of an overhead rate. An overhead schedule is based on amounts
obtained from the engineering consultant’s general ledger (after adjusting
entries have been posted to the accounts), as well as from amounts in the
consultant’s cost accounting system. The overhead schedule must be in agreement
with, or must be reconciled to, the general ledger.
The overhead schedule should
clearly display the unallowable costs that have been removed from the various
accounts (see Section 5.6.C.3 for sample overhead schedules). If the schedule
is presented “net of unallowable costs,” then the details of the unallowable costs must be disclosed in
the accompanying notes. Additionally, disclosures
must be included with the overhead schedule, other financial statements, and
any special schedules. These disclosures must include explanatory
information about the financial data, organizational structure of the firm, and
operating policies (see further discussion in Chapter 11).
An overhead rate generally is
computed as the ratio of allowable indirect costs to total allocable direct
labor costs. Accordingly, the overhead schedule should identify direct labor cost as a separate line item, and direct labor
must be in agreement with the general ledger and must reconcile to the cost
accounting system (project accounting records).
Other items, such as
Facilities Capital Cost of Money (hereinafter “cost of money”), must be separately
disclosed in the notes to the overhead schedule. Although cost of money
generally is computed as a rate based on direct labor cost, cost of money
should not be included as part of the
overhead rate.
The overhead schedule or accompanying notes should show the
calculation of the overhead rate. In some cases multiple overhead rates will be
shown, such as functional rates for segments of the business or rates for
separate subsidiaries. When a company uses Field Office (onsite) rates in
addition to Home Office (offsite) rates, costs and labor amounts for both rates should be displayed on
the overhead schedule. The rate structure and
allocation methodology should be clearly explained in the notes.
Engineering consultants are
responsible for consistently estimating, accumulating, and reporting costs.
Accordingly, all projects should be subject to the same accounting procedures
and processes.
Note: Engineering consultants
must account for costs appropriately and must maintain records, including supporting
documentation, adequate to demonstrate that the costs claimed were incurred,
were allocable to the contract, and complied with applicable FAR cost
principles. Supporting documentation includes, but is not limited to, travel
expense reports, hotel receipts, cancelled checks, time sheets, and usage logs.
Contracting officers may disallow all or part of a
claimed cost that is inadequately supported. Additionally, when an engineering consultant uses accounting
practices that are not consistent with FAR requirements, costs resulting from
such practices must be disallowed, to the extent that these costs exceed the
amount that would have resulted from the consistent application of the FAR.
FAR 31.201-6 and CAS 405-40 require unallowable costs and any directly
associated costs to be identified and
excluded from billings, claims, or proposals for Government contracts. In addition,
unallowable costs must participate in indirect cost allocations just as if the
unallowable costs were allowable. That is, all activities that benefit from the
indirect cost, including unallowable activities, must receive an appropriate
allocation of indirect costs.
Note: Section
8.30 (Table 8-1) includes a list
of common unallowable costs.
FAR 31.001 defines a directly
associated cost as “any cost which is generated solely as a result of the
incurrence of another cost, and which would not have been incurred had the
other cost not been incurred.” Engineering consultants must
maintain adequate records to identify unallowable costs, including directly
associated costs. Furthermore, CAS 405-40(e)
states:
All
unallowable costs . . . shall be subject to the same cost accounting principles
governing cost allocability as allowable costs. In circumstances where these
unallowable costs normally would be part of a regular indirect-cost allocation
base or bases, they shall remain in such base or bases. Where a directly
associated cost is part of a category of costs normally included in an
indirect-cost pool that will be allocated over a base containing the
unallowable cost with which it is associated, such a directly associated cost
shall be retained in the indirect-cost pool and be allocated through the
regular allocation process.
For directly associated
costs other than those described above in CAS 405, the directly associated
costs, if material in amount, must be purged from the indirect cost pool.
FAR 31.201-6(e)(2) provides that, when
material in amount, salary expenses for the time
employees participate in activities that generate unallowable costs should be
treated as directly associated costs. However, time spent by an
employee outside the normal working hours should not be considered, unless the
employee engaged in those company activities so frequently outside the normal
working hours that it would indicate that the activities were a part of the
employee’s regular duties.
Financial statements will vary depending on the company ownership, type
of business organization, and firm size. Publicly-traded companies generally
will have audited financial statements that include a CPA’s opinion. Other
entities also may have audited financial statements to serve the needs of
lending institutions, owners, and government agencies.
Many smaller A/E firms have
financial statements that are compiled
by, but not audited by, an accounting firm. In many cases, the accounting firm
also will assist in preparing the overhead schedule. In other cases, an engineering consultant’s
internal accounting department and management personnel will prepare the
financial statements. However, in all cases, the financial statements should
include representations from management that the amounts are timely, accurate,
and are prepared in compliance with regulations that apply to the specific
circumstances.
When
performing overhead engagements of A/E firms, it is important for auditors to
obtain written representations from management personnel. Specific
representations will vary depending on the circumstances, including the scope
of the engagement and the availability of other information, such as audited
financial statements. However, when performing any type of overhead engagement, auditors typically should require
the following management representations:
·
The financial information is accurate.
·
The financial information is complete.
·
The information is in compliance
with Government regulations (e.g., FAR Part 31, the Internal Revenue Code, and the Federal Travel
Regulation).
·
Estimates are based on sound financial data and consistent assumptions.
·
All actual indirect cost rates submitted to any governmental entity
have been disclosed.
Note: Examples of management
representation letters are included in Appendix E.
In some contract audit
environments, a management-certified cost proposal may be the starting point
for an audit or examination-level attestation. The cost proposal also may serve
as management’s representation that the submitted costs are allowable in accordance
with FAR Part 31 and other related laws and regulations. The auditor should
consider obtaining additional representations, as necessary, for matters that
arise during the course of the engagement.
Some states require annual
submissions of financial, procedural, and other company information as well as
overhead schedules. Additionally, some states
require annual CPA audits of submitted cost information, including an overhead
schedule.
Under the provisions of the Sarbanes-Oxley
Act (SOX), publicly-traded
companies must
submit annual reports that include management
representations of their firms’ internal control structure.
SOX also requires an independent CPA’s opinion on internal controls.
Management
bears the sole responsibility for identifying, segregating, and removing unallowable
costs from all billings to Government contracts. This requirement applies to direct costs, indirect costs, and any
cost proposals that are submitted for Government contracts. In establishing a
sufficient internal control system, the engineering consultant must train
accounting staff, including payables clerks and staff members responsible for
preparing project billings, in the FAR Subpart 31.2 cost principles so that
unallowable cost items can be identified, segregated, and disallowed as
transactions occur.
Some state DOTs require CPA
audits to be conducted on all overhead schedules that are prepared and
submitted by engineering consultants. These audits may either be conducted by the
same CPA that performs other accounting work for the engineering consultant
(e.g., audits of general purpose financial statements or tax compliance work)
or by a separate CPA. However, regardless of the CPA’s overall business
relationship with the engineering consultant, the overhead engagement must be
performed in accordance with certain minimum standards, which are discussed in
detail in the sample CPA Workpaper Review Program
included in Appendix A of this Guide.
Note: Although Appendix A should
be consulted for detailed requirements, the following discussion is a general
summary of the CPA auditor’s responsibilities.
The CPA auditor is
responsible for performing an audit or examination level attestation engagement
in accordance with Government Auditing Standards (GAGAS) to obtain reasonable
assurance that the engineering consultant complied with FAR Part 31 and
applicable Cost Accounting Standards. Accordingly, before opining on or attesting to the
reliability of the indirect cost rate, the CPA must perform adequate procedures
appropriate to the specific type of engagement. The engineering consultant and CPA must execute an engagement letter
that clearly specifies the type of engagement to be performed and the roles of
each party.
The CPA auditor is responsible
for—
·
Issuing an independent opinion on the engineering consultant’s
compliance with Government regulations, including FAR Part 31 and related laws.[2]
·
Issuing a report describing the extent of the auditor’s testing of the
engineering consultant’s internal controls and the results of such testing.[3]
It must be noted that,
although the CPA may be involved in some aspects of the overhead rate
computation, the CPA’s testing must be performed independently to verify that
the engineering consultant’s internal controls are working properly;
accordingly, the CPA must not
function as a component of the internal control system. As described above in
Section 2.5.A, the engineering consultant should identify, segregate, and
disallow unallowable costs as transactions occur. Management must not rely on
the CPA’s end-of-year audit testing as the sole method for detecting
unallowable costs.
Note: Before accepting FAR audit
engagements, CPAs must determine if they have the required specialized
knowledge to complete the engagement (see Statement on Auditing Standards No.
105). In cases where a CPA’s primary area of expertise does not include the A/E
industry and the FAR Subpart 31.2 cost principles, said CPA should engage the
services of a qualified specialist to consult with, conduct training, and/or
review audit programs and audit reports. CPAs should document their
qualifications to perform the audit, identify any specialists used in the
engagement and must maintain adequate evidence of their professional registration
status and results of peer reviews.
The CPA
must immediately notify the appropriate State DOTs of any findings such as
those discussed below:
·
GAGAS 5.04c and 6.31b.
Auditors must report deficiencies in internal control, fraud, illegal acts,
violations of provisions of contracts or grant agreements, and abuse.
·
GAGAS 5.18 and 6.39. When
either of the following circumstances exists, auditors should report directly
to parties outside the audited entity with respect to known or likely fraud,
illegal acts, violations of provisions of contracts or grant agreements, or
abuse:
(a) When entity management fails
to satisfy legal or regulatory requirements to report such information to
external parties specified in law or regulation, auditors should first
communicate the failure to report such information to those charged with
governance. If the audited entity still does not report this information to the
specified external parties as soon as practicable after the auditors’
communication with those charged with governance, then the auditors should
report the information directly to the specified external parties.
(b) When entity management fails
to take timely and appropriate steps to respond to known or likely fraud,
illegal acts, violations of provisions of contracts or grant agreements, or
abuse that (1) is likely to have a material effect on the financial statements
and (2) involves funding received directly or indirectly from a government
agency, auditors should first report management’s failure to take timely and
appropriated steps to those charged with governance. If the audited entity
still does not take timely and appropriate steps as soon as practicable after
the auditors’ communication with those charged with governance, then the
auditors should report the entity’s failure to take timely and appropriate
steps directly to the funding agency.
·
GAGAS 5.19 and 6.40.
Auditors should comply with the requirements discussed above even if the
auditors have resigned or were dismissed from the audit prior to its
completion.
·
GAGAS 5.20 and 6.41.
Auditors have a professional obligation to obtain sufficient evidence that
management of the audited entity appropriately reported findings to outside
parties.
There are
many factors involved in selecting a CPA to perform an overhead audit. The CPA
must follow AICPA professional standards and must obtain sufficient,
appropriate audit evidence to support the opinion that the overhead schedule
was prepared in compliance with the FAR 31.2 Cost Principles. The following list, although not comprehensive, provides some factors
for consideration. The CPA should:
·
Meet all GAGAS requirements, including requirements for adequate
continuing professional education (CPE) in governmental auditing.
·
Have received favorable peer review reports.
·
Be well versed in GAGAS, the provisions of FAR Part 31 (including the
FAR Subpart 31.2 cost principles), Cost Accounting Standards, related laws and
regulations (e.g., the Internal Revenue Code, the Federal Travel Regulation,
and 23 U.S.C. 112), and the guidelines and recommendations set forth in this
Guide.
·
Have adequate experience in applying GAGAS.
·
Have a working knowledge of the A/E industry, including common
operating practices, trends, and risk factors.
·
Be well versed in job-cost accounting practices and systems used by A/E
firms.
·
Assign direct supervisory staff to the engagement who have prior
experience performing overhead audits in compliance with FAR Part 31.
·
Have experience performing FAR audits and have knowledge of Government
procurement with regard to various types of contracts and contract payments
terms affecting the development and/or application of an allowable overhead
rate.
·
Design and execute an audit program that meets the AICPA’s professional
standards, as well as the specific testing recommendations described in the
sample CPA Workpaper Review Program provided in
Appendix A of this Guide.
Note: The following documents
provide additional useful information regarding the procurement of professional
audit services:
● Selecting
an External Auditor: Guide for Making a Sound Decision (Mid-America
Intergovernmental Audit
Forum, May 2007).
● How
to Avoid a Substandard Audit: Suggestions for Procuring an Audit (National Intergovernmental
Audit Forum, May 1988).
● Procuring
Audit Services in Government: A Practical Guide to Making the Right Decision. AGA CPAG
(Corporate Partner Advisory
Group) Research Series, Report No. 19, February 2009.
Most State departments of transportation (DOTs) award contracts for
engineering and related services using Qualifications Based Selection (QBS) procedures. Under QBS, engineering consultant selections are based
solely on elements of qualification, without consideration of price;
accordingly, engineering consultants do not submit bids or priced proposals to
be used as a basis for selection. Once a State DOT has made a selection based
on the engineering consultant’s qualifications, contract prices are negotiated
based on the engineering consultant’s estimated costs, which should be based on
actual costs incurred in prior periods. These prices must be reasonable for the
work to be performed.
23 U.S.C. Section 112(b)(2)(C) requires contracts for engineering services to be performed and
audited in compliance with the costs principles contained in Part 31 of the Federal Acquisition Regulation (FAR). Because State DOTs
construct highway improvements using both State and Federal funds, most State
DOTs use rules for selection and pricing of state-funded engineering consultant
contracts that incorporate, or are similar to, Federal rules.
Note: The timing and types of
audits performed to meet Federal requirements may vary between contracts,
depending on State DOT procedures and other circumstances. Audits are performed
to obtain reasonable assurance that consultant contract pricing is based on actual costs incurred, in
compliance with FAR Part 31 and specific contract provisions.
Contract engagements generally include the following:
This type of engagement requires an examination of the engineering
consultant’s indirect cost rate(s) for a specified period
(usually a calendar or fiscal year). In addition to ensuring that unallowable
costs have been removed from overhead, the auditor should ensure that allowable costs have been correctly
measured and properly allocated. Indirect cost rates established in these
engagements are used to adjust costs previously invoiced at provisional rates
to actual costs.
Many State DOTs also use established indirect cost rates of the most
recently completed calendar or fiscal year as provisional rates to be used for
estimating and invoicing costs on new contracts. In applying these provisional
rates, risk and materiality must be measured, with due
consideration given to all contracts that may be priced using the indirect cost
rates.
This type of engagement requires an examination of the engineering
consultant’s forward pricing indirect cost rate(s) used to prepare
estimates of costs that will be incurred in future periods. Forward pricing
rates are similar to cost-incurred rates described above in Section 3.2.A in that
forward pricing rates are based on historical costs. However, these rates are adjusted to reflect estimates of future
costs and activity levels to project indirect cost rates for future periods.
When reviewing forward pricing rates, auditors should evaluate the
reasonableness of future projections as well as the accuracy of historical cost
information used as the starting point for rate development. While most
contracts negotiated directly with Federal agencies utilize forward pricing
rates, many DOTs only will negotiate contracts
using indirect cost rates based on actual, historical cost information. Risk
and materiality should be determined based on
all contracts that may be priced using the indirect cost rate.
Contract pre-award reviews are performed to evaluate the reasonableness
and accuracy of cost proposals for specific contracts. The auditor may examine
the reasonableness of estimates used as well as the accuracy of estimate
components that are based on current or historical costs. When conducting
pre-awards reviews, auditors often rely on work done by other auditors;
however, if other audit reports do not exist, then auditors performing the
pre-award review may examine items such as indirect cost rates. Risk and materiality should be determined based only
on the contracts being covered by the pre-award review. Auditors may be
required to perform additional work for very large contracts.
These engagements are
performed to determine actual costs incurred on contracts. Auditors should
consider both direct and indirect costs, to determine whether invoiced costs were allowable in accordance
with applicable cost principles and were treated consistently with cost
accounting practices used to develop the engineering consultant’s indirect cost
rate(s). When conducting such engagements, auditors often rely on opinions
rendered by indirect cost rate auditors, including conclusions reached about
the accounting and internal control systems. Risk and materiality should be determined based only
on the contracts being covered by the contract cost review.
Auditing procedures and responsibilities may vary, depending on the
nature of the audit or examination-level attestation performed by the auditor.
Several regulatory bodies may influence the types of procedures that will apply
to planning the audit, performing audit testing, and reporting on the results.
A description of applicable auditing standards follows.
The Government Auditing Standards, also known as “Generally Accepted
Government Auditing Standards” (GAGAS), are issued by the U.S. Government Accountability Office (GAO). GAGAS apply to audits of
government entities as well as audits of Federal-aid funds paid to engineering
consultants, non-profit organizations, and other non-governmental organizations.
GAGAS may be used in conjunction with
professional standards issued by other authoritative bodies. For example, the AICPA has issued professional
standards that apply to financial audits and attestation engagements performed
by CPAs. GAGAS incorporate the AICPA’s field
work and reporting standards and, unless specifically excluded, also
incorporate the related statements on auditing standards for financial audits.
GAGAS incorporate the AICPA’s general
standard criteria, and the field work and reporting standards and the related statements
on the standards for attestation engagements, unless specifically excluded.
Note: GAGAS also prescribe requirements in
addition to those provided by the AICPA; accordingly, auditors may need to apply additional standards,
depending on the purpose and requirements of the audit or attestation
engagement.
GAGAS categorize engagements into
three types: (1) Financial Audits, (2) Attestation Engagements, and (3)
Performance Audits. These engagement types are discussed in the following
paragraphs. The standards to be applied will vary based on the engagement type
and audit objectives.
In performing a financial audit, the auditor is primarily concerned with
providing reasonable assurance about whether financial statements are presented
fairly, in all material respects, in conformity with GAAP or with a comprehensive basis
other than GAAP. An example would be an audit of an overhead schedule (considered a financial
statement) performed in compliance with FAR Part 31. Financial audits also may include other objectives that provide
different levels of assurance and entail various scopes of work.
Attestation engagements concern examining, reviewing, or performing
agreed-upon procedures on a subject matter or an assertion about a subject
matter and reporting on the results. These engagements may cover a broad range
of financial or nonfinancial subjects and can be part of a financial audit or
performance audit. Examples include examining an entity’s internal control over
financial reporting, an entity’s compliance with requirements of specified
laws, regulations, rules, contracts, or grants, and various prospective
financial statements or pro-forma financial information.
Performance audits entail an objective and systematic examination of
evidence to provide an independent assessment of the performance and management
of a specific program. These audits generally are performed to improve program
operations and may encompass a wide variety of objectives. Examples include
whether legislative, regulatory, and/or organizational goals are being
achieved, the relative cost and benefits of a program, and the validity and
reliability of performance measures.
Note: This Guide primarily deals
with financial audits and attestations. A matrix is provided in the following
subsection (see Table 3-1) to summarize applicable
standards for these types of engagements. Performance audits are beyond the scope of this Guide.
GAGAS incorporate various AICPA standards and additional
standards more specific to engagements performed on governmental entities. The
following matrix may be used as a general guide to determine the applicable
standards; however, GAGAS (the Yellow Book) should be consulted for the
complete text of the standards.
Table 3-1: GAGAS Matrix
Standard Category |
Source |
Financial Audit Standards |
Examination Level Attestation Engagement Standards |
|
|
|
|
General |
AICPA |
|
Evaluation Against
Criteria |
|
GAGAS |
Independence |
Same as Financial |
|
GAGAS |
Professional Judgment |
Same as Financial |
|
GAGAS |
Competence |
Same as Financial |
|
GAGAS |
Quality Control and Assurance |
Same as Financial |
|
|
|
|
|
|
|
|
Field
Work |
AICPA |
Planned and Supervised |
Same as Financial |
|
AICPA |
Understand Internal Control |
Similar to Financial |
|
AICPA |
Evidential Matter |
Sufficient Evidence for
Conclusion |
|
GAGAS |
Auditor Communication |
Similar to Financial |
|
GAGAS |
Results of Previous Audits |
Same as Financial |
|
GAGAS GAGAS |
Detecting Material Misstatements Elements of Finding |
Similar to Financial Similar to Financial |
|
GAGAS GAGAS GAGAS GAGAS |
Audit Documentation Determining Materiality Consideration
of Fraud and Illegal Acts Consideration of Investigations
and Legal Proceedings |
Similar to Financial Similar to Financial Similar to Financial Similar to Financial |
|
|
|
|
|
|
|
|
Reporting |
AICPA |
GAAP or Not GAAP |
|
|
AICPA |
Consistent Between Periods |
|
|
AICPA |
Informative Disclosures |
|
|
AICPA |
Opinion or
Expression of Non Opinion |
|
|
AICPA |
|
Engagement Subject
Matter |
|
AICPA |
|
Practitioner’s Conclusion |
|
AICPA |
|
Practitioner’s Reservations |
|
AICPA |
|
Report Distribution
Restrictions |
|
GAGAS |
In Accordance with GAGAS |
Same as Financial |
|
GAGAS |
Internal Control Report |
Similar to Financial |
|
GAGAS GAGAS GAGAS |
Reporting Deficiencies Reporting Significant Matters Reporting Restatement of
Financial
Statements |
Same as Financial None None |
|
GAGAS |
Views of Responsible Officials |
Same as Financial |
|
GAGAS |
Privileged and
Confidential Information |
Same as Financial |
|
GAGAS |
Report Distribution |
Same as Financial |
|
|
|
|
Note: The applicable standards
vary depending on the type of audit or attestation engagement. Additional audit
standards and procedures (e.g., standards issued by the Institute of Internal
Auditors and/or Federal agencies) may be appropriate, depending on the
circumstances.
The Sarbanes-Oxley Act of 2002 was major legislation that affected publicly-traded
companies. It established the Public
Company Accounting Oversight Board (PCAOB), which has the authority to set auditing standards
for registered public accounting firms involved with publicly-traded companies.
One key provision is the requirement that annual reports must include an
internal control report from management, along with an attestation report from
the firm’s auditor. These standards, and the internal control reports, may
provide assurances when determining the adequacy of controls for
publicly-traded consulting firms.
State departments of transportation (DOTs) rely on FAR Part 31 for
guidance when negotiating costs and reviewing project proposals with
engineering consultants. The FAR contains cost principles and procedures for
pricing contracts, subcontracts, and modifications to contracts.
The following is a general discussion of applicable cost principles
described in FAR Part 31. This discussion is on a summary level only and is not
intended to be a complete rendition of all cost principles contained in the
FAR.
The provisions apply to commercial organizations, educational
institutions, State, local and Federally-recognized Indian tribal governments,
and nonprofit organizations. FAR 31.105, dealing with construction and
architect-engineering contracts, states that the allowability of costs shall be determined in
accordance with FAR Subpart 31.2. Accordingly, the following discussion focuses
on Subpart 31.2–Contracts with Commercial Organizations.
The total cost of a contract includes all costs properly allocable to
the contract under the specific contract provisions. The allowable costs to the
Government are all costs that are reasonable, allocable, and are not prohibited
by FAR Part 31.
In some cases, a contracting State DOT may enter into an advance
agreement with an engineering consultant to clarify the allocability and
allowability of special or unusual costs. FAR
31.109 provides further clarification of advance
agreements, including examples of costs for which advance agreements may be
important.
In the absence of any advance agreements, the auditor should determine
the allowability of costs. To determine the
allowability, the auditor should consider the following:
1. Any limitations set forth in
Subpart 31.2 of the FAR;
2. Allocability;
3. Cost Accounting Standards (CAS) promulgated by the Cost Accounting Standards Board (CASB); if applicable, otherwise, Generally Accepted Accounting Principles and practices appropriate to the
particular circumstances;
4. Terms of the contract; and
5. Reasonableness.
Cost elements must be addressed for reasonableness in accordance with
FAR 31.201-2 and 31.201-3. Reasonableness concerns may arise in any number of
cost categories, including indirect labor and fringe benefits, among others.
For example, the amount of indirect labor in the indirect cost pool in relation
to direct labor may cause concerns regarding a firm’s efficiency and the extent
to which the Government should reimburse costs through the overhead rate.
Additionally, certain categories of fringe benefits also may generate
reasonableness concerns, especially in the case of privately-held firms with
compensation cost structures not subject to the constraints of stockholders’
oversight.
Note: The following section
discusses the reasonableness of general cost items. See Chapter 7 for specifics
regarding determining the reasonableness of compensation costs.
FAR 31.201-2, Determining Allowability, provides the following
(emphasis added):
(a) A
cost is allowable only when the cost complies with all of the following
requirements:
(1) Reasonableness.
(2) Allocability.
(3) Standards
promulgated by the CAS Board, if applicable; otherwise, generally accepted accounting
principles and practices appropriate to the circumstances.
(4) Terms
of the contract.
(5) Any
limitations set forth in [FAR 31.201].
FAR 31.201-3, Determining Reasonableness, provides the framework for
addressing the reasonableness of costs (emphasis added):
(a) A
cost is reasonable if, in its nature and amounts, it does not exceed that which
would be incurred by a prudent person in the conduct of competitive business.
Reasonableness of specific costs should be examined with particular care in
connection with firms or their separate divisions that may not be subject to
effective competitive restraints. No presumption of reasonableness shall be
attached to the incurrence of costs by a contractor. If an initial review of
the facts results in a challenge of a specific cost by the contracting officer
or the contracting officer’s representative, the burden of proof shall be upon
the contractor to establish that such cost is reasonable.
(b) What
is reasonable depends upon a variety of considerations and circumstances, including—
(1) Whether
it is the type of cost generally recognized as ordinary and necessary for the conduct of the contractor’s business
or the contract performance;
(2) Generally
accepted sound business practices, arm’s length bargaining, and Federal and
State laws and regulations;
(3) The
contractor’s responsibilities to the Government, other customers, the owners of
business, employees, and the public at large, and
(4) Any
significant deviations from the contractor’s established practices.
While the tests, standards, and other
considerations referenced in FAR 31.205-3 entail varying degrees of
subjectivity and professional judgment, it is strongly recommended, as a best
practice, that greater emphasis be placed on quantitative analysis in
addressing the reasonableness of costs. Specifically, ordinary costs are
amounts that are common, usual, and otherwise characteristic of the industry
segment. When analyzing cost elements for reasonableness, engineering
consultants and auditors are strongly recommended to use the concept of
ordinary cost as a starting point, as discussed below.
The starting point in the analysis of reasonableness of a specific cost
element is the establishment of an ordinary level of cost as a baseline for the
analysis. The methodology for establishing this baseline may vary depending on
the circumstances.
(a) Ratio Analysis. The methodology may include
the use of ratios, for example, the use of mean or median values as a
percentage of either direct labor or net revenues by type of engineering
services, size of firm, and location, among other parameters. When this
methodology is used, the ratios and other comparative statistics may be derived
from nationally-published, independent industry surveys.
(b) Analysis of Trend /Historical Data. The methodology for
establishing baseline costs also may include the use of trend analysis and/or
analysis of historical cost data. When trend analysis is used, consideration
should be given to both the trend within the firm in question as well as the
industry overall. Additionally, a combination of both survey and trend
analysis, as well as other empirically-based methodologies, may be used.
(c) Analysis of Variances. Once baselines for specific cost elements are
established, variances in excess of benchmark thresholds, if determined to be
material on the basis of professional judgment, should be identified, analyzed,
and addressed by the engineering consultant and/or in the auditor’s workpapers within the context of a multi-factor analysis,
in accordance with the considerations outlined by FAR 31.205-3 and other
related regulations. If costs with material variances are determined to be
reasonable, then the basis for acceptance of the variances in the context of
FAR 31.205-3 should be explicitly identified in the audit workpapers,
so that the cognizant agency or other reviewer is made fully aware of the facts
underlying this determination.
Cost categories of frequent concern with respect to reasonableness
include, but are not limited to, executive compensation (see Chapter 7),
indirect labor, vehicle costs, travel costs, occupancy costs, pension costs, and the
various elements of fringe benefits.
A cost is allocable if it is
assignable or chargeable to one or more cost objectives or cost centers on the
basis of either the relative benefits received or some other equitable
relationship. A cost must be distributed in some reasonable proportion to the
benefits derived. A cost is allocable to a Government contract if it:
1. Is incurred specifically for
the contract (direct cost);
2. Benefits both the contract
and other work, and can be distributed to them in reasonable proportion to the
benefits received (direct and indirect cost); or
3. Is necessary to the overall
operation of the business, although a direct relationship to any particular
cost objective cannot be shown (indirect cost only).
Costs that are expressly or mutually agreed to be unallowable, including directly
associated costs, must be identified and excluded from any billing, claim, or proposal
applicable to a Government contract. A directly associated cost is any cost
which is generated solely as a result of incurring another cost, and which
would not have been incurred had the other cost not been incurred. When an
unallowable cost is incurred, its directly associated costs are also
unallowable. The practices to account for and present unallowable costs are
described in CAS 405 (48 CFR 9904.405), Accounting for Unallowable Costs.
In evaluating an engineering consultant’s overhead, auditors should consider direct as well as indirect costs. A direct cost is any cost that can be
identified specifically with a particular contract or project. Costs identified
specifically with a contract or project are direct costs and must be charged
directly to the contract or project. All costs specifically identified with a
project are direct costs of that project and may not be charged to another
project, either directly or indirectly. Finally, a cost may not be charged as
direct and also be included in an indirect cost pool. For reasons of
practicality, any small dollar direct cost may be treated as an indirect cost
if the accounting treatment is consistently applied to all projects and
produces substantially the same results as treating the cost as a direct cost.
However, any variances and credits should then also be treated as indirect
costs.
Indirect costs should be accumulated by logical cost groupings with due
consideration of the reasons for incurring such costs. Commonly, manufacturing
overhead, selling expenses, and general and administrative (G&A) expenses are
separately grouped. The engineering consultant must record indirect costs in
accordance with GAAP and must consistently allocate
these costs to intermediate or final cost objectives, as appropriate.
Contracts may be subject to the Cost Accounting Standards (CAS) promulgated by the Cost Accounting Standards Board (CASB), an independent board that reports to the U.S. Office of Management
and Budget’s Office of Federal Procurement
Policy. Certain
Note: For details regarding CAS
Program Requirements, see FAR Subpart 30.2.
Generally. Allocation bases are used to distribute/allocate overhead costs to intermediate or final
cost objectives. An allocation base common to all cost objectives or projects
should be selected for the allocation of indirect costs. Although most engineering consultants use direct labor as the sole base for developing overhead rates, some engineering
consultants have rate structures that are more complex and use multiple
allocations bases to allocate costs. A typical example follows:
Example 4-1: Common
Allocation Bases
Cost
Pool |
Allocation
Base |
Employee Fringe Benefits |
Direct Labor |
Overhead Expenses |
Direct Labor and Fringe
Benefits |
General & Administrative
Expenses |
Total Cost Input* |
* When using the Total Cost Input allocation base, the base includes
direct labor, indirect labor, fringe benefits, general overhead, unallowable costs, materials, and costs for subconsultants.
Rate Structures and Cost Allocation Methods. Once an appropriate base for
distributing indirect costs has been accepted, the base should not be
fragmented by removing individual elements. Rate structures and cost allocation
methods must be consistently applied to all contracting entities, including
State DOTs. As an example, a consultant with a single, company-wide cognizant
audited rate should not establish and apply a segment rate for a contracting
entity when the costs included in the segment rate also are included in the
company-wide rate. Likewise, direct costs must be consistently allocated and
applied to all benefited objectives, regardless of specific contract
provisions. As an example, if a firm accounts for and allocates computer cost
direct to benefited objectives, and a contracting entity negotiates not to
allow computer costs as a direct cost by contract, the computer costs
associated with this contract must be consistently allocated as a direct cost
to this project.
Base Period for Allocating Indirect Costs. As provided in FAR
31.203(g)(2), “ . . . the base period for allocating indirect costs
shall be the contractor’s fiscal year used for financial reporting purposes in
accordance with generally accepted accounting principles. The fiscal year will
normally be 12 months, but a different period may be appropriate (e.g., when a
change in fiscal year occurs due to a business combination or other
circumstances).” When
a contract is performed over an extended period, as many base periods shall be
used as are required to encompass the total period of contract performance. In
certain instances, an agreed-upon provisional rate may be established for use
over the duration of the contract.
As discussed in Chapter 4, allocation bases are used to assign/allocate
certain overhead or other indirect costs to final cost objectives (projects). There are various allocation
bases commonly used in cost accounting systems for allocating indirect costs;
however, for engineering contracts administered by State DOTs, direct labor cost is the most frequently used
base. Whatever base is used for cost allocation, it should be consistent for all contracts. Some of the
common methods are discussed below.
Direct labor cost is the most common,
accepted base used to allocate overhead costs on State DOT contracts.
Direct labor costs generally are computed by multiplying all direct project
labor hours by labor rates, as summarized for all employees within the
applicable allocation unit. Labor rates are based on actual employee wages
incurred.
The direct labor hour method is another way to
allocate indirect costs based on total direct hours charged in an appropriate allocation
unit.
This method is similar to the Direct Labor Hours allocation base, except
that the base includes all hours incurred for direct and indirect activities.
Use of this base assumes that costs incurred benefit both direct and indirect objectives
and should be allocated to the appropriate cost objective receiving a benefit
as determined by the proportional number of hours assigned to that cost
objective.
This base frequently is used to allocate General and Administrative
(G&A) costs. The base consists of direct labor, fringe benefits, overhead costs, associated non-salary
direct expenses (including other costs sometimes referred to as “internal
direct expenses”) and subcontract costs.
This base is similar to the Total Cost Input base. However, the Total
Cost Value Added base excludes materials (used primarily in production only)
and subcontract costs, as distortion in allocations may occur due to a
disproportionate amount of subcontract costs or materials in the pool.
This method allocates costs to direct or indirect activities on a
common unit, usually time or quantity used. For instance, an internal cost pool
such as one for computer-aided drafting and design equipment (CADD) costs can
be allocated specifically as a direct cost to a project or as an indirect
cost based on the number of hours actually
incurred.
FAR 31.201-6 expressly requires engineering consultants to comply with
CAS 405 to account for unallowable
costs. CAS 405-40(e) provides that all unallowable costs “shall be subject to
the same cost accounting principles governing cost allocability as allowable
costs.”
CAS 405-40(e) further specifies that:
In circumstances where these unallowable costs normally would
be part of a regular indirect-cost allocation base or bases, they shall remain
in such base or bases. Where a directly associated cost is part of a
category of costs normally included in an indirect-cost pool that will be
allocated over a base containing the unallowable cost with which it is
associated, such a directly associated cost shall be retained in the
indirect-cost pool and be allocated through the regular allocation process.
Note: Allocation bases contain
allowable and unallowable costs, but indirect cost pools must be purged of
unallowable costs. Additionally, regardless of whether State DOTs contractually
limit the amount of direct labor that may be reimbursed on a contract, the
engineering consultant's direct labor base must remain as allocated per the
consultant’s job cost system, and the direct labor base should not be adjusted
for unallowable costs. A direct labor base should not be reduced for any excess
compensation adjustments but should have allocated to it the allowable overhead
in accordance with FAR 31.203(d), which provides that:
“Once an appropriate base for allocating indirect costs has been
accepted, the contractor shall not fragment the base by removing individual
elements. All items properly includable in an indirect cost base shall bear a
pro rata share of indirect costs irrespective of their acceptance as Government
contract costs. For example, when a cost input base is used for the allocation
of G&A costs, the contractor shall include in the base all items that would
properly be part of the cost input base, whether allowable or unallowable, and
these items shall bear their pro rata share of G&A costs.”
examplE 5-1:
Sample Design Firm incurred $2.5 million in
direct labor, of which $500,000 was not billable to contracts. The total $2.5
million must remain in the direct labor base, which will then be used to
allocate the allowable indirect costs.
Cost centers are established
to accumulate and segregate costs. Cost centers are developed to capture costs
associated with a single purpose. The costs are then assigned to objectives
(projects) based on unit charges. For example, unit charges frequently are
computed for cost categories such as CADD, printing, computers, and vehicles. The over- or under-allocation of
costs usually is handled as an adjustment to the overhead cost pool, which is where the
costs would have been charged if they had not been directed to the cost center.
However, if the over- or under-allocation is significant, then consideration
should be given to adjusting the contract/project charges.
Some accounting systems will
attempt to adjust the unit charge rate for the over- or under-allocation of the
cost centers. The goal of any cost center is to minimize the over- or
under-allocation by the application of a properly estimated unit charge.
Some firms choose not to
create cost centers and instead estimate the cost of providing certain services
by computing unit rates based on certain elements from general ledger accounts
(e.g., automobile depreciation from a depreciation account). Once established,
these unit charges are offset to overhead as “credit backs” or cost
recoveries for allocated direct costs as they are utilized on projects. This type of costing is less
precise and should not be utilized if the unit charges being accumulated are
significant to the firm’s overall operation. If handled on a direct-cost basis,
the direct cost rates must be supported and audited. The burden is on the
engineering consultant to prove the direct cost rates and that direct costs
were properly removed from the indirect cost pool. The overhead audit should
include disclosure notes regarding the audited direct cost rates and a listing
of cost categories that the engineering consultant charges direct. See Chapter
8 for testing guidance and Chapter 9 for disclosure guidance.
Note: Firms that do create costs centers generally capture costs either by
business activity (functional cost centers) or based on the firm’s
organizational structure, as discussed below.
This method segregates costs
unique to a business activity, typically for purposes of direct costing.
Another method of
accumulating and segregating costs is focused on the corporate structure. Some
examples of cost centers used for accumulating costs are groupings of regional
offices, specific subsidiaries, affiliates, divisions, or field offices.
Indirect costs should be accumulated by logical (homogeneous) cost
groupings (pools), with due consideration of the reasons for incurring such
costs, allocated to cost objectives in reasonable proportion to the beneficial
and causal relationship of the pool costs to final cost objective (see FAR
31.203(c)). The auditor should make a thorough study of the indirect cost activity, including activity bases used for
allocation and the cost allocated, to determine whether the activity base
chosen by the engineering consultant is appropriate for cost allocation and
results in a reasonable measure of the activity. The base should:
·
be a reasonable measure of the activity;
·
be measurable without undue expense, and, except for G&A expense;
·
should fluctuate concurrently with the activity that generates the
costs.
When an engineering consultant’s activities are decentralized, the use
of separate indirect cost rates for each geographic location will
normally produce more equitable allocation of indirect costs than the use of
composite or company-wide rates. Overhead rates determined for offsite/field
activities should be based on eliminating from the overhead pool those types of indirect costs which do
not benefit offsite activities. For example, occupancy costs may be eliminated
from offsite pools because the engineering consultant uses Government
facilities.
Fringe benefits include
costs for employee perquisites and costs associated with the employer’s portion
of payroll taxes and employment benefits. Such costs generally include, but are
not limited to, payroll taxes, pension plan contributions, paid time off,
medical insurance costs, life insurance, and certain employee welfare expenses.
Overhead costs are costs
that may benefit, or are associated with, two or more business activities, but
are not specifically allocated to an activity for reasons of practicality.
Overhead differs from general and administrative costs (below) in that these
costs can be associated with a unit based on relative benefit. Some examples of
overhead costs include rent,
depreciation, employee recruitment and training, and general or professional
insurance policy costs.
G&A expenses generally
comprise all costs associated with business operations that cannot be
specifically identified with a smaller unit of business activities. For
example, certain management or administration costs that are incurred for an
entire business unit may be considered G&A, but other accounting or legal
costs benefiting a segment of the business may be considered part of the
overhead pool of that specific business
segment.
Generally, this cost center
includes costs such as equipment depreciation or rental; software including
license costs; employee training costs on new software; equipment maintenance;
cost of special facilities or locations; and systems development labor or support costs.
For the most part, these are
costs associated with company vehicles such as cars, survey trucks, and vans
that may be used for a direct or indirect cost objective. Costs in this center
may include depreciation, lease costs, maintenance, insurance, and operation
costs such as fuel.
Costs accumulated to this
center are similar to both computer and company vehicle pools. Company
equipment can be a wide variety of items from small to large that are used in
various activities. Some examples include nuclear density meters, GPS
equipment, and traffic counting machines.
Costs in this center are
generally associated with reproduction from a single page copied to multiple
prints of large specialized drawings or blue prints. In most cases, this cost
center includes equipment, labor, ink or toner, and paper supplies.
No final cost objective
shall have allocated to it as a direct cost any cost, if other costs incurred for the same
purpose in like circumstances have been included in any indirect cost pool to be allocated to that or any other
final cost objective.
Note:
The “Like-Cost” Issue.
FAR 31.202(a) provides that “[n]o final cost
objective shall have allocated to it as a direct cost any cost, if other costs
incurred for the same purpose in like circumstances have been included in any
indirect cost pool to be allocated to that or
any other final cost objective.”
Like-cost categories should
be consistently allocated in the accounting system. As an example, employee
personal vehicle mileage must be allocated to similar cost objectives in the
same manner as company vehicle mileage. One category of like costs may not be
charged directly to contracts while the related like cost category are
recovered as part of the indirect cost rate. Other common like cost
categories are computers and telephones.
Labor costs are usually the
most significant costs incurred by design and engineering firms in the
performance of Government contracts. Incurred labor costs form the basis for
estimating labor for future contracts. Therefore, it is imperative that
engineering consultants establish and maintain a sound system of internal
control over the labor charging function.
Unlike other items of cost,
labor is not supported by external
documentation or physical evidence to provide an independent check or balance.
The key link in any sound labor charging system is the individual employee. It is
critical to labor charging internal control systems that management fully
indoctrinate employees on their independent responsibility for accurately
recording time charges. This is the single most important feature management
can emphasize in recognizing its responsibility to owners, creditors, and
customers to guard against fraud, waste, and significant errors in the labor
charging functions.
An adequate labor accounting
system, manual or electronic, will create an audit trail whenever an employee creates a
timesheet entry. A system that allows an audit trail to be destroyed is
inadequate because the integrity of the system can be easily compromised.
Access to timesheets should be controlled and preprinted, if possible, with the
employee’s name, number and fiscal week. An inadequate system would allow
employees to erase prior entries without recording the adjustment. Employees
should initial all time sheet changes and adjustments should be maintained as
part of the audit trail.
The engineering consultant
should have procedures to ensure that labor hours are accurately recorded
and that any corrections to timekeeping records are documented, including
appropriate authorizations and approvals. When evaluating the engineering consultant’s timekeeping procedures,
the auditor should consider whether the procedures are adequate to maintain the
integrity of the timekeeping system.
The engineering consultant
should have policies and procedures for training employees to reasonably ensure
that all employees are aware of the importance of proper time charging.
Note:
See Chapter 6 for further discussion of Labor-Charging System requirements.
Engineering consultants may
not be required to pay overtime to salaried employees for hours worked in
excess of 40 hours per week. Any unpaid hours worked by salaried employees in
excess of the normal 40 hours per week are commonly called “uncompensated
overtime.”
The engineering consultant
must have procedures covering the consistent recording and accounting for hours
worked, whether paid or unpaid, to ensure the proper distribution of labor costs. This is necessary because
labor rates and labor overhead costs can be affected by total
hours worked, not just paid hours worked.
Per DCAA CAM Section
6-410.3.d:
If it is
determined that Government contracts are being over charged by a material
amount due to an inequitable allocation of costs because the contractor does
not record all time worked, the contractor should be cited as being in
noncompliance with FAR 31.201-4 and CAS 418. Any material excess allocation of
costs to Government contracts should be questioned or disapproved as
applicable. Materiality is the governing factor when determining whether noncompliances should be cited and whether a contractor
should be required to implement a total-hour accounting system.
For firms with material
amounts of uncompensated overtime labor, it is necessary to apply an adjustment to minimize the risk that Government
projects will absorb disproportionate amounts of direct labor costs. This may be accomplished
through either of the following common methods, or any other equitable method,
so long as the method applied is consistent year to year, and the
methodology is reasonable and supportable:
1.
Effective Rate Method. Using this method, effective hourly pay rates are
computed weekly, based on actual time charges. This would require the client to
divide each employee’s total weekly salary by their respective hours worked,
which would result in variable wage rates being charged to contracts. For
example, if Employee Smith is paid $1,400 per week and works 40 hours per week,
then Smith’s effective hourly wage rate is $35. By contrast, if Smith actually
works 55 hours in week 1 and 50 hours in week 2, then his effective wage rates
are $25.45 and $28, respectively. Billings against Government contracts would
be limited to the effective rates.
2.
Salary Variance Method. Under
this method, overhead is reduced for the appropriate
portion of labor costs generated by uncompensated
overtime hours. The calculation may be completed one of two ways, based on the
engineering consultant’s use of standard or effective hourly rates. Standard
rates are computed as the total paid labor cost compared to total paid hours
(e.g., weekly pay divided by 40 hours, or annual pay divided by 2,080 hours).
(a) Standard Wage Rates:
If the engineering
consultant records labor at standard rates, then at year end the
overhead cost pool must be reduced by the number of uncompensated
hours multiplied by the standard wage rate. For example, if Employee Smith
earns $72,800, then his standard hourly wage rate is $35.[4] If Smith actually works 2,600 hours during
the year, then there are 520 hours of uncompensated overtime.[5]
Accordingly, the indirect cost pool must be reduced by $18,200.[6]
This example is illustrated below in Table
5-1.
(b) Effective Wage Rates: If the engineering consultant records labor at effective hourly rates, then at year end
the overhead cost pool must be reduced, and the direct
labor base must be increased, by the number of
direct labor hours multiplied by the difference between the
standard and effective hourly rates. For example, if Employee Smith earns
$72,800 working 2,600 hours during the year, his effective rate is $28. If
2,000 of Smith’s hours were spent on direct projects, the indirect cost pool must be reduced and direct labor base
increased by $14,000. This example is illustrated below in Table 5-2.
As
illustrated in Tables 5-1 and 5-2 above, the end result of using the Salary
Variance Method is the same regardless of whether the
engineering consultant
uses the Standard Rate or Effective Rate option.
Note:
Significant amounts of uncompensated overtime may have a material impact on
costs charged directly to State DOT contracts. Accordingly, State DOTs may seek
billing adjustments when appropriate.
Some engineering consultants
may have accounting systems that do not capture costs for hours worked by
salaried employees in excess of 8 hours per day or 40 hours per week. Because
there is a serious risk of incorrect charging of costs to Government contracts
under these circumstances, the following methods of distributing these salary
costs are unacceptable:
1.
Distribute labor costs to only those cost
objectives worked on during the first 8 hours of the day.
2.
Allow employees to select the cost objectives to be charged when more
than 8 hours per day are worked or the engineering consultant has an informal
policy as to how employees are to select the objectives to be charged.
Engineering consultants should
have the capability of maintaining records that segregate overtime premium
amounts as direct or indirect costs. An acceptable method is to charge the premium portion of overtime as
a direct charge when it is the engineering consultant’s regularly established
policy and when appropriate tests demonstrate that this policy results in
equitable cost allocations.
When employees normally work
on multiple contracts it is often difficult to determine which contract
“caused” the overtime. Therefore, many companies have a policy that the
overtime premium portion is allocated to the overhead pool.
Note:
Engineering consultants may treat overtime premium as either a direct or
indirect cost, depending on the specific circumstances; however, consultants
must treat overtime premium costs consistently for all contracts,
regardless of the customer (Government versus commercial) or type of contract
involved.
·
Approvals and Authorizations. The engineering consultant
should have procedures to ensure that labor hours are accurately recorded
and that any corrections to time keeping records are documented, including
appropriate authorizations and approvals.
·
Reconciliation of Labor System to Payroll and General Ledger. The engineering consultant
should have procedures requiring that the total labor costs reflected in labor
distribution summaries (job cost) agree with the total labor charges as entered
in the time-keeping, payroll systems and general ledger. This reconciliation
ensures the labor charges to contracts represent actual paid or accrued costs
and that such costs are appropriately recorded in the accounting records.
·
Reconciliation of General Ledger and Overhead Schedule to Payroll Tax
Returns (IRS Form 941s). The engineering consultant
should have procedures requiring that the total labor costs recorded in the general
ledger, and included on the overhead schedule, reconcile to the payroll data
submitted to the Internal Revenue Service.
·
Labor Costs Directly Associated with Unallowable Activities. The engineering consultant
should have procedures requiring that direct and indirect labor costs directly associated with
unallowable costs are identified and segregated.
·
Overrun Contracts. When contract costs have
exceeded or are projected to exceed contract value, these excess costs should
not be diverted to other cost objectives such as indirect labor, overhead accounts, or other contracts.
·
Significant Increases in Direct/Indirect Labor
Accounts.
Trend analyses may disclose instances where charges to direct or indirect labor accounts have increased significantly.
Two common ratios often used for trend analysis are the Productivity Ratio (direct labor/total labor) and the Multiplier
Ratio (fee revenue/direct
labor). Sufficient review should be performed to determine the nature of any
significant increase or variance from prior years.
·
Reorganization/Reclassification of Employees. The organizational
structure of the engineering consultant should be analyzed to determine if it
permits inconsistent treatment of similar labor. For example, a program manager should not charge direct on cost-type
contracts and indirect on fixed-price/ commercial contracts.
·
Adjusting Journal Entries/Exception Reports (Labor
Transfers).
Adequate rationale and supporting documentation should be available for all
significant labor transfers.
·
Budgetary Control. Engineering consultants
may operate management systems that require strict adherence to budgetary
controls. If the system is inflexible, then labor charges may tend to follow the
identical route of the budgeted amounts. Rigid budgetary control systems can
result in predetermined labor charges.
·
Mix of Contracts. Costs should be identified
and charged consistently in the accounting system, regardless of contract type.
Significantly higher inherent risk exists for firms that use
combinations of lump sum contracts and cost plus fixed fee contracts. The risk
is that direct labor and other direct costs may not be accounted for under the correct cost objective, thereby
resulting in understatement of direct labor and overstatement of indirect
labor or incorrect direct project charging. Also see the discussion in Chapter
9–General Audit Considerations.
The compensation of owners
or partners must be charged as direct labor when they are personally engaged
in performing tasks under contracts. If sole proprietors or partners do not
receive a salary, then their compensation must be determined by advance agreements
or negotiation.
In some cases, engineering
consultants contract for services provided by outside engineers, technicians, and
similar staff rather than hiring these individuals as employees. This is
commonly referred to as “Contract or Purchased Labor.” The accounting treatment
varies, depending on the circumstances under which the purchased labor costs are incurred.
Two acceptable methods of
accounting for this labor are:
1.
Charged as a direct cost to projects, or
2.
Treated as other labor (direct or indirect as appropriate)
CAS 418 requires that pooled costs
be allocated to cost objectives in reasonable proportion to the causal or
beneficial relationship of the pooled costs to cost objectives. Contract labor must share in an allocation of
indirect expenses where such a relationship exists and the allocation method is
consistent with the engineering
consultant’s disclosed accounting practices. A separate allocation base for
purchased labor may be necessary to allocate significant costs to contract
labor, such as supervision and occupancy costs, or to eliminate other costs,
such as fringe benefits, that do not benefit purchased labor.
Other Direct Costs (ODCs)
typically include subcontracts, travel, and outside printing. Internally
allocated costs based on charge-out rates developed by the firm, such as
company vehicle mileage and copying, are earlier in this chapter.
Note:
To be treated as a direct cost, the item must have been required for, and used exclusively on, a
specific job. The “but-for” principle should apply. “But for this job, the cost
would not have been incurred.” All similar costs must also be treated as direct
costs and excluded from overhead costs.
The audit procedures for
ODCs involve determining if unallowable costs were handled correctly. Per CAS 405-40 (Fundamental Requirement): “All unallowable costs shall be subject
to the same cost accounting principles governing cost allocability as allowable
costs. If a direct cost is unallowable, then it must remain
allocated as a direct cost and may not be included in any indirect cost pool.
Engineering consultants are
not always able to perform contracted services from their established home- or
branch offices, as certain contracts may require establishment of offices in
field locations, or the engineering consultant may be required to locate
personnel in office space provided by a State DOT. Some engineering consultants
may even establish a separate company for field projects. Engineering
consultants may have both field (construction management) and project (design)
office rates. Both rates may be required or established by contract if the
consultant did not have previously established field rate accounting.
Per FAR 31.203(f): “Separate cost groupings for costs allocable to offsite locations may
be necessary to permit equitable distribution of costs on the basis of the benefits
accruing to the several cost objectives.” In some cases, projects involve
engineering consultants working in State DOT provided office(s) for an extended
period of time. The life of the field office is basically determined by the
project.
For
projects where the engineering consultant’s employees do not work out of their
own offices and do not receive office support in their day-to-day activities,
the hours billed for them may not qualify for the engineering consultant’s full
overhead rate. The purpose of the field rate is to pay
the engineering consultant for the fringe benefits, project employee
management, and home office administrative support they do provide to their
field employees.
Approved costs directly identified with the project and consistently
treated, as direct costs in the engineering
consultant’s accounting records will be allowed as direct project costs.
Note: Field offices may exist in several forms. Regardless of the
engineering consultant’s organization, consistency in allocating costs to cost objectives is
critical. This Guide presents several suggested methods for computing field
office rates. The use of alternative methods may be acceptable. The use of all
methodologies must be supported by notes to the overhead schedule or in a
separate disclosure statement.
There are many situations that
may require the development of a field- or project-office rate. For example:
·
Construction Contract Administration/Construction Inspection (Field Office). These contracts involve
the management of construction projects and often involve the engineering
consultant’s personnel being located in an on-site project trailer provided by
the contractor or the State DOT. For larger, “mega” projects, the engineering
consultant’s personnel may be located in the State DOT’s main or regional
office.
·
Project Office. These contracts usually
involve services such as design, real estate, traffic center operations, and
utilities. When working on these types of contracts, the engineering consultant’s
personnel typically work out of an office provide by the State DOT.
·
“On Call” Engineers. Consultants with on-call service contracts for
short-term projects and tasks may be required by contract to apply a field rate
if the consultant is located in a State DOT’s offices.
·
Contract Employees. State DOTs contract with
engineering consultants to provide administrative functions and the engineering
consultant’s personnel are located in the State DOT’s offices to perform these
functions.
Engineering
consultants must be consistent in the development and application of field
rates. Accordingly, if an engineering consultant has computed a field rate,
this rate must be consistently applied across all business segments and
disciplines.
Field rate accounting has an impact on the home office rate. If an
engineering consultant has an established field rate for a particular project
or State DOT, then the engineering consultant’s home office rate will be higher
than if the consultant had only a single company-wide rate. As such, for
consistent cost accounting application, a State DOT that
does not have a field office project would have a higher home rate applied to
their State DOT projects.
Direct field labor is based on actual labor hours
multiplied by actual labor rates for field assigned employees. If historical data
is not available when establishing a provisional field rate for the first time,
then an estimate of direct hours for the contract(s) may be used to distribute
direct labor to the field office overhead pool and/or a provisional rate
may be negotiated.
There are many
considerations to use when developing methodologies for field and project
office rates, and these may vary between engineering consultants. However,
direct labor is the common base used in the
development of field rates. The following method described for allocating costs
is a preferred methodology. Field- and project-office rate calculations based on different methodologies
than what is provided in this Guide may be acceptable. Many firms disclose
their methodology in their audit footnotes or have an approved Cost Allocation
Disclosure Statement that documents their field office accounting methodology.
If an alternative allocation
method is used, then the consultant’s allocation must have resulted from a
“reasonable and determinable allocation plan, consistently applied.” The
engineering consultant should provide a note or other disclosure to describe
the allocation methodology in sufficient detail so an auditor can examine the
methodology and verify its logic and reasonableness.
As a general rule, State
DOTs do not require extensive administrative staffing of engineering
consultants’ field offices. Most administrative and management functions will
be performed in the home or branch office. Therefore, an equitable portion of
these offices’ indirect costs should be allocated to the field office. The costs that are
allocated, and the basis for the allocation, depend largely on the engineering
consultant’s customary accounting practices. Some State DOTs require separate
cost pools for accumulation of field office costs. Certain home office indirect
cost should be fully allocated to the home office overhead pool, and certain field office
indirect cost should be fully allocated to the field office pool (see further discussion in Section 5.6.C.3).
Fringe Benefits. The fringe benefits
applicable to the field office direct labor costs should be allocated to the
field office overhead pool. If the engineering
consultant’s accounting records do not maintain separate accounts for field
office fringe benefits, then the fringe benefits may be allocated using the
Field Office Direct Labor Rate shown below in Table 5-3:
Table 5-3: computation of field office direct labor rate
Field
Direct Labor Cost |
= |
Field Office Direct Labor Rate |
|
Total
Direct Labor Cost |
Indirect Labor–Non Project
Time. Labor
costs pertaining to non- project time of professional staff working in the
field office (training, staff development, staff meetings, and/or similar
activities) is generally recorded specifically within the Field Office Indirect
Labor accounts. If these costs are not identified or accounted for separately,
then a ratio based on the Field Office Labor Rate may be used to allocate costs to
the Field Offices, as shown below in Table 5-4:
Table 5-4: computation of field office labor rate
= |
Field Office Labor Rate |
||
Total
Labor Cost |
Indirect Labor—Support Staff. Indirect salaries, such as
accounting, legal, purchasing, personnel, management, and/or similar costs,
should also be allocated to the field office overhead pool. Project managers who spend significant amounts of time managing field
office staff may account for this management time as actual indirect in the
field office overhead pool. This actual time must be supported and documented
on the managers’ time report. All other support staff time that is not
specifically accounted for may be allocated between the home office overhead
pool and the field office overhead pool. A ratio of Field Office Labor
Percentage would be a reasonable method to allocate these costs.
Indirect Costs Fully Allocated to
Home Office.
Certain home office indirect costs
should be fully allocated to the home office overhead cost pool. These costs include, for example,
depreciation, facilities rent, real estate taxes, facility maintenance and
repairs, utilities, facility insurance, and/or similar types of costs associated with home office direct labor. (Costs of support functions that support both home
and field offices should be allocated accordingly.)
Indirect Costs Fully Allocated to Field Office. Likewise, certain field office indirect costs should be fully allocated to the field office overhead pool. Some examples of these costs include field equipment, on-site trailer rental, field supplies, field equipment, software specific to projects, and/or similar types of costs.
Indirect Costs Ratably Allocated
to Field Office. Other
general indirect costs are
allocated to the field office overhead pool based on a reasonable estimate of the benefits
accruing to the field office pool. One recommended method is to allocate
general indirect costs on the basis of the field office labor percentage. This
allocation method involves applying the field office labor percentage to the
various general expense line items on the company’s overhead schedule.
Costs such as rent, real estate taxes, facility maintenance and repairs,
utilities, facility insurance, and/or other similar costs should be allocated
between the G&A portion of the home office costs and to the field offices
on a basis that appropriately reflects the benefits received. For example, the
space costs for accounting staff and other support services benefit all
offices, including field offices; therefore, these costs should be allocated
proportionately among the home and field offices.
Separate Accounting for General and Administrative (G&A) Costs. Some engineering consultants account for G&A office costs in a separate cost pool. In this situation, G&A costs may be allocated to both field and home office operations. When G&A costs are allocated on a base other than direct labor cost, then the G&A allocation rate must be separately disclosed on the overhead schedule.
Note:
If the engineering consultant computes a field office overhead rate, then this
must be disclosed on the overhead schedule. The schedule should include a separate column listing the indirect
field expenses, direct field labor, and resulting field rate. The schedule also should include a footnote
to describe the allocation method(s) used. Tables 5-6 and 5-7 show examples of
an overhead schedule with a field office rate and supporting computations (see
the following pages).
Table 5-7: fIELD OFFICE COMPUTATIONS
The purpose of this chapter
is to provide interpretive guidance only. This chapter is not intended to be
authoritative or to supersede the FAR. The entire text of the FAR should be
consulted when determining proper accounting treatment.
Compensation for personal
services is one of the largest components of cost incurred under Government
contracts. It includes all remuneration paid currently or accrued, in whatever form,
for services rendered by an engineering consultant’s employees during contract
performance.
The objective of a
compensation system is to provide the level of pay and benefits necessary to
attract, retain, and motivate employees to direct their efforts toward
achieving the goals of the organization. To be considered adequate, an
engineering consultant’s compensation system must be reliable, be subject to
applicable management control objectives and activities, and must result in
allocable, allowable, and reasonable compensation costs to be charged to
Government contracts in accordance with FAR provisions.
As discussed previously in
Chapter 5, labor costs typically are the most
significant costs charged to Government contracts and usually comprise the base
used for allocating indirect costs. Historical labor costs are often used to estimate labor for
follow-on or similar item Government contracts.
Unlike other cost items,
labor is not supported by third party
documentation such as an invoice, purchase order, or receipt. Instead,
consultants’ employees have complete control over the documents or devices of
original entry, whether consisting of timecards, electronic media, or some
other means.
Responsibility for labor reporting is diffused throughout
the engineering consultant’s organization. Consequently, there are significant
risks associated with the accurate recording, distribution, and payment of
labor costs.
Labor cost may take one of
two paths—either as a direct charge to a project, or as an
indirect charge to overhead. When consultants use an overhead rate to recover indirect costs, Government contracts will participate in these costs. To assess the
reasonableness of the labor cost pools in accordance with
FAR 31.201-3, State DOTs may apply productivity or efficiency measurements. These measurements are compared to industry standards or State DOTs’ expectations to assess the reasonableness of the
submitted labor costs.
Productivity and/or other
efficiency measures may be used by a State DOT to assess the reasonableness of
a consultant’s labor distribution. If indirect labor
appears to be unreasonably high, then the State DOT may make further inquiries
of the consultant, may perform additional analytical procedures, and/or may
conduct intensive labor testing.
Conversely, consultants must
consistently monitor the recording of direct and indirect labor cost to ensure accuracy and must
monitor staffing levels to ensure the maximum utilization of employees to
minimize excess or idle capacity. Productivity or efficiency measurements
consistently below industry standards should warrant discussions between the
consultant and the State DOT(s). However, this type of ratio/measurement should
not be used as the sole measure of reasonableness.
Note:
Two areas of indirect labor costs, Bid and Proposal costs and Selling
costs, provide consistent areas of concern to State DOTs
and audit agencies. The allowability of these costs is discussed
specifically below.
FAR 31.205-18(a) and CAS 420.30(a)(2) provide that Bid and Proposal (B&P) costs are the—
[E]xpenses incurred in preparing, submitting, and supporting
bids and proposals (whether or not solicited) on potential Government or
non-government contracts, provided that the effort is neither sponsored by a
grant, nor required in the performance of a contract.
FAR 31.205-18(b) further provides that all contracts, regardless of whether full
CAS coverage applies, are subject to
the cost identification and accumulation provisions of CAS 420.
As further discussed in CAS 420, consultants must identify and
accumulate B&P costs by individual project. CAS 420 also requires that
costs for B&P projects be accounted for in the same manner as contracts and
include costs that would be treated as direct costs of that contract, if incurred in like circumstances, and all
allocable indirect costs, with the exception of general and administrative expenses. For example, if a
consultant charges clerical and technical support costs directly to final cost
objectives, then it must also charge them directly to B&P projects. If,
however, the consultant charges these costs to indirect cost pools, such costs
incurred in support of B&P efforts also should be charged to indirect cost
pools.
In accordance with the
B&P definition at FAR 31.205-18(a), any efforts that are “sponsored by a grant or required in the
performance of a contract” are not B&P. Accordingly, consultants must not
include costs in the B&P cost pools for developmental efforts that are
specifically required in the performance of a contract, or those efforts that
are not explicitly stated in the contract but are necessary to perform the
contract.
·
Consultants must consistently require senior managers and executives to
accurately track and record their time associated with B&P activities as
required by CAS 420. This issue is of particular concern, as many executives and managers
do not track B&P activities separately from other overhead functions.
·
The consultant should establish clear guidance regarding the specific
activities that comprise B&P activities and should ensure that all staff
members are adequately trained. The consultant should regularly monitor the
time coded by senior managers and executives to B&P activities to determine
the accuracy of efforts expended. Labor costs associated with B&P
activities should be clearly identified and must be segregated from other
indirect labor activities.
This section contains general
guidance in determining the allocability, allowability, and reasonableness of selling costs under
Government contracts, as discussed in FAR 31.205-38.
Direct selling is characterized by person-to-person contact
and includes such efforts as familiarizing a potential customer with the
consultant’s products or services, conditions of sale, service capabilities,
and similar items. It also includes negotiation, liaison between customer and
consultant personnel, technical and consulting efforts, individual
demonstrations, and any other efforts having as their purpose the application
or adaptation of the consultant’s products or services for a particular
customer’s use. Generally, the costs of direct selling efforts are allowable.
Notwithstanding any other
provision of FAR 31.205-38, sellers’ or agents’ compensation, fees, commissions, percentages, retainer
or brokerage fees, whether or not contingent upon the award of contracts, are
allowable only when paid to bona fide employees or established commercial or
selling agencies maintained by the consultant for the purpose of securing
business.
The nature of costs
classified and charged as selling expense should be compatible with the
provisions of FAR 31.205-38. Although the generic term “selling” encompasses all effort to market
a consultant’s products, the acceptability of the costs of this effort is
governed by several subsections of FAR 31.205. Costs that fall into the following categories should be classified
accordingly. These costs should be evaluated using the appropriate subsection
of FAR 31.205 as discussed below:
·
Advertising Costs (FAR
31.205-1 & -38). Also see DCAA Contract Audit Manual Section 7-1200. In most
instances, allowable advertising is limited to help-wanted advertisements.
·
Corporate Image Enhancement and Public
Relations Costs (FAR 31.205-1 & -38). Also see DCAA Contract Audit Manual Section 7-1200. Allowable public
relations costs include the following examples: costs specifically required by
contract, costs of communicating with the public, costs for participating in community service activities, and costs of plant tours and open houses (excluding any entertainment costs associated with these
efforts). Unallowable public relations costs include costs for disseminating
messages calling favorable attention to the firm’s products or services; most
costs for trade shows; and costs of sponsoring meetings, conventions, seminars, and other events when the principal purpose of the event is other
than the dissemination of technical information or the stimulation of
production.
·
Bid and Proposal/Independent Research and Development Costs (FAR 31.205-18). Also see DCAA Contract Audit Manual Section 7-1500. These costs
generally are allowable, subject to the limitations provided in FAR 31.205-18.
·
Entertainment Costs (FAR
31.205-14). Entertainment costs are expressly unallowable,
regardless of the purpose or intent of the entertainment. Costs made
specifically unallowable under FAR 31.205-14 are not allowable under any
other cost principle.
·
Long-Range Market Planning Costs (FAR 31.205-12). Costs associated with general long-range
management planning are allowable; however, organizational or reorganizational
costs are unallowable (see FAR
31.205-27 for more details).
Pursuant with FAR
31.201-2(d), consultants must maintain adequate records to demonstrate that
claimed costs have been incurred and are allocable to the Federal-aid
contracts. Accordingly, consultants must require all employees, including
senior managers and executives, to maintain a contemporaneous record of all
time devoted to selling activities. To accomplish this, the consultant must establish clear guidance
regarding the specific activities that comprise selling activities and must
ensure that all staff members are adequately trained.
Note:
The consultant must regularly monitor the time recorded by all employees,
including senior managers and executives, to determine the accuracy of efforts
expended. Labor costs associated with selling activities must be easily
identified and must be segregated from other indirect labor activities.
The Defense Contract Audit
Agency (DCAA) issued Pamphlet No. 7641.90 (DCAAP 7641.90), Information for Contractors.[7] The DCAAP provides useful
guidance but does not have the effect of law. The DCAAP is referenced at FAR
31.002 and provides extensive guidance
regarding labor charging systems. Specifically,
sections 2-301 through 2-302.2 provide guidance regarding the—
·
Accounting system,
·
Labor charging system,
·
Timecard preparation methods, and
·
Timekeeping policy.
Note: Pertinent sections of DCAAP No. 7641.90 have been extracted
and paraphrased below for emphasis and further discussion.
When performing work in
connection with Government contracts, it is essential for engineering
consultants to maintain an operable accounting system under general ledger
control. A properly designed system includes the following attributes:
·
Proper segregation of direct costs and indirect costs.
·
Identification and accumulation of direct costs by cost objective/contract.
·
A logical and consistent method for allocating indirect
costs to intermediate and final
cost objectives.
·
Accumulation of costs under general ledger control.
·
A timekeeping system that identifies employees’ labor by intermediate and final cost
objectives.
·
A labor distribution system that charges
direct and indirect labor to the appropriate cost objectives.
·
Interim (at least monthly) determination of costs charged contracts
through routine posting to books of account.
·
Exclusion from costs charged to Government contracts of amounts that
are not allowable pursuant to FAR Part 31 or other contract provisions.
·
Identification of costs by appropriate units, if required by the
contract.
The key link in any sound
labor time charging system is the
individual employee. It is critical to labor charging internal control systems
that management indoctrinates employees on their independent responsibilities
for accurately recording time charges. This is the single most important
feature management can emphasize in recognizing its responsibility to owners,
creditors, and customers to guard against fraud and waste in the labor charging
function.
To be effective, the
internal controls over labor charging should meet the
following criteria:
·
The engineering consultant should have adequate segregation of duties for labor-related activities; for example, the responsibility for timekeeping
and payroll accounting should be separated.
·
Supervisors who are accountable for meeting contract budgets should not
have the opportunity to initiate employee time charges. (It is recognized that,
for a very small company, this type of segregation may not be possible, whereas
for a larger company, this type of segregation would be required in order to
have good internal controls over labor costs.)
·
The engineering consultant’s procedures and controls must be evident,
well defined, and reasonable so there is no confusion concerning the reason for
the controls and no misunderstanding as to what is and what is not permissible.
·
The engineering consultant must continuously maintain the controls and
verify their effectiveness. Controls must be updated to correct any
deficiencies, and violations must be remedied through prompt and effective
action to serve as a deterrent to prospective violations.
·
Individual employees must be constantly, although unobtrusively, made
aware of controls that act as an effective deterrent against violations. Many
businesses accomplish this by emphasizing the importance of timecard
preparation in staff meetings, employee orientation, and through the posting of
signs throughout the workplace to remind employees of the importance of
accurate and current timecards.
·
The engineering consultant should have a system of feedback to provide
employees with opportunities to report to management any suspected mischarging
or violations of the consultant’s system of internal controls, with anonymity
guaranteed.
The engineering consultant
should provide detailed instructions for timecard preparation in a timekeeping
pamphlet and/or company procedure. Specific issues associated with automated
and manual timecard systems are provided below:
(a) Automated Timekeeping
System. When
an automated timekeeping system is in place, procedures should provide for the
accurate and current recording of labor hours by authorized employees,
as well as appropriate controls to ensure corrections to labor charges are
accurate and authorized. Generally, controls should be in place to ensure the
following:
·
Only the employee uses his or her labor charging instrument to access
the labor system.
·
Changes are initialed, authorized, and dated by the employee and
supervisor and include a description of the reason for the change. This may be
done electronically.
·
A verifiable audit trail process is in place that
collects all initial entries and subsequent changes.
·
When an engineering consultant uses an employee badge system, badge
issuance must be sufficiently controlled so that no badge number is duplicated
and badges are not issued to unauthorized persons. Additionally, procedures
must be in place to require employees to report lost badges promptly.
(b) Manual Timekeeping
System. When a manual system is in
place, procedures should provide for the accurate and complete recording of
labor hours, as well as appropriate
controls to ensure corrections to labor records are accurate and authorized.
Generally, controls should be in place to ensure—
·
Supervisory observation of employee arrival and departure to prevent
improper clock-in/clock-out.
·
Employee possession of timecard/timesheet.
·
The employee prepares his or her timecard/timesheet in ink, as work is
performed.
·
Only one timecard/timesheet is prepared per employee per period;
timecards/timesheets are preprinted with employee name and identification
number; and timecards/timesheets are submitted to the designated timekeeping
office or are collected by an authorized person.
·
Pre-coded data is printed on job cards for identification purposes
(e.g., codes for various leave types or indirect labor).
·
Direct labor employees record their time no
less often than daily. Sufficient formal subsidiary records must be maintained,
if necessary, to ensure accuracy in labor recording and the proper allocation
of labor costs to intermediate and final cost objectives when multiple jobs are worked in a day.
·
Corrections are made in ink, initialed by the employee, properly
authorized, and provide a sufficient and relevant explanation for the
correction.
·
The correct distribution of time by project numbers, contract number or
name, or other identifiers for a particular assignment. To ensure accuracy, a
listing of project numbers and their descriptions should be provided in writing
to the employee.
·
Recording all hours worked whether they are paid or not. This is
necessary because labor costs and associated overheads
are affected by total hours worked,
not just paid hours worked. Therefore, labor rate computations and labor
overhead costs should reflect all hours
worked. Unpaid hours worked are termed “uncompensated overtime.”
·
Employees and supervisors sign the timecards/timesheets in accordance
with procedures, verifying the accuracy of the recorded effort.
·
The job cost system is reconciled to the general ledger on a regular
and consistent basis. This reconciliation
should occur no less frequently than once every 30 days.
Note:
A labor-charging checklist is attached at the end of this
chapter to assist engineering consultants and accounting professionals in the
assessment of the consultant’s labor-charging system.
The engineering consultant
should implement a written policy that requires the following:
·
Supervisors must approve and cosign all timecards.
·
The supervisor is prohibited from completing an employee’s timecard
unless the employee is absent for a prolonged period of time on some form of
authorized leave. If the employee is on travel status, the supervisor for the
employee may prepare a time sheet. Upon his or her return, the employee should
turn in his/her time sheet and attach it to the one prepared by the supervisor.
·
The guidance should state that the nature of the work determines the
proper distribution of time, not availability of funding, type of contract, or
other factors. Accordingly, direct labor hours must be assigned to the cost
objective/project that caused the hours to be incurred, regardless of whether
the hours are billable to clients. Non-billable labor hours may not be charged, or
later reassigned, to other projects or to overhead.
·
Procedures must be established to verify that the total labor hours reflected in labor distribution summaries agree
with the total labor charges as entered into the timekeeping and payroll
systems. This reconciliation attests that the labor charges to contracts
represent actual paid or accrued costs and such costs are appropriately
recorded in the according records. Each employee’s time charge should be
distributed as recorded, regardless of whether all the labor is billable to clients.
·
The company policy should state that the accurate and complete
preparation of timecards is a part of each employee’s job. The policy also
should state that careless or improper preparation of timecards may lead to
disciplinary actions under company policies and/or applicable State and Federal
statutes.
Auditors are encouraged to
apply the requirements of DCAAP 7641.90 to their examinations of engineering consultants’
labor-charging systems, as State DOTs may challenge any FAR audit or
attestation engagement that does not adequately address the reliability and
accuracy of a consultant’s labor-charging system. In the absence of any
deficiencies noted in such examinations, State DOTs generally will accept audit
opinions that are developed in compliance with DCAAP criteria. This includes
attestations or audits performed by independent CPAs or Government auditors,
such as the DCAA.
Table 6-1: lABOR cHARGING
cHECKLIST
Pursuant to FAR 31.205-6—
(a) Compensation
for personal services is allowable subject to the following general criteria
and additional requirements contained in other parts of [FAR 31.205-6] . . . .
(1) Compensation for personal services must be for
work performed by the employee in the current year and must not represent a
retroactive adjustment of prior years’ salaries or wages. . . .
(2) The total compensation for individual employees or
job classes of employees must be reasonable for the work performed; however,
specific restrictions on individual compensation elements apply when
prescribed.
(3) The compensation must be based upon and conform to
the terms and conditions of the contractor’s established compensation plan or
practice followed so consistently as to imply, in effect, an agreement to make
the payment.
(4) No presumption of allowability will exist where
the contractor introduces major revisions of existing compensation plans or new
plans and the contractor has not provided the cognizant state DOT, either
before implementation or within a reasonable period after it, an opportunity to
review the allowability of the changes.
(5) Costs that are unallowable under other paragraphs
of . . . [FAR] Subpart 31.2 are not
allowable under . . . [FAR] 31.205-6 solely on the basis that they constitute
compensation for personal services.
Total compensation generally includes allocable and allowable wages, salaries,
bonuses, deferred compensation, and employer contributions to defined
contribution pension plans. Individual elements of compensation must be
reviewed for allowability in compliance with the FAR.
FAR 31.205-6 distinguishes between allowability and reasonableness of
compensation. It lists specific requirements for the allowability of certain
elements of compensation. For an element of compensation to be allowable, it
must meet the FAR requirements specific to that element. The total of all
allowable compensation elements must be reasonable for the work performed.
Reasonableness of compensation is discussed below in Section 7.3.
Pursuant to FAR 31.205-6(b)(2), compensation not covered by
labor-management agreements for each employee or job class of employees must be
reasonable for the work performed. Furthermore,
Compensation is reasonable if the aggregate of each
measurable and allowable element sums to a reasonable total. In determining the
reasonableness of total compensation, consider only allowable individual
elements of compensation. In addition to the provisions of FAR 31.201-3, in
testing the reasonableness of compensation for particular employees or job
classes of employees, consider factors determined to be relevant by the
contracting officer. Factors that may be relevant include, but are not limited
to, conformity with compensation practices of other firms—
(i) Of the same size;
(ii) In the same industry;
(iii) In the same geographic area; and
(iv) Engaged in similar non-government work under
comparable circumstances.
The engineering consultant is responsible for preparing an analysis to support
the reasonableness of claimed compensation costs in accordance with FAR
31.205-6. Typically, this analysis focuses on executive positions because those
positions comprise the highest compensation levels and the most significant
area of audit risk.
Additionally, pursuant to FAR 31.205-6 (a)(6)(i)(A) and (B):
Compensation costs for certain individuals give rise
to the need for special consideration. Such individuals include—
(A) Owners of closely held corporations, members
of limited liability companies, partners, sole proprietors, or members of their
immediate families; and
(B) Persons who are contractually committed to acquire
a substantial financial interest in the contractor’s enterprise.
Accordingly, in compliance with FAR 31.205-6, engineering consultants
must ensure and properly document that the compensation for each employee or
job class of employees is reasonable for the work performed. The auditor is
responsible for reviewing/testing the engineering consultant’s compensation
analysis, to the extent considered necessary based on the auditor’s risk
assessment. Additional audit guidance appears in DCAA Contract Audit Manual
(DCAA CAM) Sections 6-413 and 6-414. Much of the guidance included therein has
been incorporated into this Guide in the following sections.
Pursuant to FAR 31.205-6, an engineering consultant
is permitted to charge reasonable compensation to Government contracts as either a direct
cost, indirect cost, or a combination of both.
FAR 31.205-6(p) limits allowable compensation for Senior
Executives(†) to the Benchmark Compensation Amount (BCA) as determined by the Office of Federal
Procurement Policy (OFPP), Section 808(b) of Public Law 105-85. The BCA is established
based on the compensation of executives of publicly-owned U.S. corporations
with annual sales over $50 million for the fiscal year. The BCA applies to
Senior Executives at corporate offices and business segments.
(†) Note: FAR 31.205-6(p)(2)(ii)(B) defines “Senior Executives” as “the five most highly
compensated employees in management positions at each home office and each
segment of the contractor, whether or not the home office or segment reports
directly to the contractor’s headquarters.” Additionally, CAS 410 defines
“segment” as “one of two or more divisions, product departments, plants, or
other subdivisions of an organization reporting directly to a home office,
usually identified with responsibility for profit and/or producing a product or
service.”
Although the BCA is the
statutory maximum for Senior Executive compensation costs that may be charged
to Government contracts, the BCA must not be construed as an entitlement or a
guaranteed amount of cost recovery. Instead, compensation is subject to the
reasonableness provisions of FAR 31.205-6, and owners of closely-held firms
are subject to an additional restriction—no payment that represents a
distribution of profits may be submitted as a cost against a
Government contract.
Pursuant to DCAA CAM Section 6-614.4c:
Executive positions within a company are usually
unique positions within that company. Only the largest of firms have the
potential for a class of employees performing vice-presidential level duties,
which can be described as having similar rank, function, and responsibility.
Normally, executives are not part of a class of employees and must be evaluated
individually.
The engineering consultant’s policies and procedures should provide
descriptions of how executive compensation levels are established and who approves
these levels, as well as the eligibility criteria and basis for establishing
base salary, cash bonuses, long-term perquisites, benefits, services, and
incentive pay bonuses.
In developing FAR-allowable overhead rates, engineering consultants
should evaluate the reasonableness of executive compensation costs in
accordance with FAR 31.205-6 and should prepare documentation to support this
evaluation. Additional guidance on the evaluation of executive compensation
costs appears in DCAA CAM Sections 6-413 and 6-414, which should be consulted
for more details prior to performing the analysis.
The engineering consultant must determine the reasonableness of executive
compensation in a manner compliant with the criteria established in FAR
31.205-6 and the two major Armed Services Board of Contract Appeals (ASBCA)
decisions dealing with compensation: Techplan Corporation,[8] and Information Systems and
Networks Corporation.[9]
The engineering consultant should prepare a compensation analysis in
accordance with the procedure described below in Section 7.5.C. In compliance
with FAR 31.205-6, the consultant must disallow costs in excess of the amount
deemed reasonable as determined by the compensation study.
Note: In cases where a consultant does not perform an acceptable
compensation analysis, State DOTs may use the National Compensation Matrix
(NCM), which will be designed to meet the requisite Techplan
and Information Systems criteria, as a baseline for determining the
reasonableness of claimed compensation costs. The specifics of the NCM are
discussed below in Section 7.7.
The approach that engineering consultants should use to evaluate
compensation reasonableness should include the following steps:
Step 1. Examine all elements of compensation and eliminate from FAR-allowable
overhead those elements which are defined as unallowable under FAR 31.205-6 or
other applicable FAR cost principles. For example, compensation calculated
based on changes in corporate securities (such as stock options) is expressly
unallowable, and should be excluded from overhead and from the compensation
evaluated.
Step 2. For the individual executives or classes of employees to be examined,
prepare a schedule listing all allowable components of compensation and the
amount paid for each. Compensation includes wages, salary, bonuses, incentive
compensation, deferred compensation, and employer contributions to defined
contribution pension plans.
Step 3. Obtain nationally-published compensation surveys to match the
engineering consultant in terms of revenue, industry, geographic location, and
other relevant factors. Engineering consultants and auditors should ensure
survey data used to support reasonableness determinations is based on reliable
and unbiased surveys that are representative of the engineering consultant’s
relevant market or industry. In most cases, no one survey is sufficient to
determine the market rate of pay for all the engineering consultant’s
positions. A primary survey may be selected with secondary surveys used to
corroborate the results of the primary survey. Typically, industry best
practices include the use of three surveys. DCAA CAM Section 5-808.8c(2)
provides guidance on evaluating compensation survey data. Some types of surveys
that should generally not be used include magazine or newspaper surveys, free
internet surveys, and GSA schedules.
Nationally published surveys typically identify the mean, median or
percentile amounts of salary, bonus and other elements of compensation by
revenue ranges, number of firm employees, or discipline. Geographical regions,
position title, job descriptions, and additional data analysis typically are
standard topics.
The engineering consultant must match the job description and duties of
each of its executives to the survey data. However, matching positions based
solely on job titles may result in an inaccurate comparison. For instance, in a
small business an executive will perform certain duties that are performed by
multiple people in a larger company.
Step 4. From these surveys, develop an estimated reasonable compensation
amount for each executive position. First, determine the survey median
compensation amounts for each comparable position, selecting survey data for
firms of comparable size and geographic area. Some surveys will classify firms
by size based on number of staff, while others will use total revenues. Use the
category that best matches the survey data to the subject firm.
For example, assume the subject firm has 45 employees and revenues of
$9 million. Survey data, such as the sample shown below in Table 7-1, should be
analyzed as described in the following steps.
Table
7-1: Sample survey data for determining reasonableness of compensation
Position: President / CEO |
|
|
|
|
|
|
Survey 1 |
Number
of |
Salary |
Bonus / Incentive |
Other Compensation |
Total Compensation |
|
|
Employees |
(median) |
(median) |
(median) |
(median) |
|
|
1-20 |
$101,000 |
$15,000 |
$8,000 |
$124,000 |
|
|
21-50 |
145,000 |
32,000 |
11,000 |
188,000 |
|
|
51-100 |
210,000 |
47,000 |
18,000 |
275,000 |
|
|
101-200 |
241,000 |
82,000 |
24,000 |
347,000 |
|
|
|
|
|
|
|
|
Step 5. Apply appropriate escalation factors to adjust survey data to a common
date of July 1 of the same year or the mid-point of the Consultant’s Fiscal
Year. The escalation factor used should be supported by survey data on trends
in compensation for the years examined. Often, surveys will include an
executive summary section that will present data on such trends.
Step 6. Develop a composite median amount by averaging the median total
compensation amounts, after application of any necessary escalation factors.
Step 7. Next, increase the composite median by 10 percent, based on DCAA
guidance (see DCAA CAM Section 6-414.4) which allows for a 10 percent range of
reasonableness to be applied in developing estimated reasonable compensation.
Disclaimer: The following data in Table
7-2 are presented for illustration purposes only and must not be relied upon or
applied to an analysis of actual compensation costs.
Table
7-2: Estimated Reasonable Compensation
(M = million)
Position: President / CEO |
Salary |
Bonus / Incentive |
Other Compensation |
Total Compensation |
|
|
|
(median) |
(median) |
(median) |
(median) |
Survey 1 |
Staff
size 21-50 |
$145,000 |
$32,000 |
$11,000 |
$188,000 |
Survey 2 |
Revenue
$5-10M |
127,000 |
35,000 |
15,000 |
177,000 |
Survey 3 |
Revenue
$5-15M |
146,000 |
42,000 |
14,000 |
202,000 |
|
|
|
|
Average |
189,000 |
|
|
Range
of reasonableness (ROR) factor |
* 10% |
||
|
|
|
Adjusted
for 10% ROR |
207,900 |
|
|
|
President / CEO estimated
reasonable compensation |
207,900 |
||
Note: If survey data from prior years
is used, then adjust to the current year using an appropriate escalation
factor. In this example, only one year of data is presented. |
Note: Only allowable elements of compensation should be included in the
analysis. Survey and actual data should be reviewed for allowability prior to
inclusion. Allowability of specific compensation elements is discussed in FAR
31.205-6 and elsewhere in this chapter. The term “Other Compensation” as used
here includes all FAR-allowable compensation other than salary and bonus or
incentive compensation.
Step 8. Compare total actual compensation for each executive to the estimated
reasonable compensation developed in Step 7 for that position.
Disclaimer: The following data in Table
7-3 are presented for illustration purposes only and must not be relied upon or
applied to an analysis of actual compensation costs.
Table
7-3: Comparison to Actual Executive Compensation:
|
|
Actual Salary |
Actual Bonus / Incentive |
Actual Other Comp. |
Actual Total Comp. |
Estimated Reasonable
Total Comp.(†) |
Potential |
President / CEO |
$144,000 |
$52,000 |
$18,000 |
$214,000 |
$207,900 |
$6,100 |
|
|
|
|
|
|
|
|
|
Perform
this analysis for each executive as defined in this chapter, and accumulate
total potential unreasonable compensation. |
(†)Note: No compensation claimed
for any Senior Executive may exceed the benchmark compensation amount (BCA)
discussed previously in Section 7.4.
Step 9. In the cases where total compensation exceeds the estimated
reasonable amount, FAR-allowable compensation for that executive should
generally be limited to the estimated reasonable compensation, with one notable
exception, as explained below in Section 7.6.
Pursuant to DCAA CAM Section 6-414.4h (entire text reproduced below)—
Often contractors will propose that their executives
should be paid more than 110 percent of the reasonable compensation based on the
average compensation paid by comparable firms for executives with similar
duties. Above average levels of compensation are usually identified by
percentiles, such as the 75th percentile. For an executive with responsibility
for overall management of a segment or firm, such a proposal may be justified
by clearly superior performance as documented by financial performance that
significantly exceeds the particular industry’s average. The ASBCA, in its
decision on Information Systems & Networks Corporation ASBCA No. 47849, “capped” executive
compensation at the 75th percentile when justified by performance.
(1) Examples of financial performance measures may
include the following:
·
Revenue Growth
·
Net Income
·
Return on Shareholder’s [sic] Equity
·
Return on Assets
·
Return on Sales
·
Earnings per Share
·
Return on Capital
·
Cost Savings
·
Market Share
(2) The contractor must show that the measure chosen
is representative of the executive’s performance. Consideration should be given
to the competitive environment in which the contractor operates. There should
be no extra compensation awarded because of high performance measured by a
standard which is not affected by the executive’s performance, and certainly
there should be no extra compensation due to performance which results
primarily from the contractor’s status as a Government contractor. Performance
is typically measured using more than one criterion of performance. For
example, a contractor may have significant sales growth through acquisitions
and mergers while operating at a loss. In this situation, the contractor would
not be considered to have superior performance based on the lone measure of
sales growth.
(3) Use of a particular measure to justify higher than
average compensation should be applied consistently over a period of years,
with both increases and decreases in the performance measures reflected in the
changes to compensation claimed as reasonable.
To justify the superior performance necessary to evaluate an
engineering consultant’s executive compensation at higher than the median (up
to but not exceeding the 75th percentile), the consultant must prepare and document
an analysis of the firm’s performance in comparison to selected performance
measures from the list above (as excerpted from DCAA CAM 6-414.4h(1)).
Typically, superior performance may not be based on only one performance
measure; instead, superior performance in comparison to three or more measures
must be established to present a compelling case for the allowability of higher
than median executive compensation.
The analysis methodology steps include the following—
Step 1. Calculate a minimum of three financial performance measures stated
above using the engineering consultant’s actual financial data for the same
time period.
Step 2. Calculate the firm’s composite financial performance measure. This is
done by calculating the simple average of the financial performance measures
calculated in the previous step.
Step 3. Using proxy data available from SEC filings and the following
criteria, identify the same financial performance measures used in the
engineering consultant’s analysis:
·
in SIC code 87;
·
in the same revenue range; and
·
for the same time period as the engineering consultant’s data.
Note: If no SEC proxy data are available commensurate with the engineering
consultant’s revenue amount, it may be appropriate to consider financial data from
other sources, such as Dun and Bradstreet or Standard & Poor’s.
Step 4. Calculate the proxy composite financial performance measure. This is
done by calculating the simple average of the financial performance measures
calculated in the previous step.
Step 5. Compare the engineering consultant’s composite financial performance
measure to the proxy composite financial performance measure to identify the
consultant’s applicable percentile.
Step 6. Provide a copy of each executive’s position description, job duties,
and the relationship between executives’ performance and the firm’s
performance.
If the engineering consultant can successfully demonstrate superior
performance, then the analysis performed in compliance with this Section (7.6)
should be performed using survey data at the applicable percentile. For
example, if the firm’s financial performance is at the 75th
percentile, then the compensation analysis should use compensation survey data
at the 75th percentile as well. Some surveys are robust enough to
provide data at any percentile ranking; however, it may be necessary to
extrapolate survey data if the applicable percentile is not presented. Additionally, pursuant to DCAA CAM Section
6-414.4h(3):
Use of a particular measure to justify higher than average
compensation should be applied consistently over a period of years, with both
increase and decreases in the performance measures reflective in the changes to
compensation claimed as reasonable.
Note: Regardless of firm performance, executive compensation costs in
excess of the Benchmark Compensation Amount[10] are unallowable.
As discussed previously in Section 7.5.B, engineering consultants are
responsible for preparing a compensation analysis to demonstrate that claimed
compensation costs are reasonable in compliance with FAR 31.205-6, as
interpreted and clarified by the ASBCA in the Techplan and Information Systems cases. State DOTs and/or independent CPA
auditors should review the consultant’s analysis to validate compliance with
the procedures described in Section 7.5.B.
In cases where engineering consultants do not prepare an appropriate,
compliant compensation analysis, State DOTs may use the National Compensation
Matrix (NCM) as a tool for determining reasonable levels of compensation. The
NCM will establish compensation amounts deemed reasonable for certain key
positions within consulting firms. The NCM methodology will be developed based
on the criteria established in Section 7.5.B.
The Audit Guide Task Force recommends that the NCM be prepared under
the direction, guidance, and authority of the Federal Highway Administration (FHWA). Accordingly, the FHWA would provide details
regarding the specific criteria, methodology, and surveys used in the
preparation of the NCM. Additionally, FHWA would have the sole discretion to
determine the surveys used to develop the NCM, and funding for the purchase of
the surveys and preparation of the matrix would be shared by the various State
DOTs.
The NCM will be updated and published on an annual basis. In the event
that the NCM has not been updated in a given year, the amounts stated in the
most recent NCM should be escalated based on guidance issued by FHWA. The methodology and application of the NCM is
discussed in the following section.
The following position descriptions should be used to match the
individual’s job duties to the formal job title assigned to such employee.
The following position descriptions[11] were used in developing the sample NCM—
1.
Chief Executive Officer (CEO). According to PSMJ, “[t]he CEO is
responsible for day-to- day operations and business strategies carried out by
the firm. Comparable titles include that of president, chief operating officer,
or managing partner. . . .” ERI further
indicates that the CEO “[p]lans, develops, and
establishes policies and objectives of organization in accordance with board
directives and corporation charter. This is the top executive and principal
organization leader in the organization . . . . This position is distinguished
from others in that it is the top ranking executive and, in most cases, is the
highest paid executive in the organization. Reports to Board of Directors and
often is a member of the board. Responsible for the profitability of the entire
organization.”
2.
Executive Vice President (EVP). According to PSMJ, “[t]he
executive vice president (EVP) assists the CEO with overall firm
responsibilities. Unlike administration or operations directors, this executive
typically has authority over all business functions of a firm rather than over
only a limited, defined area. The EVP usually shares responsibilities with the
CEO; each has day-to-day responsibility for separate, designated business
areas. The EVP usually shares responsibilities with the CEO; each has
day-to-day responsibility for separate, designated business areas. This
executive will usually assume CEO operational responsibilities in the absence
of the CEO.” ERI further indicates that the EVP “[a]pproves,
revises, and implements overall corporate growth strategies and personnel
activities. As title practices vary among organizations, this level may be
called Executive Vice President, Senior Vice President, or other variations
depending on the organization. . . .
This position is distinguished in that it is responsible for a broad
range of activities or functions in the organization.”
3.
Senior Vice President (SVP). PSMJ describes this position as
“[r]esponsible for a segment of a firm’s practice,
such as a design discipline, business unit, geographic region, or project type.
The SVP usually reports directly to the CEO or the executive vice president.
Usually, firms with greater than 50 total staff will have more than one senior
vice president. The SVP has more authority than most firms’ principals, and may
supervise various principals who report to the specific senior vice president.”
ERI indicates “[a]s title practices vary among organizations, this level may be
called Executive Vice President, Senior Vice President, or other variations
depending on the organization. In smaller organizations the Senior or Executive
title may not exist and the position may be referred to as a Vice President.”
4.
Other Principals.
According to PSMJ, “[o]ther principals usually have
some ownership interest in the firm and focus on project delivery. Typically
these individuals spend significant time working with clients and charging to
projects. Other than top management or business development management, these
principals spend more time in marketing and sales than other managers. Many
firms have principals with no added functional titles. This indicates that
design firms continue to focus certain senior individuals (i.e., principals) on
project delivery rather than dividing responsibility for project delivery between
their other functional managers.”
5.
Director of Finance.
According to PSMJ, “[t]he director of finance has full responsibility for the
firm’s financial operations. The ability to commit the firm’s resources or to bind
the firm to financial commitments is what differentiates this title from other
financial positions. This title is generally given to individuals who have a
substantial authority to manage all of the firm’s business assets. Director of
finance is the highest-ranking management position with no project or technical
design responsibilities. Alternative titles include vice president of finance
and chief financial Officer.” ERI describes this position as the “Top Financial
Officer,” that typically reports to the CEO or COO and director level personnel
report to this position.
6.
Director of Administration.
According to PSMJ, “[t]he director of administration has management
responsibility for all support areas of a firm’s operations except technical
and project production. This includes responsibility for finance, human
resources, marketing, and general administration. Alternative titles include
vice president of administration or general manager. Generally, the person
reports directly to the CEO, and managers of specific administrative functions
report to this individual. This position is not common in most design firms.
Fewer than 20% of firms report having a director of administration. As such,
the analysis for this position is based on a small sample. It is most common in
mid-sized firms.”
7.
Director of Operations.
According to PSMJ, “[t]he director of operations has responsibility and
authority to deliver completed projects to the firm’s clients. Normally, those
directly in charge of projects (project managers, department heads, or branch
office managers) report to this individual. Typical responsibilities include
allocation of the production staff, resolving scheduling conflicts, and
efficient utilization of the design staff. Large firms with multiple offices
typically assign more than one person to this position. In this case, the
individual’s management responsibility is limited to local, regional, or
client-service type organizations (e.g., office, environmental business,
Northeast region).” ERI describes the
Operations Director as “Directs the operations function in conjunction with
business growth, introduction of new operational systems, meeting organizational
financial objectives, and meeting organizational goals in relation to safety,
quality, and timely delivery of products or services. Assists with development
of organization's policies, practices, and attainment of operating goals, while
maintaining some management responsibility.”
8.
Director of Information
Technology (IT). PSMJ describes this position
as, “. . . responsible for a firm’s computer assets, including hardware,
software, and networks. Alternative titles include data processing manager, manager
of automated services, computer manager, manager of information systems, and
chief information officer.” ERI further
indicates that alternative position titles may include “[d]irector
Computer Operations; Information Systems Director; Information Technology
Director; IT Director.”
Disclaimer: A sample, proposed NCM format appears below in Table 7-4 and is
presented for illustration purposes only. Table 7-4 must not be relied upon or applied to an analysis of actual
compensation costs. The sample NCM amounts below are provided merely to
illustrate how revenue might be categorized/bracketed in a final NCM, which is
currently being considered for development and implementation by the FHWA. If
the NCM concept is accepted by the FHWA, then a compensation study will be
commissioned, and a final NCM will be issued for use by State DOTs as a
baseline for determining reasonableness.
Note Regarding Revenues in Excess of NCM Bracket 9: AASHTO has proposed that, for engineering consultants with revenues
that exceed Bracket 9 of the NCM, a 20 percent premium may be appropriate. As
noted by the ASBCA in the Techplan Corporation
case, “every time revenues double, there is a 20 percent
increase in the Chief Executive Officer's compensation.” AASHTO has recommended
that, for purposes of determining premium values above the NCM limits, this 20
percent should be applied to all positions, if applicable—not
only to the CEO’s compensation. However, the maximum amount permitted for any
position may not exceed the BCA in effect at that time.
Table
7-4: Proposed format for National
Compensation Matrix (ncm)
The engineering consultant is responsible for preparing an acceptable
compensation analysis in compliance with the criteria established by FAR 31.205-6 and the Techplan and Information Systems cases. State DOTs will be required to accept the engineering
consultant’s analysis, if deemed to be compliant with the Techplan and Information Systems criteria discussed previously in Section 7.5.B.
Accordingly, State DOTs will not be permitted to impose any additional state
limitations, unless mandated by State law. However, if the engineering
consultant does not prepare an acceptable analysis, State DOTs may use the NCM
as a tool for determining the reasonableness of claimed compensation costs.
The methodology and application of total compensation related to the
NCM is separate and independent of a State DOT’s contracting terms. Under the
NCM methodology, the focus is on total compensation rather than on the category
of labor (i.e., direct or indirect).
Engineering consultants should be aware that if a State DOT imposes a
direct hourly rate cap pursuant to contractual agreement, then the difference
between the paid versus billed amounts must still be considered a direct charge
to the contract. The amount not reimbursed by the State DOT may not be moved to
another project or transferred to an indirect labor account. Accordingly, the unrecovered amount
represents a reduction to the profitability of that specific contract.
Engineering consultants are required to prepare a schedule to
demonstrate the application of, and compliance with either:
·
A compensation analysis prepared in accordance with the criteria
discussed above in Section 7.5, or
·
The NCM.
Each year, the schedule must be submitted to the engineering
consultant’s home State DOT and the consultant’s CPA along with an updated
overhead schedule. For engineering consultants working in
multiple states, the non-home State DOT should contact the home State DOT to
ensure that the schedule has been submitted by the consultant and accepted by
the home State DOT. If the engineering consultant receives a cognizant audit,
the schedule would only be submitted to the State DOT that performs the
cognizant agency review.
For each Senior Executive, the engineering consultant must voluntarily
disallow all compensation that exceeds the maximum amounts established by the
consultant’s analysis, or alternatively, the NCM, as determined by the firm’s
gross revenue. The following information
must be provided on the schedule and must be disclosed separately for each
applicable position:
1. Employee/owner/officer first and last name or employee identification
(ID) number.
2. Position title.
3. Total wages/salaries paid including taxable fringe benefits.
4. Total bonuses paid.
5. Total employer contributions to defined contribution pension plans
(whether paid, earned, or otherwise accrued).
6. Total of items 3 through 5 above.
7. The applicable amount from the consultant’s analysis or the NCM.
8. The excess compensation required to be disallowed from the indirect
labor or bonus line item.
Note: The reviewing State DOT must be able to verify and reconcile the
schedule to the consultant’s financial records.
An important aspect of a FAR audit is the identification of related parties
and transactions with related parties. This aspect of the audit is important
because of (1) the requirement under
GAAP to disclose material related-party transactions and certain control
relationships, (2) the potential for distorted or misleading financial
statements in the absence of adequate disclosure, and (3) the instances of
fraudulent financial reporting and misappropriation of assets that have been
facilitated by the use of an undisclosed related party.
Potential
related-party indicators[12] that may impact
audit risk include, but are not limited to, the following:
·
Agreements under which one party pays expenses on behalf of another
party.
·
Circular business arrangements and transactions between related
parties.
·
Engaging in business deals (such as leases) at greater or less than
market value.
·
Discovery of an undisclosed related party.
·
Inadequate disclosure.
·
Payments for services at inflated prices.
·
Revenue recognition based on sales that lack economic substance.
·
Sale of land with arranged seller financing.
·
Sale of securities.
·
Services or goods purchased from a party at nominal cost or no cost.
·
Unusual, high-value transactions, particularly close to quarter- or
year-end.
·
Use of a related party to mitigate market risks.
The consultant must provide a list of all employees who are related to
company executives as reported above. For each related party, the list should
include the following six items:
1. Employees’ first and last names or employee IDs.
2. Name or employee ID of related executive, and nature of
relationship.
3. Position title or job classification.
4. Brief description of the employee’s job duties.
5. Total wages or salaries paid, including taxable fringe benefits.
6. Total bonuses paid.
Auditors should review this information to evaluate whether there is a
risk that compensation paid to a related party is unreasonable given the nature
of their position or job responsibilities. Based on auditor judgment and risk
assessment, the auditor should determine if additional audit procedures are
necessary.
Pursuant to FAR 31.205-6(a)(6)(i)(A), compensation
for certain individuals in closely-held firms requires special review and
consideration. This is required because small firms typically do not have
compensation committees, and the owners and officers of these firms may
exercise considerable influence over their own levels of compensation.
Additionally, small firms typically have principals who are responsible
for a variety of job duties. For example, it is common for a principal in a
small firm to perform some overlapping job duties of CEO, CFO, Division
Manager, and/or Project Manager. Many of these duties involve material amounts
of direct labor that must be tracked to the appropriate
projects. However, the following practices may cause a disproportionate
distribution/allocation of principals’ labor to the direct and indirect labor pools—
·
Principals take infrequent draws in lieu of taking regular salaries.
·
Principals take low salaries coupled with high bonuses.
·
Principals wait until the firm’s profitability is known at year end and
treat any remaining cash surplus as compensation.
Note: For additional guidance regarding labor distribution, see Chapter 5 (Cost Accounting) and Chapter 6 (Labor
Charging Systems and Other Considerations).
To address the issue stated above, consultants must review executive
compensation to ensure that labor is appropriately distributed to the direct and
indirect labor pools. Absent other guidance, compensation costs should be
distributed based on the ratio of each principal’s direct and indirect labor
hours. If material, an adjustment should be made to correct distortions of the
labor pools.
Payments made under bonus and incentive-pay plans frequently represent
a large portion of the total compensation costs claimed by consultants. To be
allowable charges against Government contracts, bonus payments must be
allocable to Government contracts, reasonable in amount, and must not represent
a distribution of profits to owners.[13] FAR 31.205-6(f)(1) further specifies
that bonus payments are allowable, provided the:
Awards are paid or accrued under an agreement entered into
in good faith between the contractor [consultant] and the employees before the
services are rendered or pursuant to an established plan or policy followed by
the contractor [consultant] so consistently as to imply, in effect, an
agreement to make such payment; and . . . [b]asis for
the award is supported.
FAR 31.205-6(a)(6)(ii)(B) states that
for owners of closely-held firms, allowable bonus amounts may not represent a
distribution of profits. Accordingly, there must be
clear distinctions of the various portions of total compensation; specifically,
which portion is a true bonus based on stated objectives and which portion is a
profit distribution.
Typically, bonus plans are applicable to a broad class of employees.
Some plans include eligibility for all employees, while others limit
eligibility to professional and management staff. Individual participation may
be based on the productivity of an individual, team, overall company, or some
combination of these factors. Bonuses may be based on a percentage of an
employee’s base salary, or alternatively may be issued as lump sum
distributions, based on the available pool of money to be distributed.
By contrast, profit-distribution plans involve a distribution of net earnings to
owners. Individual distributions are based on partners’ capital account
balances, level of partnership (e.g., junior versus senior partner), number of
owned shares, or some other factor linked to ownership.
Some companies have both bonus plans and profit-distribution plans. However, only the portion
that is a valid bonus is allowable as a recoverable overhead expense. Consultants should prepare and
maintain written bonus plans that identify eligibility requirements and provide
details regarding how bonus payments are determined. Profit-distribution
agreements also should be in writing. This will serve to reduce confusion as to
what is a bonus and what is a profit distribution. An acceptable bonus policy
should include an adequate description of the performance measures used to
determine bonus amounts, such as employee performance evaluation ratings,
contributions toward the firm’s revenue growth, and responsibilities for cost
containment.
Written bonus plans should include, at a minimum, the following
components–
·
Eligibility criteria.
·
Period of bonus plan.
·
Performance criteria (e.g., individual expectations—must be measurable
and verifiable criteria).
·
Incentives awards/spot bonuses must be related to performance, as
measured by quantitative and qualitative factors.
·
Form of payment to be received.
·
Distribution timeline.
Fringe benefits are defined at FAR 31.205-6(m) as the cost of
“vacations, sick leave, holidays, military leave, employee insurance, and
supplemental unemployment benefit plans.” Fringe benefit costs are allowable to
the extent that they are reasonable and are required by law, an
employer-employee agreement, or an established policy of the consultant.
Frequently, additional fringe benefits are available to all employees.
The more common elements are discussed in the following sections.
FAR 31.001 defines deferred compensation as:
[A]n award made by an employer to compensate an
employee in a future cost accounting period or periods for services rendered in
one or more cost accounting periods before the date of the receipt of
compensation by the employee. This definition shall not include the amount of
year end accruals for salaries, wages, or bonuses that are to be paid within a
reasonable period of time after the end of a cost accounting period.
To be allowable as charges against Government contracts, the cost of
deferred awards must be measured, allocated, and accounted for in compliance
with CAS 415.
Defined. FAR 31.001 defines a pension plan as a “deferred compensation
plan established and maintained by one or more employers to provide
systematically for the payment of benefits to plan participants after their
retirements, provided that the benefits are paid for life or are payable for
life at the option of the employees.” Pension plan accounting is complex and is
subject to various laws, regulations, and policies including FAR Part 31, the
Internal Revenue Code (I.R.C.) and related regulations, the Employee Retirement
Income Security Act (ERISA), CAS 412 (cost accounting standard for composition and
measurement of pension cost), and CAS 413 (adjustment and allocation of pension cost).
Accordingly, costs associated with pension plans must be reviewed carefully to
determine the allowability of claimed costs.
Funding Requirements. “Qualified pension plans” are definite, written programs that meet the eligibility criteria set
forth in the Internal Revenue Code. All other pension plans
are considered unqualified pension
plans. Costs for either type of plan may be allowable, depending on the
specific circumstances. Except for nonqualified pension plans using the
pay-as-you-go method, one of the critical FAR requirements
is that, for pension costs to be allowable
in the current year, they must be funded by the due date for filing the Federal
income tax return, including extensions. Pension costs assigned to the current
year but not funded timely are unallowable
in any subsequent year.
Allowable Contributions. The amount contributed to
qualified pension- or profit-sharing plans on behalf of principals and other
employees is allowable. However,
the payments must be reasonable in amount and be paid pursuant to an agreement
entered into in good faith between the consultant and employees, before the
work or services are performed and pursuant to the terms and conditions of the
established plan. Contributions for pension costs must comply with FAR
31.205-6(j), which incorporates CAS 412 and 413.
Changes in Pensions Plans. As noted in FAR
31.205-6(j)(1), the cost of changes in pension plans are not allowable if the
changes are discriminatory to the Government or are not intended to be applied
consistently for all employees under similar circumstances in the future.
Additionally, one-time-only pension supplements not available to all plan
participants are generally unallowable,
unless the supplemental benefits represent a separate pension plan, and the
benefits are payable for life at the option of the employee. Finally, increased
payments to retired participants for cost-of-living adjustments are allowable if paid in accordance with a
consistent policy or practice.
Defined. An ESOP is a stock bonus plan designed to invest
primarily in the stock of the employer corporation. The consultant’s
contributions to an Employee Stock Ownership Trust (ESOT) may be in the form of
cash, stock, or property. An ESOP may be designed as a deferred compensation
plan or as a supplementary pension plan; each would be covered by different
regulations. To determine whether certain ESOP costs are allowable, FAR 31.205-6(q) should be referenced
along with applicable CAS provisions (see note below). Private companies must
have an annual outside valuation performed to determine the market value of
their ESOP shares.
Note: On May 1, 2008, the Cost Accounting Standards Board, Office of
Federal Procurement Policy, issued a final rule amending Cost Accounting
Standard 412, “Cost Accounting Standard for composition and measurement of
pension cost,” and CAS 415, “Accounting for the cost of deferred compensation.”
These changes to the CAS direct that costs of all Employee Stock Ownership
Plans, regardless of type, be accounted for in accordance with CAS 415, and
provide criteria in CAS 415 for measuring ESOP costs and assigning those costs
to cost accounting periods. The amendments specify that the provisions of CAS
415, and not any other standard, govern accounting for ESOP costs. Pursuant to
CASB 9904.415-20, CAS 415 applies to the cost of all deferred compensation
except the cost for compensated personal absence, and the cost for pension
plans that do not fit the description of an ESOP, as defined in CASB
9904.415-30. The final rule also revises CASB 9904.415-40 to specify the
requirements for measurement and assignment of ESOP costs.
* The FAR has not been revised to reflect the changes in CAS 412 and
415.
General Considerations. FAR
31.205-6(q)(2) provides that the costs of
ESOPs are allowable subject to the following conditions:
(i)
For ESOPs that meet the definition of a pension plan at [FAR] 31.001,
the contractor—
A.
Measures, assigns, and allocates the costs in accordance with 48 CFR
9904.412;
B.
Funds the pension costs by the time set for filing of the Federal
income tax return or any extension. Pension costs assigned to the current year,
but not funded by the tax return time, are not allowable in any subsequent
year; and
C.
Any amount funded in excess of the pension cost assigned to a cost
accounting period is not allowable in that period and shall be accounted for as
set forth at 48 CFR 9904.412-50(a)(4). The excess amount is allowable in the
future period to which it is assigned, to the extent it is not otherwise
unallowable.
(ii)
For ESOPs that do not meet the definition of a pension plan at [FAR]
31.001, the contractor measures, assigns, and allocates costs in accordance
with 48 CFR 9904.415.
(iii) Contributions by the
contractor in any one year that exceed the deductibility limits of the Internal
Revenue Code for that year are unallowable.
(iv) When the contribution is in
the form of stock, the value of the stock contribution is limited to the fair
market value of the stock on the date that title is effectively transferred to
the trust.
(v)
When the contribution is in the form of cash—
(A) Stock purchases by the ESOT in excess of fair market value are
unallowable; and
(B) when stock purchases are in excess of fair market value, the
contractor shall credit the amount of the excess to the same indirect cost
pools that were charged for the ESOP contributions in the year in which the
stock purchase occurs. However, when the trust purchases the stock with
borrowed funds which will be repaid over a period of years by cash contributions
from the contract to the trust, the contractor shall credit the excess price
over fair market value to the indirect cost pools pro rata over the period of
years during which the contractor contributes the cash used by the trust to
repay the loan.
(vi) When the fair market value
of unissued stock or stock of a closely held corporation is not readily
determinable, the valuation will be made on a case-by-case basis taking into
consideration the guidelines for valuation used by the IRS.
Note: Given the complexity of ESOPs, specific guidance should be consulted
for the proper cost accounting treatment relating to ESOP costs, including stock forfeitures and similar
items.
FAR 31.205-6(g)(2) provides that severance
pay is allowable only when
payment is required either by: (1) law, (2) an employer-employee agreement, (3)
an established policy that is, in effect, an implied agreement on the
consultant’s part, or (4) the circumstances of the particular employment.
Normal severance pay relates to recurring, partial layoffs,
cutbacks, and involuntary separations. These costs are allowable when they are properly allocated. By contrast, abnormal
severance refers to any mass termination of employees, which is
usually unpredictable. Actual costs of normal severance pay must be allocated to
all work performed at the consultant’s facility. Accruals of normal severance
pay are acceptable if the amount is both (1)
reasonable in light of prior experience, and (2) is allocated to both
Government and non-government work. For accruals, FAR 31.205-6(g)(5) notes that
“Abnormal or mass severance pay is of such a conjectural nature that
accruals for this purpose are not allowable. However, the Government recognizes
its obligation to participate, to the extent of its fair share, in any specific
payment. Thus, the Government will consider allowability on a case-by-case
basis.” Special compensation paid to
terminated employees after a change in management control is unallowable to the extent that it
exceeds normal severance pay.
In many cases, executives have available to them enhanced or
supplemental benefits that are not available to the majority of the workforce. These
supplemental benefits or executive benefits should be evaluated on a
case-by-case basis to determine their levels of compliance with applicable
subparts of FAR 31.205-6 and the Cost Accounting Standards. The reasonableness of
these benefits should be evaluated based on market surveys or other available
data. The prevalence of such plans within the industry should also be considered
in determining reasonableness.
These plans are designed to provide executives with earned benefits in
excess of amounts payable under qualified retirement plans. These plans are
often referred to as “ERISA Excess Plans.” These plans should be evaluated
in accordance with FAR 31.205-6(j) and CAS 412.
LTI plans are compensation plans that have an award period of two or
more years. These payments typically are based on the achievement of long-term
business goals or as a method of retaining key executives. The most common LTI
plans for publicly-traded companies are based on stock options, which are unallowable per
FAR 31.205-6(i).
Severance payments should be evaluated in accordance with FAR 31.205-6(g). Most severance policies
are based on a formula that relies on length of service/employment as the
determining criterion in the calculation of the severance amount. In many
cases, executives are awarded severance in excess of the normal or established
policy. In many instances, severance payments are based on executive employment
contracts; however, the fact that a severance payment is based on an executive
employment contract does not necessarily support the amount as reasonable.
“Golden parachutes” are payments made under a contract
entered into by a consultant and key personnel under which the consultant
agrees to pay certain amounts to its key personnel in the event of a change in
ownership or control of the consultant. The
costs of golden parachute benefits are expressly unallowable per FAR
31.205-6(l)(1).
FAR 31.205-6(l)(2) provides that special compensation paid to an
employee is unallowable if the compensation is contingent on an employee
remaining with the organization after an actual or prospective change in
management control. These costs are
frequently referred to as “golden handcuffs.”
This chapter was designed to
provide FAR interpretation guidance only. This chapter is not meant to be authoritative
or to supersede the FAR. The entire text of the FAR should be consulted when
determining proper accounting treatment (see Appendix D for a listing of
resource materials). Specific requirements for State DOTs based on individual
State statutes or policies must be separately addressed with the individual
DOTs. For use as a quick reference, a listing of common unallowable expenses
appears in Section 8.30.
The purpose of this chapter
is to provide guidance for selected items
of cost, as identified in FAR 31.2. This chapter is organized by FAR Part
31.2 sub-sections in ascending order, numerically.
As with all costs charged to
Government contracts, the selected items of cost discussed in this chapter are
allowable only if they are reasonable in amount, allocable to intermediate or
final cost objectives, are properly assigned/allocated to appropriate cost
objectives, and are not otherwise prohibited by FAR Part 31 and/or related
Federal and State laws, regulations, and policies.
Additionally, the
deductibility of costs per the Internal Revenue Code (I.R.C.) is not necessarily
determinative of their allowability under Government
cost-reimbursement type contracts, as there are many types of costs that are
deductible for Federal tax purposes but fail to satisfy the allocability,
allowability, or reasonableness criteria of FAR Part 31. For example, the
I.R.C. allows deductions for advertising; interest; 50 percent of entertainment costs, including alcoholic
beverages; and full rental costs of property under common control, while FAR Part 31 requires disallowances for these items.
Note: For additional useful guidance, see the FAR Cost Principles Guide, which is published by the Defense Contract Audit Agency and available
at: http://www.dcaa.mil/FAR_Cost_Principles_Guide.pdf.
One of the concepts that must be addressed, per FAR 31.201-6 Accounting for Unallowable Costs, is that costs that are expressly unallowable or mutually agreed to be
unallowable, including mutually agreed to be unallowable directly associated
costs, shall be identified and excluded from any billing, claim, or proposal
applicable to a Government contract. A directly associated cost is any cost
that is generated solely as a result of incurring another cost, and that would
not have been incurred had the other cost not been incurred. When an
unallowable cost is incurred, its directly associated costs are also
unallowable.
Costs must be supported and, per FAR 31.201-2(d),
engineering consultants must maintain adequate records, including supporting
documentation, to demonstrate that the costs comply with applicable FAR cost
principles. The contracting officer may disallow all or part of a claimed cost
that is inadequately supported.
In accordance with FAR 31.201-3, a cost is reasonable if, in its
nature and amount, it does not exceed that which would be incurred by a prudent
person in the conduct of competitive
business. The reasonableness of specific costs must be examined with particular
care in connection with firms or their separate divisions that may not be
subject to effective competitive restraints. No presumption of reasonableness
shall be attached to the incurrence of costs by an engineering consultant. The burden of proof shall be upon the consultant to establish a
cost is reasonable.
What is reasonable depends upon a variety of
considerations and circumstances, including:
·
Whether it is the type of cost
generally recognized as ordinary and necessary for the conduct of the engineering consultant’s business or the contract performance;
·
Generally accepted sound
business practices, arm’s-length bargaining, and Federal and State laws and
regulations;
·
The engineering consultant’s responsibilities to the Government, other customers, the
owners of the business, employees, and the public at large; and
·
Any significant deviations from
the engineering
consultant’s established practices.
In accordance with FAR Part 31, a direct cost is a cost attributable to
a single final cost objective. The fact that a direct cost is not reimbursed
through a contract does not allow the engineering consultant to include the
cost in the indirect cost pool. Any direct cost, whether reimbursed or
not, is unallowable as part of the indirect cost rate, except as follows: for
reasons of practicality, the engineering consultant may treat any direct cost of a minor dollar amount as an indirect cost if the accounting treatment—
·
Is consistently applied to all final cost objectives; and
·
Produces substantially the same results as treating the cost as a
direct cost.
Per FAR 31.205-1(c), advertising and public relations costs include “ .
. .the costs of media time and space, purchased services performed by outside
organizations, as well as the applicable portion of salaries, travel, and
fringe benefits of employees engaged in the functions and activities . . . .”
Selected allowable
advertising costs include:
·
Employee recruitment, including help-wanted advertising costs in accordance with FAR
31.205-34; and
·
Costs of activities to promote sales of products normally sold to the
U.S. Government, including trade shows, which contain a significant effort to promote exports from the United
States.
Allowable advertising can recruit direct as well as
indirect labor. Costs of recruiting employees with skills needed only for commercial
contracts are unallowable, however. Costs are considered unallowable when no specific
vacancies are to be filled or if the advertising done is out of proportion to
the number or importance of the positions to be filled.
Per FAR 31.205-1(f)(2),
unallowable public relations and advertising costs include “[a]ll costs of trade shows and other special events which do
not contain a significant effort to promote the export sales of products
normally sold to the U.S. Government.”
The unallowable costs
specified in FAR 31.205-1(f)(2) pertain to exhibiting
products and services at trade shows. Accordingly, labor costs for booth
attendants, and other associated costs such as booth rental and promotional
items, must be disallowed—unless incurred for the export sales purposes
described above. By contrast, labor costs generally are allowable for employees
who merely attend trade shows for the purpose of training.
Public relations include
functions and activities dedicated to enhancing an organization’s image or
products and maintaining or promoting favorable relations with the public.
Specifically, costs of
promotional material, motion pictures, videotapes, brochures, handouts, and magazines that are designed to elicit favorable
attention to the engineering consultant are unallowable unless used primarily
for employee training and orientation. Costs of memberships in civic and
community organizations and costs of souvenirs, models,
imprinted clothing, buttons and other mementos provided to customers or the
public are also unallowable. Costs of sponsoring meetings, symposia, seminars and other special events when
the principal purpose of the event is other than the dissemination of technical
information are unallowable.
Allowable public relations
costs include costs incurred for (a) responding to
inquiries on company policies and activities; (b) communicating with the public, press, stockholders, creditors, and customers; and (c) conducting
general liaison with news media and Government public relations officers, to
the extent that such activities are limited to communication and liaison
necessary to keep the public informed on matters of public concern such as
notice of contract awards, plant closings or openings, employee layoffs or
rehires, and financial information.
Bad debts, including actual
or estimated losses arising from uncollectible accounts receivable due from
customers and other claims, and any directly associated costs such as collection and legal costs are unallowable.
Costs must be reasonable in amount considering what is
normal for a comparable business, the established compensation plan or practice
of a given engineering consultant, or restraints imposed by business
circumstances. (See FAR 31.201-3 & 31.205-6(b) for more
information.) Auditors may challenge either the reasonableness of individual
components of employee compensation or the reasonableness of total compensation
costs.
For more specifics and
details regarding Compensation, see Chapter 7.
This cost is unallowable, including
the portion of cost related to transportation to and from work regardless of
whether the cost is reported as taxable income to the employees. Costs
associated with luxury vehicles warrant additional attention to
ensure costs are reasonable, allowable, and allocable.
Contributions or donations, including cash, property,
and services, are unallowable except for costs of participation in community
service activities such as blood bank drives,
charity drives, disaster assistance, and/or similar types of activities.
Facilities capital cost of
money is an imputed cost related to an engineering consultant’s investment in
fixed assets/facilities used in contract performance, regardless of whether the
source of the investment is equity or borrowed capital. Cost of money is
charged as a rate, in a manner similar to overhead. The resulting cost of money
is not a form of interest on
borrowing. The costs of the capital investment must be determined, measured,
and allocated to contracts in accordance with CAS 414.
Engineering consultants are
not required to propose facilities
capital cost of money in pricing and performing a contract. However, when an
engineering consultant chooses to claim cost of money, the estimated facilities
capital cost of money must be specifically identified in the cost proposals
relating to the contract under which the cost is to be claimed.
Accounting for facilities
capital cost of money generally occurs through a memorandum entry of the cost.
The engineering consultant must maintain, in a manner that permits audit and
verification, all relevant schedules, cost data, and other data necessary to
fully support the entry.
On the engineering
consultant’s overhead schedule, the facilities capital cost of money amount
must be shown as a separate line item or, alternatively, must be disclosed in
the notes. This is necessary to distinguish cost of money from the company’s
other expenses. This is required because, per FAR 15.404-4, profit/fee does not
include amounts applicable to facilities capital cost of money.
The cost of money rate
(Prompt Payment Act Interest Rate) is the arithmetic mean of certain interest rates specified by the
Secretary of the Treasury. These rates are published semiannually in the Federal Register on or about January 1
and July 1. For a fiscal year ending December 31, the arithmetic mean would be
the simple average of the rates for the January 1 through June 30 period and
the July 1 through December 31 period.
The average book value of
the investment base is multiplied by the cost of money rate. The resulting
value is divided by the allocation base units (e.g., direct labor hours or dollars of total cost input)
for the corresponding indirect cost pool.
Appendix A to CAS 414 contains the standard form
used to compute facilities capital cost of money and includes a detailed example
in which the total cost of money on facilities capital is computed on a
step-by-step basis.
In general, depreciation of
plant, equipment and other capital/fixed assets is allowable if it does not
exceed the amount used for financial reporting purposes. Depreciation is
generally based on the useful business life of the asset and should not be
based on accelerated depreciation methods that may be acceptable for IRS tax
purposes. Special consideration must be given to consistency between organizations under
common control, fully depreciated assets, asset disposals, capital leases, rentals and other special CAS provisions contained in the FAR.
Normal depreciation is generally
considered allowable if reasonable and allocable.
Most of the engineering
consultants under contract to State DOTs are not subject to full CAS coverage; therefore, the
following would generally apply:
Costs are reasonable if the
engineering consultant follows policies and procedures that are (a) consistent with those followed in the same
cost center for business other than Government, and (b) reflected in the
engineering consultant’s books of accounts and financial statements. Thus, the firm is not
using accelerated methods of depreciation in determining taxable income.
Reimbursement of fixed asset
costs shall be based on the asset costs amortized over the estimated useful
life of the fixed assets using depreciation methods acceptable for financial purposes
(e.g., straight line, double-declining balance, or sum-of-the-years’-digits).
Allowable depreciation shall not exceed the amounts used for book and statement
purposes and shall be determined in a manner consistent with the depreciation policies
and procedures followed in the same cost center on non-government business (FAR
31.205-11(c)). In
addition, if the amounts used for book and financial statement purposes are not
reasonable or equitable, costs should be questioned.
Note:
Expenses computed based on special tax deduction methodologies (e.g., I.R.C.
Section 179) are not allowable.
For those engineering
consultants that are required to follow CAS, the consultant must comply with the provisions of CAS 409,
Depreciation of Tangible Capital Assets, and CAS 404, Capitalization of
Tangible Assets. CAS 404 and CAS 409 are incorporated into FAR Part 31. (See
Section 8.11 for a discussion of the treatment of gains and losses on sale of
assets per FAR 31.205-16.)
Employee welfare and morale
expenses incurred on activities to improve working conditions,
employer-employee relations, employee morale, and employee performance are
allowable. Expenses and income generated by employee welfare and morale
activities should be in compliance with FAR 31.205-13.
Although gifts are an
expressly unallowable expense, the cost principle specifically excludes two
categories of awards from the unallowable gift definition:
·
Awards covered by the compensation cost principle FAR 31.205-6; and
·
Awards made pursuant to an established plan or policy for recognition
of employee achievements.
Note:
Employee morale type expenses are often covered by the entertainment cost principle, FAR 31.205-14. FAC 90-31, effective October 1, 1995 clarified that entertainment
costs are unallowable under any cost principle, without exception.
Consequently, the entertainment cost principle at FAR 31.205-14 overrides all other cost principles.
Recreation expenses are
expressly unallowable unless they meet the following criteria:
·
The claimed cost is for employee participation in a sports team or
employee organization.
·
The team or organization is company sponsored.
·
The team’s or organization’s activity is designed to improve company
loyalty, team work, or physical fitness.
Taken together, the cost
principles at FAR 31.205-13, Employee Morale, and FAR 31.205-14, Entertainment, expressly disallow certain costs that some engineering consultants
may have considered allowable prior to the effective date of the current rule,
October 1, 1995. Examples of unallowable costs include, but are not limited to:
·
Entertainment provided as part of public
relations, employee relations, or company celebrations;
·
Gifts to the public;
·
Gifts to employees which are not for performance or
achievement or are not made according to an
established plan or policy;
·
Travel tickets or tickets to shows or sporting events; and
·
Recreational trips, shows, picnics, or parties.
Costs associated with the
reimbursement of employee travel expenses are allowable, provided that the
employee is in travel status for an official business purpose, the nature of
the cost is allowable, and the cost does not exceed the per diem rates
established in the Federal Travel Regulation. Reasonableness is considered in nature and
amount both for the engineering consultant as a whole and for the employee(s)
benefited by the expenditure.
Types of activities that
fall under this subsection are very restrictive and limited. Examples of allowable activities include in-house
publications, health clinics, wellness/fitness, employee counseling services,
and food and dormitory services.
Costs of amusement,
diversions, social activities, and any directly associated costs (such as tickets to shows or sports events, meals, lodging, rentals,
transportation, and gratuities) are unallowable. Costs of membership in social,
dining, country clubs or other organizations having the same purposes are also
unallowable, regardless of whether the cost is reported as taxable income to
the employees. Examples of unallowable company sponsored employee social
events, include but are not limited to, outings to professional and college
sporting events, company picnics, theme and holiday parties, and expo fairs.
Costs of fines and penalties
resulting from violations of, or noncompliance with, Federal, State, local, or
foreign laws and regulations, are unallowable except when incurred as a result
of compliance with specific terms and conditions of the contract or written
instructions from the contracting officer.
Gains and losses from the sale, retirement, or other disposition (but see
FAR 31.205-19)
of depreciable property shall be included in the year in which they occur as
credits or charges to the cost grouping(s) in which the depreciation or
amortization applicable to those assets was included (but
see last paragraph below). However, no gain or loss shall be recognized as a
result of the transfer of assets in a business combination (see FAR 31.205-52).
Gains and losses on disposition of tangible capital assets, including those
acquired under capital leases (see FAR 31.205-11(h)), shall be considered as
adjustments of depreciation costs previously recognized. The gain or loss for
each asset disposed of is the difference between the net amount realized,
including insurance proceeds from involuntary conversions, and its undepreciated balance. The gain recognized shall be limited
to the difference between the acquisition cost (or for assets acquired under a
capital lease, the value at which the leased asset is capitalized) of the asset
and its undepreciated balance.
Gains and losses on the disposition of depreciable property shall not be
recognized as a separate charge or credit when either of the following
conditions exists:
·
Gains and losses are processed
through the depreciation reserve account and reflected in the depreciation allowable
under FAR 31.205-11; or
·
The property is exchanged as
part of the purchase price of a similar item, and the gain or loss is taken
into consideration in the depreciation cost basis of the new item.
The term idle facilities refers to completely unused facilities that
exceed the engineering consultant’s current needs. Costs of idle facilities
must be excluded from overhead unless:
·
The costs are necessary to meet fluctuations in workload, or
·
The facilities, when acquired, were necessary but have become idle
because of changes in requirements, production economies, reorganization, or
other unforeseeable causes. Costs of idle facilities are allowable for a reasonable
period, which generally may not exceed one year.
Costs of idle capacity are costs of doing business and are a factor in the
normal fluctuations of usage or overhead rates from period to period. Such
costs are allowable provided the capacity is necessary or was originally
reasonable and is not subject to reduction or elimination by subletting,
renting, or sale, in accordance with sound business, economics, or security
practices. Widespread idle capacity throughout an entire plant, or among a
group of assets having substantially the same function, may be idle facilities.
The composition of bid and
proposal (B&P) costs is frequently a key issue. Although marketing[14] and B&P activities can
be similar in nature and frequently are performed by the same employees, there
is an important distinction between the activities. That is, basic B&P
costs are costs incurred in preparing, submitting, and supporting bids and proposals (whether or
not solicited) on potential Government or non-government contracts. By
contrast, marketing
costs are more general in nature. Therefore, engineering consultants must
establish procedures for segregating B&P costs from selling and marketing
costs.
B&P costs are allowable
and should be treated as indirect costs, unless a specific contract requires submission of a proposal for
subsequent work and authorizes the costs to be charged directly to that
contract.
FAR 31.205-32 provides that
(emphasis added):
Precontract costs means
costs incurred before the effective date of the contract directly pursuant to
the negotiation and in anticipation of the contract award when such incurrence
is necessary to comply with the proposed contract delivery schedule. These
costs are allowable to the extent that they would have been allowable if
incurred after the date of the contract.
Precontract costs are associated with
specific contracts and therefore may not be included in the indirect cost pool. Precontract costs that meet the
requirements of FAR 31.205-32 may be charged directly to projects; however, an
advance agreement may be required (see FAR 31.109(h)). Precontract
labor must remain as a direct cost regardless of whether it is billable to a
client.
Note:
Contracting agencies and engineering consultants should be aware that any
project costs incurred prior to Federal authorization of that project, or phase
of work within the project, are not eligible for reimbursement from Federal
funds.
Costs of insurance on the
lives of key personnel, such as officers, partners, or proprietors are
allowable only to
the extent that (1) the insurance represents additional compensation, and (2) the amount paid is
reasonable. However, if the company or its owners are beneficiaries, the costs
are unallowable.
Professional liability
insurance (also referred to as errors and
omissions insurance) protects against damages to clients or third parties
resulting from professional errors or judgments. The cost of professional
liability insurance is allowable, subject to tests of allocability and
reasonableness.
Alternately, the costs
incurred by an engineering consultant to correct its own defects, settle claims
in lieu of correcting its own defects, or similar acts are unallowable costs as
either a direct or indirect charge, however represented. Simply changing the
label to “warranty” or “settlement” does not render the costs allowable.
Per FAR 31.205-19(d)(3), actual losses are unallowable unless expressly provided for in the
contract, except :
(i) Losses incurred under the nominal deductible
provisions of purchased insurance, in keeping with sound business practice, are
allowable; and
(ii) Minor losses, such as spoilage, breakage, and
disappearance of small hand tools that occur in the ordinary course of business
and that are not covered by insurance, are allowable.
Engineering consultants may elect
to provide coverage for certain risks from their own resources under a program
of self-insurance. The engineering consultant’s decision to self-insure should
be based on a determination that the coverage can be provided by self-insurance
at a cost not greater than the cost of obtaining equivalent coverage from an
insurance company or State fund. If purchased insurance is available, the
charge for any self-insurance coverage plus insurance administrative expenses
shall not exceed the cost of comparable purchased insurance plus associated
insurance administrative expenses.
Generally, engineering
consultants will rely on self-insurance to cover ordinary risks and losses and
will maintain various forms of purchased insurance to cover major risks and
catastrophic losses.
The self-insurance charge
plus insurance administration expenses may be equal to, but must not exceed,
the sum of comparable purchased insurance plus the associated insurance
administration expenses. The engineering consultant’s actual loss experience
shall be evaluated regularly and self-insurance charges for subsequent periods
shall reflect such experience in a similar manner as would purchased
insurance.
As discussed in FAR 31.205-19(c)(2), the requirements of FAR 28.308 must be met. This requires
self-insurance programs to be submitted for pre-approval when 50 percent or
more of the self-insurance costs to be incurred at a segment will be allocated
to negotiated Government contracts and the self-insurance costs at the segment
are expected to be $200,000 or more annually.
Interest on borrowings
(however represented), bond discounts, costs of financing and refinancing capital
(net worth plus long-term liabilities), legal and professional
fees paid in connection with preparing prospectuses, and costs of preparing
and issuing stock rights are unallowable (but see FAR 31.205-28).
However, interest assessed by State or local taxing authorities under the
conditions specified in FAR 31.205-41(a)(3)
is allowable.
Lobbying and political activity costs are
generally unallowable. Some examples of these types of costs are activities
that attempt to influence the outcomes of Federal, State, or local elections,
contribute to political parties or organizations, influence Federal, State, or
local legislation, legislative liaison activities or influence employees of the
executive branch of government.
Certain activities may be
allowable if detailed records are maintained. They may include activities such
as providing technical and factual presentation of information through
testimony, statements or letters in response to a document request on topics
directly related to contracts, or lobbying activities that may directly reduce
contract cost.
Any excess of costs over income
under any other contract (including the engineering consultant’s contributed
portion under cost-sharing contracts) is unallowable. This would include costs
applicable to direct project labor and/or expenses not being fully
reimbursed due to contractual limitations.
All costs incurred in
connection with planning or executing the organization or reorganization of the
corporate structure of a business, including mergers and acquisitions, or raising capital are unallowable. The exception
to this is under (b), the cost of activities primarily intended to provide
compensation. These costs will not be considered organizational costs but are
governed by FAR 31.205-6.
The rationale for
disallowing these costs is that the Government entered into a contract with a
specific entity considered competent to perform the work and should not
reimburse the costs of corporate changes not incident to contract performance.
Patent costs not required by the
Government contract are unallowable. Certain costs may be allowable if they are
incurred as a requirement of a Government contract. They include costs such as
preparing disclosures, filing documentation, searching records and counseling
related to general patent matters.
Work performed by
professionals and engineering consultants with special skills are allowable but
must be supported by detailed evidence of the nature and scope of the work
performed.
Engineering consultants may
engage outside professionals and consultants on a retainer-fee basis. FAR
31.205-33(e) requires that
allowable retainer fees be supported by evidence that:
·
The services covered are necessary and customary,
·
The fee is reasonable in comparison with maintaining an in-house
capability, and
·
The level of past services justifies the amount of the retainer fees.
The supporting evidential
matter requirements also apply to retainer agreements, except retainer
agreements are not required to (and generally do not) have specific statements
of work.
FAR 31.205-33(f) contains three specific documentation requirements that must be
met for any professional and consultant service costs including those on
retainer-fee basis to be allowable. These requirements are:
·
Details of all agreements (e.g., work
requirements, rate of compensation, and nature and amount of other expenses if
any) and details of actual services performed.
·
Invoices or billings submitted by
consultants, including sufficient detail as to the time expended and nature of
the actual services provided.
·
Consultant work products and related
documents, such as trip reports indicating persons visited and subjects
discussed, minutes of meetings, and collateral memoranda and reports.
Certain costs of relocating
permanent employees are allowable if numerous requirements are met. For more
details see FAR 31.205-35(a). Limitations for considering costs allowable
include the following criteria, as set forth in FAR 31.205-35(b):
(1) The move must be for the
benefit of the employer.
(2) Reimbursement must be in
accordance with an established policy or practice that is consistently followed
by the employer and is designed to motivate employees to relocate promptly and
economically.
(3) The costs must not be
otherwise unallowable under [FAR] Subpart 31.2.
(4) Amounts to be reimbursed
shall not exceed the employee’s actual expenses, except as provided for in
paragraphs (b)(5) and (b)(6) of this subsection.
(5) For miscellaneous costs of the
type discussed in paragraph (a)(5) of this subsection, a lump-sum amount, not
to exceed $5,000, may be allowed in lieu of actual costs.
(6) Reimbursement on a lump-sum
basis may be allowed for any of the following relocation costs when adequately
supported by data on the individual elements (e.g., transportation, lodging, and meals) comprising the
build-up of the lump-sum amount to be paid based on the circumstances of the
particular employee’s relocation:
(A) Costs of finding a new home,
as discussed in paragraph (a)(2) of this subsection.
(B) Costs of travel to the new
location, as discussed in paragraph (a)(1) of this subsection (but not costs
for the transportation of household goods).
(C) Costs of temporary lodging,
as discussed in paragraph (a)(2) of this subsection.
When
reimbursement on a lump-sum basis is used, any adjustments to reflect actual
costs are unallowable.
The following types of relocation costs are unallowable:
(1) Loss on
the sale of a home.
(2) Costs incident
to acquiring a home in the new location as follows:
(i) Real
estate brokers’ fees and commissions.
(iii) Real
and personal property insurance against
damage or loss of property.
(v) Owner’s
title policy insurance when such
insurance was not previously carried by the employee on the old residence.
(However, the cost of a mortgage title policy is allowable.)
(vi)
Property taxes and operating or maintenance costs.
(3)
Continuing mortgage principal payments on a residence being sold.
(4) Costs
incident to furnishing equity or nonequity loans to
employees or making arrangements with lenders for employees to obtain
lower-than-market rate mortgage loans.
Some examples of the
conditions which would cause the costs to be unallowable include the following:
·
The claimed costs include mortgage-related costs, and the employees
were not homeowners prior to the move.
·
The move is for a period less than 12 months.
·
The move does not benefit the employer.
·
The employer does not have a consistent relocation policy for all
employees.
·
The claimed costs include a loss on the sale of a home.
·
The claimed costs represent continuing mortgage principal payments on a
sold residence.
An operating lease is the
most common type of agreement used to lease realty or personal property. Under
an operating lease, the engineering consultant pays
rent to a third party at prevailing market rates. Operating lease payments
generally are allowable in full, provided that the leased assets are allocable
to, and used in, the engineering consultant’s primary business activities. By
contrast, special consideration is required for arrangements that are either
structured as capital leases (a.k.a. “financing leases”) or involve common
control.
In some cases, leased
property is considered a purchased asset and must be accounted for as a capital
lease. Accounting for capital
leases requires the property acquired through the lease to be capitalized and
amortized/depreciated over the property’s useful life. The criteria for
classifying leases are discussed in paragraph 7 of FASB Statement No. 13. If a lease
meets one or more of the following four criteria, the lease shall be classified
as a capital lease; otherwise, it shall be classified as an operating lease:
1.
The lease transfers ownership of the property to the lessee by the end
of the lease term.
2.
The lease contains a bargain purchase option.
3.
The lease is equal to 75 percent or more of the estimated economic life
of the leased property.
4.
The present value at the beginning of the lease term of the minimum
lease payment (with certain exclusions) equals or exceeds 90 percent of the
fair value of the leased property to the lessor at the inception of the lease
over any related investment tax credit retained by the lessor and expected to
be realized by him.
Common control is another important issue when
considering the allowability of rental costs. Charges in the
nature of rent for property between any divisions, subsidiaries, or
organizations under common control,
are allowable to the extent that they do not exceed the normal costs of
ownership, such as depreciation, taxes, insurance, facilities capital cost of
money, and maintenance, provided that no part of such costs shall duplicate any
other allowed cost.
Per FASB Statement No. 57—Related Party Disclosures, common control is defined as “The possession, direct or
indirect, of the power to direct or cause the direction of the management and
policies of an enterprise through ownership, by contract or otherwise.” The key
question is whether a party involved in the transaction has the ability to
exercise control over the operating and financial policies of any related
party. An individual does not need to have over 50 percent ownership to have
control. The auditor needs to review the transactions that actually occurred to
determine whether common control exists. A review of the actual decision-making
process and the reasonableness of lease terms are required.
Sale and leaseback rental costs are allowable only
up to the amount the engineering consultant would be allowed if the consultant
retained title, computed based upon the net book value of the asset on the date
the consultant becomes a lessee of the property adjusted for any gain or loss
recognized in accordance with FAR 31.205-16(b). The gain or loss is the difference between the net amount
realized and the net book value (the undepreciated
balance) of the asset on the date of the sale and leaseback transaction. The
annual lease cost limitation should reflect the amortization of the adjusted net book value
and other costs of ownership which may include facilities capital cost of
money, taxes, insurance, and/or similar types of costs.
For personal property (property other than real
estate) under common control, rental costs are allowable to the extent that they do not exceed the
normal costs of ownership as indicated above unless the same (or similar)
property is also rented at the same price to unaffiliated organizations.
Generally. Selling is a generic term that includes efforts to market a company’s goods
and services. Selling costs usually are considered necessary for the overall operation of a business, but not all
types of selling costs are allowable charges against Government contracts.
Costs in the following categories should be reviewed for allowability:
·
Advertising (FAR 31.205-1).
·
Corporate image enhancement and public relations costs (FAR 31.205-1).
·
Bid and Proposal costs (FAR 31.205-18).
·
Entertainment costs (FAR 31.205-14).
·
Long-range market planning costs (FAR 31.205-12).
Determining Allowability. Selling
costs are allowable if they:
·
Are reasonable and allocable in accordance with FAR 31.201-3 and FAR
31.201-4, respectively;
·
Meet the criteria established in FAR 31.205-1(d) through (f), FAR
31.205-12, and FAR 31.205-18 (as applicable); and
·
Are not specifically disallowed by other FAR cost principles (e.g., the
FAR 31.205-14 Entertainment cost principle).
Note:
One example of allowable selling costs is direct
selling, which involves person-to-person
contact to induce a particular customer to purchase the engineering
consultant’s services.
Selling and marketing costs cannot be adequately identified
by mere reference to account titles. Such a cursory analysis is not sufficient
to assess the allocability and allowability of costs within an account. The
actual composition of the account or the activities it represents must be known
and analyzed.
Allocability. Any selling and marketing costs are subject to Government
challenge if the costs can be considered unnecessary/unallocable
to Government contracts. In determining the reasonableness of selling costs,
the Government considers the nature and amount of the expense in light of the
expenses that a prudent individual would incur in a competitive business, the
proportionate amounts expended as between Government and commercial business,
the trend and comparability of current costs with historical costs, the general
level of selling costs in the industry, and the nature and extent of the
selling and marketing efforts in relation to the contract value.
General Advertising. Costs of promotional
material, brochures, handouts, magazines, or other media designed to call favorable
attention to the company and its activities are unallowable. FAR 31.205-38 prohibits claiming these costs
as selling expenses since FAR 31.205-1 specifically identifies these
costs as unallowable advertising or public relations costs.
Federal income taxes and
excess profits taxes are unallowable, as are taxes in connection with financing,
refinancing, refunding operations, or reorganizations. State and local taxes
are allowable (e.g., property, franchise, income, and use taxes). However, if
taxes are paid late or in error, any penalties or interest assessed by the
Government (Federal, State, or local) are unallowable.
Engineering consultants that elect Subchapter S Corporation tax
status are not taxed at the corporate level; accordingly, no payments or accruals
for income taxes should be recorded in the consultant’s financial records. S
Corporation income passes through to the shareholders and is taxed on their
personal income tax returns.
Note:
Auditors should ensure that engineering consultants that have elected
Subchapter S tax status[15]
claim only the State or local taxes that are required to be paid by, or are
otherwise accrued by, the engineering consultant at the corporate level. The State and local income taxes resulting
from the individual shareholders’ pass-through income are not allocable to
Government contracts and must not be included in the engineering consultant’s
overhead rate .
Depending on their nature
and purpose, travel expenses may be allowable as either indirect or direct
contract charges. Travel costs incurred in the normal course of overall
administration of the business are allowable and shall be treated as indirect
costs. Travel costs attributable
to specific contract performance are allowable and may be charged to the
contract, subject to any special limitations contained in said contract.
Costs for transportation may
be based on mileage rates, actual costs incurred, or on a combination thereof;
costs of lodging, meals, and incidental expenses may be based on per
diem, actual expenses, or a combination thereof, provided the method used
results in a reasonable charge as provided in the Federal Travel Regulation (FTR). In accordance with FAR
31.205-46(a)(2), lodging, meals,
and incidental costs must be disallowed to the extent that, on a daily basis,
they exceed the FTR per diem rates.
As provided in FAR 31.205-46(a)(7), travel costs shall be allowable only if the following
information is documented:
·
Date and place of the expenses;
·
Purpose of the trip; and
·
Name of person on trip and that person’s title or relationship to the
contractor.
Costs of travel in aircraft
owned, leased, or chartered by the engineering consultant require additional
substantiation and should be subject to additional audit scrutiny. Refer to FAR
31.205-46(c)(1) for additional
information.
In cases where transportation
costs and consultant-owned or -leased vehicles are involved, only the portion
of mileage incurred in connection with company business are allowable;
accordingly, engineering consultants are encouraged to maintain mileage logs.
Auto lease payments incurred without a documented business purpose do not meet
the criteria contained in FAR 31.206-46(d); therefore, these costs are
unallowable in full. Related costs such as insurance, gasoline, and car repair
also would be unallowable. Extra scrutiny should be applied to costs associated
with luxury vehicles.
In the reviewing the
allowability of legal costs, the following must be considered:
·
Costs incurred in connection with any proceeding brought by a Federal,
State, or local government for violation of a law or regulation by the
engineering consultant generally are unallowable. (Specific criteria appear in
FAR 31.205-47.)
·
Costs of legal, accounting, and other related costs that arise as a
result of a dispute between engineering consultants that are partners in a
joint venture, or similar shared interest arrangement, are unallowable. FAR
31.205-47 also requires for these
costs, including directly associated costs, which may be unallowable, to be segregated in the accounting system.
·
Legal costs pertaining to organization or reorganization activities are
unallowable.
·
In certain situations, significant legal costs may be incurred in one
or more accounting periods and recoveries from settlements may be received in
subsequent periods. A portion of the recoveries should be credited to the
accounts where the legal costs were incurred.
Note:
In determining whether retainer fees are allowable, see Section 8.21 and the
criteria established by FAR 31.205-33.
Generally. A business combination
occurs when a corporation and one or more other businesses are combined into a
single accounting entity. These combinations are classified as mergers or consolidations and historically were accounted
for as purchases or pooling of interests. However, on July 5, 2001, the
Financial Accounting Standards Board (FASB) issued Statement 141, which
eliminated the pooling of interests accounting method. FASB 141 requires the
purchase method of accounting to be used for all business combinations
initiated after June 30, 2001.
The Purchase Method and
Goodwill.
Under the purchase method, a business combination is
accounted for as the acquisition of one company by another (a merger). Goodwill
may result in these transactions and is computed as the difference between:
·
The purchase price of the acquired company (acquiree),
and
·
The sum of the book values of the acquiree’s net
assets (total tangible and identifiable intangible assets less liabilities).
Allowability of Business
Combination Costs. When the purchase method is used, allowable costs for depreciation and cost of
money are limited to the amounts that would have been allowable if the
combination had not occurred. Costs for amortization, expensing, or write-down of goodwill (including costs that arise from
the impairment[16]
of goodwill) are unallowable. Engineering consultants must maintain detailed
records to identify and track elements of costs for future reporting periods.
Costs of alcoholic beverages are unallowable, and the
engineering consultant’s records should clearly segregate these costs, which
must be excluded from the indirect cost schedule. Additionally, these costs
must be excluded from any direct billings to Government contracts.
The table on the following page
lists expenses that generally are ineligible for cost reimbursement on
Government contracts (either as direct or indirect costs). The list is not all
inclusive, but it identifies many types of costs commonly incurred by
engineering consultants.
Table 8-1: Listing of common Unallowable costs
FAR |
|
Reference |
Unallowable Costs |
|
|
31.205-1 & 31.205-38(b)(1) |
Advertising |
31.205-1(f)(2) |
Trade Show Expenses |
31.205-1(f)(2) |
Trade Show Labor |
31.205-1(f)(5) |
Brochures and Other Promotional
Material |
31.205-1(d)(2) |
Souvenirs/Imprinted Clothing Provided
to Public |
31.205-1(f)(7) |
Membership in Civic and Community
Organizations |
31.205-3 |
Bad Debts |
31.205-3 |
Collection Costs |
31.205-6(m)(2) |
|
31.205-8 & 31.205-1(e)(3) |
Contributions or Donations |
31.205-13(b) |
Employee Gifts and Recreation |
31.205-14 |
Membership in Social,
Dining, and Country Clubs |
31.205-14 |
Social Activities |
31.205-15(a) |
Fines, Penalties,
and Mischarging Costs Related to Violation |
31.205-19(e)(2)(v) |
Life Insurance on Key Employees |
31.205-19 |
Costs to Correct Defects in Materials and
Workmanship |
31.205-20 |
Interest Expense |
31.205-22 |
Lobbying and Political Activity Costs. |
31.205-27 |
Organization/Reorganization Legal Fees |
31.205-27 |
Organization/Reorganization Accounting Fees |
31.205-27 |
Organization/Reorganization Incorporation Fees |
31.205-27 |
Organization/Reorganization Labor |
31.205-27 |
Capital Raising (Equity or Long-Term
Debt) Legal Fees |
31.205-27 |
Capital Raising (Equity or Long-Term
Debt) Accounting Fees |
31.205-27 |
Capital Raising (Equity or Long-Term
Debt) Lender Fees |
31.205-30(c) |
Patent Costs |
31.205-33(e) |
Retainer Agreements (unless properly supported) |
31.205-35 |
Relocation Costs (in certain circumstances) |
31.205-46 |
Travel Costs in Excess of FTR Rates |
31.205-49 |
Goodwill |
31.205-51 |
Alcoholic Beverages |
Auditors must exercise significant
judgment in planning and performing engagements and must consider both the
environment in which the engineering consultant operates and the adequacy of
the consultant’s accounting systems and procedures to comply with Federal
requirements. Auditors must consider specific Government regulations and
individual contract provisions when designing, performing, and evaluating audit
procedures. A wide variety of tools and publications is available to provide
guidance in determining the appropriate procedures, testing methods, and
reporting formats (see Appendix D – Listing of Resource Materials). The following are some publications
that may be helpful:
·
Government Auditing Standards (also referred to “Generally
Accepted Government Auditing Standards,” “GAGAS,” or “Yellow Book Standards”) by U.S. Government
Accountability Office.
·
Generally Accepted Auditing Standards, related Statements on Auditing Standards (SASs) and Statements on
Standards for Attestation Engagements (SSAEs) by American Institute of
Certified Public Accountants (AICPA).
·
DCAA Contract Audit Manual (CAM) by the Department of Defense Contract Audit Agency.
·
Internal Control–Integrated Framework by Committee of Sponsoring
Organizations (COSO) of the Treadway Commission.
·
OMB Circular A-123 Revised, Management’s
Responsibility for Internal Control, by the U.S. Office of Management and
Budget (OMB).
·
Auditing Standards promulgated by the Public Company Accounting
Oversight Board (PCAOB) by SEC as a result of
the Sarbanes-Oxley Act of 2002.
·
Cost Accounting Standards (CAS), 48 CFR, Chapter 99, by Cost Accounting Standards Board (CASB), an independent board located administratively within the Office of
Federal Procurement Policy (OFPP).
In performing audits of engineering consultants that provide services
on projects funded by the Federal Government, auditors must assess the
consultant’s compliance with Government regulations (e.g., FAR Part 31 and
relevant sections of the Cost Accounting Standards (CAS)) and contract terms. This
is an important objective; accordingly, auditors should obtain reasonable
assurance that management has met its obligations, including:
·
Developing a system of internal controls to ensure compliance with
applicable laws and regulations;
·
Ensuring that employees are made aware of compliance policies; and
·
Ensuring that procedures are enforced and are updated in accordance with
changes in applicable laws, regulations, and interpretive guidance.
Management is responsible
for maintaining an effective internal control structure. In recent years, a
significant amount of guidance has been issued regarding appropriate internal
control assessment procedures. For example, the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) has established a common
internal control model, which is discussed in detail below in subsection B. The
unique requirements of cost-based Government contracting require the evaluation
of cycles and elements of internal control as part of the engagement. The
following important elements should be considered during the auditor’s
evaluation of internal control of an engineering consultant—
·
Systems for monitoring compliance with Government regulations.
·
Estimating systems and proposal preparation practices.
·
Contract cost accounting practices, including:
-
Systems for tracking and allocating labor cost,
-
Systems for allocating non-labor direct costs, and
-
Systems for allocating costs through cost centers.
·
Billing procedures and controls.
·
Processes for accounting for miscellaneous revenues and credits.
·
Change order identification, pricing, and
reporting.
·
Cost aspects of related-party and inter-organizational transactions.
The Committee of Sponsoring
Organizations of the Treadway Commission (COSO) issued an integrated
internal control framework[17]
designed to provide businesses with guidance in meeting the three primary
objectives of internal control: (1) effectiveness and efficiency of operations,
(2) reliability of financial reporting, and (3) compliance with applicable laws
and regulations. The COSO framework consists of five interrelated components
derived from common business operations. According to COSO, these components
provide an effective framework for describing and analyzing the internal
control system implemented in an organization. The five components include the
following:
The control environment sets
the tone of an organization/entity by influencing the control consciousness of
its managers and employees. The control environment provides discipline and
structure and is the foundation for all other components of internal control.
Control environment factors include integrity, ethical values, management’s
operating style, systems used to delegate authority, and the processes used to
develop and manage employees.
Every entity faces a variety
of risks from external and internal sources that must be assessed. A
precondition to risk assessment requires the establishment of objectives;
accordingly, risk assessment is the identification and analysis of relevant
risks in relation to the achievement of an entity’s assigned objectives. Risk
assessment is a prerequisite for determining how risks should be managed.
Control activities are
composed of policies and procedures that help ensure that management directives
are achieved. Control activities help ensure that appropriate actions are taken
to address risks that may hinder the achievement of the entity’s objectives.
Control activities occur throughout the organization, at all levels and in all
functions, and include a range of activities such as approvals, authorizations,
verifications, reconciliations, reviews of operating performance, as well as
procedures for safeguarding assets and maintaining adequate segregation of
duties.
Information systems play a
key role in internal control systems, as these systems are used to compile and
report on operational, financial, and compliance-related information used to
run and control a business entity. In a broader sense, effective communication
procedures should be developed to ensure that information is disseminated
appropriately within the organization. For example, formalized procedures
should exist for employees to report suspected fraud. Effective communication
procedures also should be developed to ensure adequate communication with
external parties, such as customers, suppliers, regulators, and shareholders.
Internal control systems
must be monitored—a process that assesses the quality of the systems’ performance
over time. This is accomplished through ongoing monitoring activities or
separate evaluations. Internal control deficiencies detected through these
monitoring activities should be reported upstream, and corrective actions
should be taken to ensure continuous improvement of the system.
Controls over estimating
systems and proposal preparation are important to minimize the risk of contract
losses. Management must establish these controls to ensure that reliable cost
estimates support contract proposals, that the cost data are accurate, current
and complete, and that the source of cost data is well documented. The controls
should be documented in written policies and procedures, and auditors should
perform procedures to determine whether (a) the estimating process is
consistent and (b) whether management
adequately monitors the estimating/proposal system to ensure compliance with
the written policies.
Contract cost accounting
practices and systems are critical for Government contracting. Well-controlled systems
ensure that costs are distributed to cost objectives accurately and form a
basis for comparing actual costs with estimated costs. Auditors should perform
testing of the engineering consultant’s control systems to obtain reasonable
assurance that:
·
Costs are accurately distributed to cost objectives,
·
Costs are reasonable and in accordance with contract provisions,
·
Unallocable or other otherwise unallowable costs are
segregated from allowable costs,
·
Cost-allocation practices are reasonable and in conformity with
applicable Cost Accounting Standards and GAAP, and
·
Costs incurred on all projects are periodically reconciled to the
financial accounting system.
Accurately accounting for
labor is paramount to accurate
cost-based accounting. Detailed records must be maintained, accumulated, and
controlled to ensure that both the direct labor and indirect labor amounts are
accurate. Procedures must be in place to ensure that direct labor charges are
distributed to respective contracts. Indirect labor must be captured and
assigned to appropriate indirect labor categories. Auditors should ensure that
the combined total cost of direct and indirect labor displayed in the general
ledger reconcile to the overall labor recorded in the payroll system for the
accounting period under audit.[18]
The engineering consultant’s
management is responsible for ensuring the accuracy of recorded financial data;
accordingly, management must establish controls to ensure that transactions are
reviewed and approved and that errors are promptly corrected. Management also
must maintain records to support the transactions and to provide an audit trail. When integrated accounting systems are in place, management must
implement procedures to ensure accuracy in the manner in which transactions are
recorded, summarized, and transferred through the systems.
Auditors should perform
testing to assess the adequacy of the engineering consultant’s controls over
disbursements and expenditures, allocations of other direct costs, billing
procedures, related-party transactions, and inter-organizational transfers. Auditors
frequently use internal control questionnaires (ICQs) to document the existing controls.[19]
The ICQs should be used in conjunction with additional procedures (see Chapter 10)
to determine whether the engineering consultant’s controls are adequately
designed and function properly.
To perform effective risk
assessments, it is crucial for auditors to obtain an understanding of the
engineering consultant’s business. Risk assessments provide an understanding of
the engineering consultant and its environment, including the internal control
structure. The risk assessment process allows auditors to gather appropriate
evidence related to the likelihood of the occurrence of a material misstatement in the engineering consultant’s
financial statements regarding the classes of transactions and the operation,
and effectiveness of, the consultant’s internal control structure.
Audit risk includes inherent
risk, control risk, and detection risk. During the planning phase of an audit engagement, auditors should
obtain the following types of information for use in establishing materiality levels for high-risk cost items—
·
The engineering consultant’s products and services, including the relationship
of those products and services to cost-based Government contracts;
·
The nature, size, and location of the engineering consultant’s
operations;
·
Mix of Government and commercial business;
·
Competition in the industry;
·
Types of contracts (e.g., lump sum, cost plus fixed fee, and time and
materials);
·
The engineering consultant’s accounting policies and procedures;
·
Key data for significant contracts including the following:
-
Government agency or department
-
Type of contract
-
Contract price
-
Revenues, costs, and profit or loss recognized to date
-
Incentive, escalation, or other relevant contract provisions;
·
Government regulations affecting contract accounting, such as FAR cost
principles and State laws;
·
Key changes in operations, systems, or segments of the business;
·
CAS Disclosure Statement and revisions, if applicable;
·
Key information-processing systems;
·
Related party and inter-organizational transactions;
·
Litigation, claims and disputes;
·
Prior audited indirect cost rates;
·
Prior filings with the SEC such as Form 10-K; and
·
Minutes from board of directors’ meetings.
Note:
The majority of the above items will be disclosed in the engineering
consultant’s responses to the standard AASHTO
Internal Control Questionnaire for Consulting Engineers. See Appendix B.
In planning for an audit,
auditors may obtain information from the engineering consultant pertaining to
other audits. Such audits may include FAR audits performed by independent CPAs,
other State DOTs, local government agencies, or Federal Government agencies
(e.g., the Defense Contract Audit Agency, U.S. Department of Transportation, or
Army Audit Agency), as well as general-purpose financial statement audits,
compilations, and/or attestations performed by CPA firms.
Considering the prevalence
of technology and its rapid rate of change, auditors should carefully assess
the impact of technology on the control environment. Accounting records may be
stored in a wide range of internal information systems, including large
host-based systems, networked environments, and stand-alone desktop computer
applications. Many engineering consultants also use outside service providers
for payroll, benefits, and related tax services. Additionally, the Internet
commonly is used for transmitting data or for accessing regulations and other
information involved in Government contracting.
Auditors should apply the
same standards for evaluation of controls to highly automated environments and
manual systems. However, the audit tests may vary significantly depending on
the level of automation and integration of management information systems. In
certain instances, auditors may need to employ experts to conduct a proper
assessment of internal controls. Particular attention should be focused on the
engineering consultant’s internal controls as new automated accounting systems
are implemented or significant upgrades are applied to legacy systems.
Engineering consultant personnel must be adequately trained on new systems and
must be knowledgeable of the interrelationship between these systems and the
overall internal control environment.
Audit risk involves the
possibility that the auditor’s testing and review may not detect material
misstatements, mischarging, or violations of Government regulations. Accordingly,
risk assessment is crucial to planning and conducting any audit engagement.
If the auditor assesses a
firm’s internal control risk as low, then the auditor may
decide to accept a higher level of “detection risk” by limiting the audit procedures. Conversely, when internal control
risk is assessed as high, the auditor should
perform a greater amount of testing to reduce the detection risk. When determining control risk, the auditor should consider all
factors that may identify risk areas, such as the engineering consultant’s:
·
Size, business volume, and types of accounting systems;
·
Familiarity with the Federal Acquisition Regulation and applicable Cost Accounting
Standards;
·
Employee labor classifications;
·
Structure of cost/profit centers and departments;
·
Performance metrics tied to meeting budgets or other project-related
financial measures;
·
Changes in procedures and practices for direct/indirect time charging;
and
·
Contract/cost objectives where the potential for labor mischarging is
high (see further discussion below in Section 9.10).
When performing risk
assessments, auditors must consider materiality. Under GAGAS, the terms “material” and “significant” are used synonymously. The
auditors’ responsibility when assessing materiality in financial audits is best
stated in GAGAS
4.26:
Under both
AICPA standards and GAGAS, the auditors’
responsibility is to plan and perform the audit to obtain reasonable assurance
that material misstatements, whether caused by errors
or fraud, are detected. The concept of materiality recognizes that some matters, either
individually or in aggregate, are important for fair presentation of financial
statements in conformity with generally accepted accounting principles, while
other matters are not important. In performing the audit, matters that, either
individually or in aggregate, could be material to the financial statements are
a primary consideration. Additional considerations may apply to GAGAS financial
audits of government entity or entities that receive governmental awards. For
example, in audits performed in accordance with GAGAS, auditors may find it
appropriate to use lower materiality levels as compared with the materiality
levels used in non-GAGAS audits because of the public accountability of
government entities and entities receiving government funding, various legal
and regulatory requirements, and the visibility and sensitivity of governmental
programs.
Note:
See Section 10.2 for a discussion of audit sampling as applied to overhead
audits.
The level of risk related to
an engineering consultant audit varies depending on the types of contracts
employed by the consultant as well as the mix of contract types (i.e., fixed-price
or cost-plus contracts[20]).
If the engineering consultant uses primarily fixed-price (lump sum or unit
rate) contracts, then the auditor should place more emphasis on the
consultant’s estimating procedures and controls designed to ensure that all
direct costs are excluded from indirect cost pools. Conversely, if the
engineering consultant primarily enters into cost-plus contracts, then the
audit emphasis should be on allowability and should focus on determining
whether the costs recorded in the cost accounting system reflect actual costs,
regardless of whether such costs are billable. Engineering consultants with a
mix of fixed-price and cost-plus type contracts require special emphasis on consistent allocation of costs regardless
of whether contract revenues are based on costs incurred.
The relationship of an
engineering consultant’s cost-plus Government contracts to total contracts and
the mix of Government and commercial work also will affect the auditor’s
assessment of audit risk and planning materiality and will have a significant
influence the design of appropriate audit procedures. Accordingly, these
considerations will impact audit procedures and may have a significant impact
on the control environment and management’s commitment to internal control
aspects unique to Government contracting.
Before accepting a FAR audit
report or examination-level attestation report, the home State DOT or other
reviewing State DOT must determine whether the auditor has adequately complied
with the procedures described in Chapter 9 (General Audit Considerations) and
performed adequate testing in compliance with the recommended minimum audit
testing procedures discussed in the following sections.[21]
When employing a CPA firm
(or other service provider/auditor) to audit[22]
a proposed overhead rate, the engineering consultant
must inform the CPA that:
·
The audit should comply with AASHTO’s minimum recommended audit procedures, as discussed in the following
sections.
·
All CPA workpapers used as the basis to
establish an audited overhead rate must be made available to
the home State DOT, or surrogate/agent, for review at a location of mutual
agreement, as determined by the State DOT and engineering consultant. (Audit
documentation also may be subject to review by the Federal Highway Administration,
the U.S. DOT OIG, and/or the U.S. Comptroller General.)
·
A sufficient audit trail of the sampling performed by the CPA, or other
auditor, must be maintained by the engineering consultant and made available
for review as stated above.
·
The CPA should consider meeting with representatives of the reviewing
State DOT to discuss the audit process. This is especially important in cases
where the auditee is a new client of the CPA or in cases where the CPA has
limited experience in performing FAR overhead audits. Any such meetings should
occur during the planning phase of the CPA’s audit, with subsequent follow-up
meetings, if deemed necessary.
Audit work must meet professional
standards (Government Auditing Standards and either Generally Accepted Auditing
Standards or Attestation Standards), and the audit must be planned and
performed to provide reasonable assurance that the overhead rate presented on
the overhead schedule complies with the Cost Principles of FAR Part 31.2.[23]
The auditor should begin
this process by gaining familiarity with the auditee, as described in Statement
on Auditing Standards (SAS) No. 108:
Obtaining
an understanding of the entity and its environment, including its internal
control, is an essential part of planning and performing an audit in accordance
with generally accepted auditing standards. The auditor must plan the audit so
that it is responsive to the assessment of the risk of material misstatement
based on the auditor’s understanding of the entity and its environment,
including its internal control.
Note:
As a practice aid, auditors are encouraged to obtain a completed copy of the AASHTO Internal Control Questionnaire for Consulting Engineers from the engineering
consultant/auditee (see Appendix B).
After gaining an
understanding of the consultant’s business and evaluating the client’s internal
control structure, the auditor should develop a plan for substantive testing. This
plan may include both statistical and non-statistical sampling techniques
which, when combined with other audit procedures, must be designed to provide
sufficient, appropriate audit evidence to support the auditor’s opinion on the
compliance of the overhead schedule with the Cost Principles of FAR 31.2. The
auditor may obtain audit evidence through a variety of procedures, including
planning and performing risk assessments, analytical procedures (e.g.,
comparisons with historical cost patterns using comparative, ratio, and/or
trend analysis), directed inquiries, tests of transactions, and other
procedures described in the professional standards. An auditor often considers
the combined evidence obtained from various types of procedures to determine
whether there is sufficient audit evidence.
As discussed in DCAA CAM
Appendix B-102.c, it should be noted that:
Although
the extent of the auditor’s examination of records can be minimized by other
sources of reliance, it seldom can be eliminated when substantial dollar values
or sensitive issues are involved. In all audits, a certain amount of record
examination is required to ascertain that controls are actually effective and
that procedures and practices, which were satisfactory in the past, have not
changed. Furthermore, the auditor must consider the objectives as well as the
effectiveness of internal controls. For example, controls designed to assure
that costs are properly recorded from purchase orders and vouchers to
appropriate accounts would influence a sample selection that is designed to
determine if those costs were assigned to appropriate contracts.
Additionally, auditors
should be aware of the following:
·
The overhead schedule should be prepared based on cost data from the engineering
consultant’s general ledger, after the adjusting entries have been posted to
the accounts and reconciled with any published financial statements.
·
The overhead schedule must be reconciled to the
post-closing trial balance or general ledger.
·
All unallowable costs uncovered through audit testing must be removed
from the overhead schedule, regardless of amount. Accordingly, any type of
planning materiality level established by the auditor
for use in determining large-dollar items[24] may not be used as a minimum tolerance
level, or “floor,” to allow expressly unallowable costs to remain in the
indirect cost pool. Examples of
expressly unallowable costs include, but are not limited to, interest expense, bad debts, donations, and advertising.[25]
Decisions related to sample
selection are dependent on the audit objectives. When a representative sample is
required, the use of statistical sampling approaches generally yields better
results than those obtained from non-statistical techniques. However, when a
representative sample is not required, a targeted, judgmental selection may be
effective if the auditors have isolated certain risk factors or other criteria
to isolate the selection.
This chapter presents some
basic issues to be considered in designing an audit sample. For further
guidance, auditors are encouraged to consult DCAA CAM Appendix B: Statistical Sampling Techniques, which
presents essential principles and methods of statistical sampling as applied to
overhead audits.
Appendix B of the DCAA CAM
provides the following guidance:
B-302.a: A prerequisite to the application
of any sampling process is the need to identify the specific audit objectives
to be attained by examination of the area under evaluation. Prior to initiation
of the sampling process, the auditor should definitively set forth in the
sampling plan the characteristics and values to be examined during the audit.
The auditor’s sampling objective should satisfy the audit objectives of the
area being audited.
B-302.g: When the auditor has reason to
believe that a cost category includes a significant amount of unallowable
expenses, the purpose in taking a sample will generally be to estimate the
total amount of unallowable expenses. On the other hand, if the auditor has no
reason to believe the costs being audited include unallowable amounts, the
purpose will generally be to obtain additional assurance that the costs do not,
in fact, include a significant amount of unallowable expenses. In either case,
the auditor should seek to develop a sampling plan that will provide maximum
support for conclusions in return for the time spent in the selection,
examination, and evaluation of the sample. In addition, the sample size should
provide a reasonable balance between: (1) the amount of support the sample will
provide for audit conclusions and (2) the expenditure of auditor resources the
sample will require.
Depending on the audit
objectives, acceptable sampling methods may include any one or more of the
following, among others:
·
Judgmental Sampling. A method in which items are
selected based on auditor judgment, without regard to the parameters of a
statistical model.
·
Block Sampling. A judgmental method in which
items are grouped and selected in sequential order; once an initial item in a
group is chosen, the rest of the group also is selected.
·
Haphazard Sampling. A judgmental method based on the arbitrary
selection of items.
·
Statistical Sampling. A collection of procedures and
methods that allow for the proper application of statistical procedures, such
as the extrapolation of an audit finding to all the cost elements within a
defined test stratum.
·
Random Sampling. A statistical sampling technique in which each member of the
population has an equal chance of being selected.
·
Systematic Sampling (Nth Record Sampling). A statistical sampling
technique involving the selection of items from an ordered sampling frame.
After the required sample size has been calculated, every Nth record is
selected from a list of population members.
Based on the sampling objective
and purpose of the test, it is critical for the auditor to consider when it is
most appropriate to use attribute sampling, variable sampling, or some
combination of the two methods. DCAA CAM Appendix B provides the following
guidance—
B-303.a: The sampling of characteristics
may be divided into two broad categories of sampling for attributes and sampling
for variables [emphasis added]. When sampling to determine the rate or
proportion of errors in the records or to obtain assurance that an error rate
is not excessive, the auditor is sampling for attributes. Sampling for
variables is performed when a sample is selected in order to estimate an amount
such as the dollar value of unallowable costs contained in the total dollar
value of material invoices charged to a Government contract. The distinction is
important because the methods used to evaluate sample results differ.
B-402: Use of Sampling for Attributes.
a.
Attribute sampling can be classified into two approaches of acceptance and
estimation sampling. Their use depends on audit objectives. With acceptance
sampling, the goal is to either accept or reject the universe. With estimation
sampling, the goal is to estimate the actual error rate in the universe.
b.
Attribute sampling is performed when there are only two possible outcomes from
the evaluation of a sample item: the sampled item either is or is not in
compliance with the control being tested. An audit can be built around
questions answerable by either “yes” or “no”, a feature that distinguishes
sampling for attributes from sampling for variables.
B-502: Use of Sampling for Variables.
Variable sampling is generally used to verify account balances
or cost elements and note any differences. This type of sampling is substantive
testing (as opposed to compliance testing) whereby sample items are evaluated
for error amounts or variables (as opposed to attributes). The audit sampling
universe (e.g., accounts, vouchers, or bill of material) is the entire grouping
of items from which a sample will be drawn. Variable sampling can be applied to
proposals, incurred costs, progress payments, forward pricing rates, and defective pricing.
An
important objective of variable sampling is to estimate a particular universe characteristic
such as total unallowable costs (or questioned cost). The estimated questioned
cost is commonly known as the “point estimate.” A point estimate strikes a
balance between potential understatement (considering both likelihood and
amount) and potential overstatement of the true universe amount. In statistical
sampling, “confidence level” and “precision” are used to measure the
reliability of the point estimate. The confidence level deals with “sureness”
(or assurance) while precision deals with “closeness” (or accuracy). Auditors
must establish desired levels of reliability (discussed in B-504)[26]
[footnote added] in order to properly evaluate the sample results.
Note:
Consistent with DCAA CAM Appendix B-304, before selecting a statistical audit sample
using variable sampling techniques to test for unallowable cost items, auditors are expected to scan the
engineering consultant’s general ledger so that large dollar or sensitive (LDS)
transactions can be removed/stratified[27]
for complete examination, including verification to source documents.
Accordingly, the sampling universe should be limited to the group of
items that remain after the LDS items have been removed.
The auditor should determine
an appropriate sample size after considering the size of the firm, the
auditor’s previous experience with the firm, the number of transactions and
high-risk accounts in the indirect cost pool, and the assessed level of control
risk. The test sample of an account balance or line item must be sufficient to
comply with GAGAS 4.26. Additionally, in
accordance with SAS No. 111, the auditor should document the sampling plan,
including factors used in the determination of sample sizes.
Auditors are encouraged to
consult the AICPA’s Audit Sampling guide,[28]
an interpretive publication designed to assist practitioners in the application
of the guidance found in SAS No. 111. The Audit
Sampling guide includes detailed information and tables for determining
sample sizes based on the facts and circumstances of an engagement, assessed
risks, expected deviation, reliability of controls, and the type of sampling
being used. Additionally, the DCAA’s EZ-Quant statistical analysis software
program is useful for determining and analyzing audit samples using either
attribute sampling or variable sampling techniques. EZ-Quant is a free program
available for download at http://www.dcaa.mil/ezquant.htm.[29]
Note:
Although there is no single optimal sample size for use on all engagements,
auditors are encouraged to apply sampling methods using a 95-percent confidence
level with a precision level in the range of 2 to 5 percent.[30] Additionally, as stated
previously, all unallowable costs uncovered through audit testing must be
removed from the overhead schedule, regardless of amount, as FAR Part 31 does
not establish a tolerance level to permit any amount of unallowable costs to
remain in the indirect cost pool.
Isolated Errors Versus
Systemic Errors. When an unallowable cost (error) is uncovered during audit testing,
the auditor must determine if the error is isolated or instead is due to a
systemic internal control deficiency or other problem. If determined to be an
isolated error, the auditor should document the basis for this determination
and should remove the unallowable cost from the overhead pool. However, if the error
is systemic, then, in addition to removing the unallowable cost from the
overhead pool, the auditor must determine the effect of the error on the
overhead rate and must perform additional testing of the account or line item,
as deemed necessary.
Note:
The auditor and consulting engineer should discuss all errors uncovered during
the audit process, regardless of type or amount. Material, systemic errors may
require enhanced internal controls over the costs in question.
For the majority of
engineering consultant contracts, labor is the largest single component
of cost. Labor costs are composed of direct labor assigned to contracts (regardless
of whether the labor is billable) and indirect labor charges allocated to
contracts through an overhead rate. Verification of labor costs should begin with the
examination of the engineering consultant’s internal control structure and
testing of those controls, as discussed in Section 9.2. Based on the assessed
level of control risk, the auditor should determine an appropriate labor sample
with a minimum of 26 timesheets
chosen for testing across an appropriate mix of direct-charge employees,[31]
including supervisors and/or project managers. The following examples are
presented for illustrative purposes only and are not meant to encompass the
full range of acceptable labor testing. The sample size should increase appropriately
based on the size of the labor population and conclusions drawn from the risk
assessment for labor testing.
Example 10-1:
The auditor is planning labor testing for a firm with 200 full-time
employees. Assume that the auditor assessed control risk as low, as the auditor’s initial
procedures revealed that the firm’s controls over labor were well designed,
fully documented, and properly administered. The firm pays employees biweekly
but requires each employee to submit timesheets at the end of each workweek.
The auditor could randomly select 26 unique employees and test a single weekly
timesheet for each employee across separate and discrete weeks, resulting in
the review of timesheets covering 26 unique weeks within the audit period.
Alternatively, the auditor could randomly select 13 employees and test two
weekly timesheets from randomly selected pay periods for each employee (or
perform similar testing that would provide adequate coverage).
Example 10-2:
Assume the same facts as above, except that the auditor assessed
control risk as high, based on the
firm’s lack of consistent written controls over labor charging practices. The
auditor conducted preliminary interviews with several managers and employees,
several of whom had different understandings of the proper methods for labor
approval and charging. In this instance, it would be appropriate to increase
the audit sample beyond the 26 minimum timesheets, and the auditor would be
advised to consider stratifying the sample based on his or her expectation of
areas that would be most prone for risk.
After the timesheet sample
is selected, the auditor should apply the following minimum procedures:
1.
The sample should be traced from
employee time records to:
·
The payroll records, to ensure hours are recorded and properly
allocated.
·
The cost system, to ensure hours are posted properly to jobs.
·
The general ledger, to ensure that the total posted is recorded in the
financial accounting system.
2.
The timesheets also should be
reviewed for compliance with the model time-charging practices established by
DCAAP 7641.90 Chapter 2-302, as referenced in FAR 31.002. For example, auditors
should determine whether individual employees prepared and signed their own
timecards, whether supervisors approved the timecards, and how labor movement
was documented and approved. (See Section 6.4 for further discussion of the
DCAAP 7641.90 factors.)
3.
The overall labor costs recorded in the general ledger accounts
must be reconciled to:
·
The job cost system.
·
The payroll reports submitted to the Internal Revenue Service (i.e.,
Form 941s—Employer’s Quarterly
Federal Tax Return).
4.
Audit procedures also must be
performed to determine if the labor accounts and individual time card entries
sufficiently screen labor to:
·
Determine the allowability of payroll cost. Do the
timecards identify time spent on unallowable activities?
·
Determine the proper allocation of labor. Do the records charge all labor performed on similar tasks the same
way?
·
Determine if labor is posted in a manner from which
the labor base can be computed. If the base is direct labor costs excluding premium
overtime, do the records accumulate direct labor and direct premium overtime?
Note:
An auditor who selects a smaller sample size than that recommended above must
include an adequate explanation in the workpapers to
justify the deviation. If the State DOT conducting the review determines that
the deviation is not properly justified, the State DOT may reject the overhead
rate determined through the audit.
Indirect cost accounts must
be examined for compliance with the cost principles of FAR 31.2 and the general
financial statement assertions: occurrence, completeness, accuracy, authorization,
cutoff, and classification. Auditors may use a combination of analytical
testing and detailed transaction testing to obtain reasonable assurance that
the indirect costs accounts substantially comply with applicable laws and
regulations; however, auditors should structure audit testing in a manner
consistent with the following discussion.
Based on the risk assessment
process previously described, the auditor should determine high-risk accounts
or line items and should perform adequate detailed testing of these accounts.
In this testing—
·
Large-dollar[32]
or sensitive (LDS) transactions should be removed/stratified for complete
examination, including verification (vouching) to source documents. The auditor
should prioritize the LDS items in terms of risk and materiality to determine
whether the LDS items constitute adequate audit coverage of the aggregate
account balance. If this coverage is deemed adequate, then no further
examination of the account may be required.
·
In
situations where the auditor determines that additional testing beyond the LDS
items is required, the remaining indirect costs in
the high-risk accounts (the sampling universe) should be tested on a sample
basis, using the sampling parameters recommended above in Section 10.2.[33]
A minimum random sample in the range of 2
to 20 transactions is recommended for each high-risk account. This requires
transactions to have been verified from the overhead schedule back to the
general ledger and requires that the transactions be vouched from the general
ledger to source documents.
Note:
The auditor should increase the sample size appropriately based on the results
of the risk analysis and assessment, when the population size would so justify,
or when unallowable activity is found in an account. Recurring transactions,
such as monthly rent, should be counted as only one transaction toward the
minimum sample.
Although the following cost
items will not necessarily constitute high-risk areas in all engagements, the
auditor should consider the following factors in deciding which accounts to
examine in detail. The auditor should expand or reduce the list, as appropriate
for each engagement:
1.
Printing/Reproduction. Were direct costs
consistently handled and all direct costs removed from the indirect cost pool?
2.
Dues and Subscriptions. Review for civil/country club
dues, Political Action Committee (PAC) contributions and other lobbying costs,
scholarship donations, and non-business purchases.
3.
Travel.
·
Were
entertainment costs, alcoholic beverages, and personal charges removed from the indirect
cost pool? (FAR 31.205-15 and FAR 31.205-51)
·
Were
costs for personal use of company vehicles removed from the indirect cost pool?
·
Were
travel costs in compliance with the Federal Travel Regulation? (FAR 31.205-46)
·
Were
direct travel costs treated consistently, and were all direct costs removed from the indirect cost pool?
4.
Seminars and Conventions. Review registration forms for
allowability/business purpose, sponsorships, golf fees, door prize donations,
and booth rental costs.
5.
Insurance. Did the premiums cover only the
audit period? (Review for prepayments related to future periods and late
payments for coverage provided in prior periods.) If the company is self insured, were the associated costs in compliance with
FAR 31.205-19?
6.
Professional and Consultant
Service Costs.
Review for organization and reorganization costs (FAR 31.205-27), bad debt
collections (FAR 31.205-3), direct project costs, and other unallowable
activities. Examine retainer fees for reasonableness and adequate support (FAR
31.205-33(d)).
7.
Rent. Review costs for facilities and
other property, including personal property, to
determine if common control exists (FAR 31.205-36).
8.
Depreciation. Compare claimed depreciation to
tax return and review for systematic and rational allocation method. Ensure the
amount is based on GAAP methods (AICPA).
Ensure that assets are ordinary and necessary business assets and that their
associated costs are reasonable in amount. No Internal Revenue Code (I.R.C.)
Section 179 write-offs are permitted (FAR 31.205-11(a) & (c)).
9.
Employee Morale. Review for unallowable
entertainment costs per FAR 31.205-14 (including employee
parties). See also DCAA CAM Sections 7-2103(e)(3) & (4).
10.
Accounts Titled “Other Indirect
Costs,” “General Office,” or Similar Titles. Review for overall allocability
and allowability in accordance with FAR Part 31 and applicable Cost Accounting
Standards. (See
Section 8.30 for a list of common unallowable costs.)
11.
Subconsultants/Outside Consultants. Ensure proper segregation of
direct and indirect cost, business purpose of activities performed, and
reasonableness.
12.
Miscellaneous Income and Expense
Accounts.
Review for overall allocability and allowability in accordance with FAR Part 31
and applicable Cost Accounting Standards.
13.
Gains on Sale of Assets. Ensure proper credit on gains
on sales of assets originally included as part of the depreciation expense
cost.
14.
Loss on Sale of Assets. Ensure proper reporting within
the year the transaction occurred, appropriate calculation, appropriate
application of credit or charge to the cost groupings in which the depreciation
or amortization was originally posted, and appropriate posting
of cash awards.
Note:
The auditor should fully document the identification of high-risk accounts,
based on a risk assessment and the application of professional judgment. If the
auditor’s procedures vary significantly from those listed above, the auditor
must provide an adequate explanation to justify the deviation. If the State DOT
conducting the review determines that the deviation is not properly justified,
the State DOT may reject the overhead rate determined through the audit.
A general discussion of
allocated costs (cost centers) appears in Section 5.3 of this Guide. With
respect to FAR overhead audits, auditors should consider the following issues when
performing risk assessments of cost centers and allocated costs:
·
Allocability. Are costs posted to the cost
center properly allocated? Do the costs belong to the function being priced?
·
Allowability. Are
costs posted to the cost center allowable? Do the costs exclude interest,
profit, and/or other costs expressly unallowable per FAR Part 31?
·
Consistency. Do the unit charge records
indicate the consistent assignment of all similar
charges to projects.
Note:
The third item (consistency) is the most commonly overlooked issue and can
result in substantial audit adjustments.
State DOTs must review and
approve overhead rates submitted by engineering consultants. The engineering
consultant bears the burden of establishing the accuracy of the overhead rates
and that direct costs were properly removed from the indirect cost pool. The
overhead audit report should include disclosure notes regarding the audited
direct cost rates and a listing of cost categories that the engineering
consultant charges directly to contracts.
Some firms choose not to
create cost centers. These firms estimate the cost of providing certain
services by extracting certain cost elements from ledger accounts (e.g., automobile
depreciation from a general ledger depreciation account). Once established,
these unit charges are offset to overhead as they are utilized on
projects. This type of costing is less precise and should not be utilized if
the unit charges being accumulated are significant to the firm’s overall
operation.
Invoices received from
vendors and/or employee expense reports support ODCs. ODCs are processed
through the cost accounting system and must be assigned directly to the
appropriate cost objectives (projects). To ensure that ODCs are properly
excluded from the overhead cost pool, the engineering
consultant should establish dedicated accounts in the general ledger to
accumulate the various types of ODCs. Examples of common ODCs include project
travel, vendor printing, employee mileage, rented vehicles and equipment, and
costs of subcontractors.
Note: Auditors
should be aware that, instead of establishing dedicated ODC accounts as recommended
above, some engineering consultants capture both ODCs and indirect costs
in summary accounts that appear on the overhead schedule.[34]
Accordingly, auditors should examine
indirect expense accounts to determine whether—
●
The indirect
cost pool was properly reduced for the ODCs that were billed to projects,
● Costs were allocated
consistently to projects when such costs were incurred for similar purposes,
and
● Costs were priced
consistently to direct and indirect cost objectives.
In cases where a CPA fails to
meet the minimum audit procedures, the reviewing State DOT may consider
referring the CPA to the appropriate Board of Accountancy for review under the
AICPA Code of Professional Conduct,
which provides the following in Section
501-5–Failure to Follow Requirements of Governmental Bodies, Commissions, or
Other Regulatory Agencies in Performing Attest or Similar Services:
Many
governmental bodies, commissions or other regulatory agencies have established
requirements such as audit standards, guides, rules, and regulations that
members are required to follow in the preparation of financial statements or
related information, or in performing attest or similar services for entities
subject to their jurisdiction. For example, the Securities and Exchange
Commission, Federal Communications Commission, state insurance commissions, and
other regulatory agencies, such as the Public Company Accounting Oversight
Board, have established such
requirements.
If a member
prepares financial statements or related information (for example, management’s
discussion and analysis) for purposes of reporting to such bodies, commissions,
or regulatory agencies, the member should follow the requirements of such
organizations in addition to generally accepted accounting principles. If a
member agrees to perform an attest or similar service for the purpose of
reporting to such bodies, commissions, or regulatory agencies, the member
should follow such requirements, in addition to generally accepted auditing
standards (where applicable). A material departure from such requirements is an
act discreditable to the profession, unless the member discloses in the
financial statement or his or her report, as applicable, that such requirements
were not followed and the reason therefore.
When reviewing a CPA’s workpapers, if the reviewing DOT determines that the CPA
auditor has failed to follow the minimum audit procedures presented in this
Guide, then:
·
The submitted/audited overhead rate will be rejected by the reviewing
DOT, and the rate will not be considered cognizant.
·
If the reviewing DOT rejects the audited overhead rate, the engineering
consultant will be afforded the opportunity to correct the defects in the
audit. Generally, this will require more extensive testing by the auditor.
·
Before the engineering consultant resubmits the audited overhead
schedule to the reviewing DOT, the engineering consultant must ensure that the
auditor performs additional audit procedures in compliance with the minimum
testing procedures.
·
If the follow-up submittal still does not meet the minimum procedures,
then the reviewing DOT may disallow all audit fees associated with the overhead
audit that were included in the submitted overhead rate. The reviewing DOT may
be required to perform additional audit procedures before an acceptable
overhead rate can be established.
Note:
State DOTs generally will deem an overhead audit insufficient due to an
auditor’s failure to comply with the recommended minimum testing procedures as
established in this chapter (unless deviations from the minimum testing
requirements are adequately identified and justified in the auditor’s workpapers), failure to apply properly the FAR Subpart 31.2
cost principles, and/or failure of a CPA or other audit group to provide access
to all audit workpapers used to determine the audited
overhead rate. For additional guidance, see Chapter 11 and the CPA Workpaper Review Program in Appendix A.
Although auditors’ reports
may be presented in a variety of formats and styles, in all cases these reports
must meet the GAGAS Reporting Standards for Financial Audits or Attestation
Engagements. Accordingly, CPAs must perform appropriate examination procedures
before they opine on, or attest to, the reliability of the engineering
consultant’s overhead rate.
GAGAS reporting standards first
incorporate the AICPA reporting standards for each
type and then require additional GAGAS standards. There are ten standards for financial
audits and nine standards for attestation engagements. See Chapter 2 of this Guide for a summary matrix of the standards.
The complete text of the standards is available in the Yellow Book.
This chapter provides basic
guidelines for reporting and minimum disclosures that must be made by the
engineering consultant’s management and included in auditors’ reports. A
typical report package contains the following:
·
Independent Auditor’s Report on overhead schedule.
·
Overhead schedule.
·
Listing of unallowable account adjustments with FAR References.
·
Notes to the overhead schedule including minimum disclosures.
·
Independent Auditor’s Report on Internal Control.
Note:
The AASHTO Audit Subcommittee and the ACEC Transportation Committee have
approved the report formats.
The
following is an example of a typical audit report that would be issued by a CPA
firm or a State or Federal agency on the overhead schedule for a consulting engineering firm. If the
auditor performed an “attestation engagement examination,” then the report
wording would be modified, but in both cases an auditor’s opinion is required.
The complete report would include the overhead schedule and footnote
disclosures (see following pages).
INDEPENDENT AUDITOR’S REPORT ON
THE
Statement of Direct Labor, Fringe
Benefits, and
General Overhead
Board of Directors
The Company
We have audited the Statement of Direct
Labor, Fringe
Benefits, and
General Overhead (hereinafter referred to as “overhead schedule” or
“the Schedule”) for the fiscal year ended December 31, 2XXX. The Schedule is
the responsibility of the Company’s management. Our responsibility is to
express an opinion on the Schedule based on our audit.
We conducted our audit in accordance
with generally accepted auditing standards and the financial audit standards
contained in the Government Auditing
Standards issued by the
Comptroller General of the United States of America. Those
standards require that we plan and perform the audit to obtain reasonable
assurance about whether the Schedule is free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the Indirect Cost Schedule. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall presentation of the Schedule. We believe that
our audit provides a reasonable basis for our opinion.
The accompanying overhead schedule was
prepared on a basis of accounting practices prescribed by Part 31 of the
Federal Acquisition Regulation (FAR) and certain other Federal and State
regulations as discussed in Note 2, and is not intended to be a presentation in
conformity with generally accepted accounting principles.
In our opinion, the overhead schedule
referred to above presents fairly, in all material respects, the direct labor,
fringe benefits, and general overhead of the Company for the year ended December 31,
2XXX on the basis of accounting described in Note 2.
In accordance with the Government Auditing Standards we have issued a report dated April 4, 2XXX on
our consideration of the Company’s internal controls and its compliance with
laws and regulations.
This report is intended solely for the
use and information of the Company and government agencies or other customers
related to contracts employing the cost principles of the Federal Acquisition
Regulation and should not be used for any other purpose.
(Signature of Official
Representative/CPA Firm)
DATE, 2XXX
The following is an example
of a report on internal control with no reportable conditions, which is a GAGAS requirement for financial audits
(see Chapter 2). For both financial audits and attestation engagements,
auditors’ reports should disclose deficiencies in internal control, fraud,
illegal acts, violations of contracts or grant agreements, and abuse. (See the
Yellow Book for specific reporting
requirements)
INDEPENDENT AUDITOR’S REPORT ON
INTERNAL CONTROL AND COMPLIANCE
Board of Directors
The Company
We have audited the overhead schedule of
the Company for the fiscal year ended December 31, 2XXX, and have issued our
report thereon dated (DATE, 2XXX). We conducted our audit in accordance with
auditing standards generally accepted in the United States of America and the
standards applicable to financial audits (or examination level attestation
engagements) contained in Government
Auditing Standards, issued by the Comptroller General of the United States.
Internal Control Over Financial Reporting
In
planning and performing our audit, we considered the Company’s internal control
over financial reporting as a basis for designing our auditing procedures for the
purpose of expressing an opinion on the schedule, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we do not express an opinion on the
effectiveness of the Company’s internal control over financial reporting.
The
management of the Company is responsible for establishing and maintaining
internal control over financial reporting. In fulfilling this responsibility,
estimates and judgments by management are required to assess the expected
benefits and related costs of internal controls over financial reporting. The
objectives of internal control over financial reporting are to provide
management with reasonable, but not absolute, assurance that assets are
safeguarded against loss from unauthorized use or disposition, and that
transactions are executed in accordance with Part 31 of the Federal Acquisition
Regulation. Because of inherent limitations in any internal control structure,
errors or irregularities may nevertheless occur and not be detected. Also,
projection of any evaluation of the structure to future periods is subject to
the risk that procedures may become inadequate because of changes in conditions
or that the effectiveness of the design and operation of policies and
procedures may deteriorate.
A
deficiency in internal control exists
when the design or operation of a control does not allow management or
employees, in the normal course of performing their assigned functions, to
prevent or detect misstatements on a timely basis. A significant deficiency is a control
deficiency, or combination of control deficiencies, that adversely affects the
Company’s ability to initiate, authorize, record, process, or report financial
data reliably in accordance with Part 31 of the Federal Acquisition Regulation
such that there is more than a remote likelihood that a misstatement of the
Company’s overhead schedule that is more than inconsequential will not be
prevented or detected by the Company’s internal control. A material weakness is
a significant deficiency, or combination of significant deficiencies, in
internal control, such that there is a reasonable possibility that a material
misstatement of the Company’s overhead schedule will not be prevented or
detected, and corrected, on a timely basis.
Our
consideration of internal control over financial reporting was for the limited
purpose described in the first paragraph of this section and was not designed
to identify all deficiencies in internal control over financial reporting that
might be deficiencies, significant deficiencies, or material weaknesses. We did not identify any deficiencies in
internal control over financial reporting that we consider to be material
weaknesses, as defined above.
Compliance
and Other Matters
As part of obtaining reasonable
assurance about whether the Company’s overhead schedule is free from material
misstatement, we performed tests of the Company’s compliance with certain
provisions of laws, regulations, contracts, and grant agreements, including
provisions of the applicable sections of Part 31 of the Federal Acquisitions
Regulation, noncompliance with which could have a direct and material effect on
the determination of the amounts reported on the overhead schedule. However, providing an opinion on compliance
with those provisions was not an objective of our audit, and accordingly, we do
not express such an opinion. The results
of our tests disclosed no instances of noncompliance or other matters that are
required to be reported under Government Auditing Standards.
We noted certain matters that we
reported to management of the Company in a separate letter dated (DATE, 2XXX).
This report is intended solely for the
use and information of the Company and government agencies or other customers related
to contracts employing the cost principles of the Federal Acquisition
Regulation. This report should not be used for any other purpose.
(Signature of Official Representative of
Firm)
(DATE, 2XXX)
The following subsections
describe disclosures that should be included with audit reports, regardless of
whether the audits reports are generated from financial audits or attestation
engagements. In cases where examples are included, they are for illustrative
and explanatory purposes only and are not intended to be comprehensive
regarding rules and regulations. Some of the recommended disclosures may not be
appropriate or necessary for certain firms. Conversely, additional disclosures
may be required for firms with unusual or complex issues. Disclosures should be
included with the overhead audit report for each fiscal year and may either be
included in the notes to the overhead schedule or as a separate section within
the report.
Provide an overview of the
company including when the company was formed, type of organization (e.g.,
corporation, LLC, or LLP), major business activities, primary customer groups, type
of ownership (e.g., subsidiary of corporation, division of another company,
privately held firm) and any other pertinent general company information.
The basis of accounting
practices should be clearly stated, as described below.
EXAMPLE 11-1: The Company’s overhead schedule was prepared on the
basis of accounting practices prescribed in Part 31 of the Federal Acquisition
Regulation (FAR). Accordingly,
the overhead schedule is not intended to present the results of operations of
the Company in conformity with accounting principles generally accepted in the
United States of America.
Describe the financial
accounting system (i.e., cash, accrual, or hybrid) and job cost accounting
system (e.g., job order, modified job order, standard, or hybrid). Include a
description of accounting policies and procedures governing the classification
of costs as direct or indirect. Describe how project costs are accumulated and
assigned to projects.
Disclosures should include
language to—
·
Identify the reporting unit.
(e.g., company wide; business segment; or technical
specialty such as design, construction administration, geotechnical, or
environmental; and/or geographical location pertaining to the overhead rate or rates).
·
Identify the company’s overall rate structure in terms of the base(s)
for allocation. Describe if more than one base is used, depending on the
customer (e.g., different bases used for Federal and State projects).
EXAMPLE 11-2:
Single
Base
- All costs are allocated based on Direct
Labor cost.
Multiple
Bases
- Fringe benefits costs allocated based on Direct + Indirect
Labor.
- Office overhead costs allocated based on
Direct Labor + Fringe Benefits.
- General and administrative costs allocated
based on Value Added Costs (all company costs,
excluding subconsultants).
·
Identify whether a dual rate structure exists for field office projects
and home office projects. Specify the allocation methods used.
·
Identify that Nonsalary Direct Project Costs,
sometimes referred to as Other Direct Costs (ODCs) are consistently charged to
all projects, and not just projects that reimburse for ODCs (e.g., computer
costs, reproduction, equipment charges, and vehicle usage).
Include a listing of cost items generally charged directly to projects.
·
Identify cost allocation practices between related business entities
(e.g., parent company allocating costs to subsidiaries or divisions, allocations
between subsidiaries or divisions, and/or allocations to specific product
lines).
The disclosures associated
with labor costs must include details
regarding—
1.
Project Labor. Describe how the company
charges labor to all projects (i.e., actual,
average, or standard hourly rates).
2.
Variances. Describe how and when
variances are recorded if using other than actual labor costs.
3.
Paid Time Off. Explain the company’s policy
and accounting practice as to paid vacation, sick leave and comp time. Include
the engineering consultant’s policy as to accounting for accrued sick leave
upon termination.
4.
Paid Overtime and
Uncompensated Overtime. Indicate where the premium
portion of overtime pay is recorded in the cost accounting system. Detail the
procedures for recording uncompensated overtime incurred by employees charging
direct project time.
EXAMPLE 11-3:
Premium Overtime costs are incurred in meeting certain deadlines. If an
employee is eligible for overtime, they have their choice of a cash payment
equal to time and a half (premium portion), or compensatory time off at time
and a half. The premium portion of paid overtime is included in the indirect
cost pool.
Uncompensated Overtime: The
Company did not pay certain salaried employees for time worked in excess of 40 hours
per week. The time in excess of 40 hours was credited to the indirect cost pool. The credited amount ($xx,xxx) consisted of hours worked in excess of 40, times
the employee’s standard hourly rate.
5.
Highly Compensated
Employees/Officers/Owners.
FAR 31.205-6(p) sets a specific
dollar limit on the compensation (total compensation as defined in FAR
31.205-6(a)) of “senior executives.” Other bases
(such as independent salary surveys) may be used to determine reasonable
compensation levels. The reasonable compensation limit or
range that was used by the auditor should be disclosed in the notes to the
audit report. Distributions of profits to owners are unallowable as direct or
indirect labor costs.
EXAMPLE 11-4: The Company
paid compensation to senior executives in excess of the FAR 31.205-6(p) limit of $XXX,XXX per person.
The total, which was adjusted to the overhead schedule, amounted to $XXX,XXX.
6.
Pension Plans, Deferred
Compensation Plans, and ESOPs. If
pension and/or deferred compensation costs (as defined by FAR 31.205-6(j) and 31.205-6(k)
respectively) are included in indirect costs, identify whether
the plan(s) meet the above regulations and explain how the costs were
determined (e.g., cash contribution, stock or options to purchase stock of the
engineering consultant, or assets other than cash). In regard to Employee Stock
Option Purchase (ESOP) plans, identify
the dollar amounts of principal, interest, and administrative costs of the
contribution to the Employee Stock Option Trust (ESOT). Identify any
other significant impacts from market valuations.
EXAMPLE 11-5: The Company operates a 401(k) pension plan, meeting the
requirements of FAR 31.205-6(j), to which it makes a cash
contribution of 2 percent of participating employees’ salaries per year.
In addition, the Company has a leveraged deferred
compensation ESOP started in 1984. The plan provides for cash
payments of the appraised value of the stock (held by the ESOT for the employee) upon retirement, leaving the
Company after 10 years service, or death. Since CAS 9904.415(a)(3) has not been satisfied, the
Company assigns the payments to the period in which the compensation is paid to
the employee. The amount of the company’s share of ESOP expense included in the
overhead pool for the year is $xxx,xxx.
7.
Contract/Purchased Labor. Provide the
methodology used by the engineering consultant to account for contract labor (not sub-contracts). In some cases this labor
will be considered to be a direct cost item invoiced to the project, but in other
cases the firm may choose to have this labor treated the same as employee
labor, and therefore it would be included in the direct labor base.
EXAMPLE 11-6: The Company uses contract labor for engineering related services, and bills
this labor as if it were for regular employees. The Company provides office
space, administrative support, and controls the contract laborers. Therefore,
contract laborers are considered employees, and their labor costs ($52,000 for
the period audited) have been included in the direct labor base.
Policies regarding costs related
to acquisition and disposition of assets should be clearly identified along
with the related depreciation methods. Costs and accounting treatment for
capital and operating leases should be disclosed.
EXAMPLE 11-7: Certain assets are purchased and depreciated, while others
are leased and considered operating leases, and the annual lease costs are
included in the overhead pool. The depreciation reflected on the
Company’s financial statements differs from the acceptable depreciation for
Federal income tax purposes. Since the financial statement amounts included in
the overhead pool are lower than the amounts used for
Federal purposes, the amounts included on the Overhead Schedule are allowable
under FAR 31.205-11(e).
Identify any related
parties, who are considered to have common
control, to the extent that audit adjustments are required, and the amounts of
required adjustments per FAR 31.205-36.
EXAMPLE 11-8: The
Company rents one of its two offices from a Limited Liability Partnership (LLP)
partially owned by a company shareholder. The actual occupancy costs of
$350,000 include interest expense of $140,500. The rent expense recorded in the
Company’s financial statements includes a $400,000 charge from the related
party LLP. The calculation to determine the allowable portion of the rent
follows:
Total rent expense recorded (from related LLP) $400,000
Less: Profit included in rent charges ( 50,000)
Less: Unallowable interest expense (
140,500)
Allowable portion of related party rent $ 209,500
Consequently, rental expense has been reduced by $190,500 ($400,000 rent expense less $209,500 allowable portion) in accordance with FAR 31.205-36(b)(3).
The officers of the Company have personal usage of Company vehicles. Amounts attributable to this personal use ($X,XXX for 20xx) were disallowed.
Provide the cost-of-money
rate, as calculated in accordance with FAR 31.205-10.
EXAMPLE 11-9: The cost-of-money rate has been calculated in
accordance with FAR 31.205-10, using average net book values of equipment
and facilities multiplied by the average treasury rate for the applicable
period. Equipment and
facilities include furniture and fixtures, computer equipment, vehicles, and
leasehold improvements. The calculation was made as follows:
12/31/xx
Net
Book Value of Corporate Assets $ 267,520
Average
Treasury Rate 5%
Computed
Facilities Capital Cost of Money $ 13,376
Direct
Labor Base $1,042,535
Cost-of-Money
Rate 1.28%
Note:
When calculating FCCM, the net book value of the related party building may be included in
the total net book value of tangible assets for the company.
Provide a listing of the
types of costs that were charged directly to contracts, along with a
description of the control procedures used to ensure that these costs were not
also included in the indirect cost pool.
To avoid duplication of
audit work, it is common practice for auditors to rely on the work of others.
GAGAS 4.23 states:
Underlying
GAGAS audits is the premise that audit organizations
in federal, state, and local governments and public accounting firms engaged to
perform a financial audit in accordance with GAGAS cooperate in auditing
programs of common interest so that auditors may use others’ work and avoid
duplication of efforts. Subject to applicable laws and regulations, auditors
should make appropriate individuals, as well as audit documentation available,
upon request and in a timely manner to other auditors or reviewers to satisfy
these objectives. The use of auditors’ work by other auditors may be
facilitated by contractual arrangements for GAGAS audits that provide for full
and timely access to appropriate individuals, as well as audit documentation.
Note: Additional guidance is provided in GAGAS 7.41, 7.42, and 7.43.
In 1995, Congress passed the
latest version of the National Highway System Designation Act (hereinafter referred to as “the NHSD Act”).
The focus of Section 307 of the NHSD Act was to remove the ceilings on overhead rates and indirect salaries that
had been established by some states, to avoid duplicate indirect cost audits of the same firm by
multiple audit entities, and to reinforce the need for all auditors to use the
FAR for the purpose of determining cost eligibility.
This legislation impacted
how some states paid consulting engineers for the overhead portion of their costs on
Federally-participating contracts. Heretofore, approximately one-half of the
State DOTS had self-imposed ceilings on overhead limits and/or maximum hourly
rates associated with indirect labor. Section 307 of the NHSD Act prohibited the use of such limitations on
Federal-aid contracts.
The NHSD Act, however,
provided a one-year window for states to adopt statutes that would establish
“an alternative process intended to promote engineering and design quality and
ensure maximum competition.” If a statute were adopted by a State within this
period, Section 307 would not bind the state. Thirteen states adopted such
statutes within the allowed time period. Such states were referred to as “opt-out States,” and included the
following: Connecticut, Delaware, Florida, Kentucky, Louisiana, Maine,
Maryland, Minnesota, New York, North Carolina, Utah, Tennessee, and West
Virginia.
In 2006, the Transportation
Appropriations Act (SAFETEA-LU) contained language that eliminated the concept
of opt-out States, thereby promoting greater uniformity. Of the thirteen
opt-out States, alternative processes were repealed for all states except
Minnesota and West Virginia.
The underlying guidance
concerning cognizant audits is contained in 23 CFR 172 and 23 U.S.C. 112 and
supporting documents published by FHWA. Section 174 of the 2006 Transportation
Appropriations Act and the implementation guidance issued by FHWA served to
re-emphasize the importance of cognizant audits, while not actually changing the underlying regulations specific to
issuance or acceptance of cognizant audits.
23 U.S.C. 112 provides
definitive guidance on indirect rates and the acceptance of cognizant audits. 23 U.S.C. 112 (b)(2), Contracting for engineering and design
services, provides the following:
(A) General
Rule – Subject to paragraph (3), each contract for program management,
construction management, feasibility studies, preliminary engineering, design,
engineering, surveying, mapping, or architectural related services with respect
to a project . . . shall be awarded in the same manner as a contract for
architectural and engineering services is negotiated under Chapter 11 of Title
40.
(B)
Performance and audits – Any contract or subcontract awarded in accordance with
subparagraph (A), whether funded in whole or in part with Federal-aid highway funds,
shall be performed and audited in compliance with cost principles contained in
the Federal Acquisition Regulation of part 31 of
title 48, Code of Federal Regulations.
(C)
Indirect cost rates – Instead of performing its own audits, a recipient of
funds under a contract or subcontract awarded in accordance with subparagraph
(A) shall accept indirect cost rates established in accordance with the
Federal Acquisition Regulation for 1-year
applicable accounting periods by a cognizant Federal or State government
agency, if such rates are not currently under dispute.
(D)
Application of rates – Once a firm’s indirect cost rates are accepted under this paragraph, the
recipient of the funds shall apply such rates for the purposes of contract
estimation, negotiation, administration, reporting and contract payment and
shall not be limited by administrative or de facto ceilings of any kind.
The AASHTO Audit Subcommittee and ACEC Transportation Committee worked
together to develop the following guidance, which was later incorporated by
FHWA into the Administration of
Engineering and Design Related Services Contracts–Questions and
Answers
prepared by the FHWA and available on the Internet at http://www.fhwa.dot.gov/programadmin/172qa.cfm#r39.
A cognizant agency can be
any of the following:
·
A Federal agency,
·
The Home State Transportation or Highway Department (the State where
the consulting firm’s accounting and financial records are located), or
·
A Non-Home State Transportation or Highway Department to whom the Home
State has transferred cognizance in writing for the particular indirect cost audit of a consulting firm.
Cognizant approved rates may
be established by any one of the following methods:
·
A Cognizant Agency either: (a) performs an indirect cost rate audit, or
(b) contracts with and directs the work of a CPA who performs this work.
·
A Non-Home State auditor or CPA working under the State’s direction
issues an audit report, and the Home State issues a cognizant letter of
concurrence. If the Home State does not accept the indirect cost rate audit
performed by another State, the Home State will have 180 days from receipt of
the audit report to issue a cognizant approved rate; otherwise, the Non-Home
State audit report will be used to establish a cognizant approved rate for the
one-year applicable accounting period.
·
An indirect cost audit performed by an
independent CPA (not part of the engineering consultant’s organization) hired
by the consulting firm will be used to establish a cognizant approved rate if
one of the following conditions is met:
(a) The Home State reviews
the CPA’s audit report and related workpapers, and
the Home State issues a cognizant letter of concurrence with the audit report.
(b) A Non-Home State reviews
the CPA’s audit report and related workpapers and
issues a letter of concurrence with the CPA report, which is then accepted by
the Home State. If the Home State does not accept the Non-Home State’s review,
the Home State will have 180 days from receipt to complete a review of the CPA
audit report and either concur with it, modify it, or reject it due to a
material error requiring re-submittal; otherwise, the CPA audit report with
which the Non-Home State has concurred will be used to establish the cognizant
approved rate for the one year applicable accounting period.
A CPA Workpaper
Review Program appears in Appendix A of this
Guide. Government auditors should use the Program when performing overhead audits or when reviewing the workpapers of others, to determine whether is it
appropriate to issue a cognizant letter of concurrence. The workpaper review program is a tool to assist in determining whether: (a) the
CPA’s audit was conducted in accordance with GAGAS, (b) the CPA adequately
considered the auditee’s compliance with FAR Part 31 and related laws and regulations, and (c) and the audit
report format is acceptable. Chapter 9 of this Audit Guide includes a
recommended format for the audit report and required disclosures.
Examination level
engagements following GAGAS (Yellow Book) requirements are acceptable. This Uniform Audit and Accounting Guide
also should be followed when performing these engagements.
For many State DOTs, it will
not be feasible to perform comprehensive CPA workpaper
reviews for all engineering firms that perform work and are located in their
home states; however, the onus remains on State DOTs to obtain reasonable
assurance that the rates submitted by engineering consultants are FAR
compliant. Accordingly, to accept rates without performing a comprehensive workpaper review, the State DOTs should perform a risk
analysis.
The Internal Control
Questionnaire provided in Appendix B of this Guide provides a framework for
assessing engineering consultants’ internal control structures. Additional
steps also may be required, including a site visit; further desk review,
including correlation analysis using data from prior years; or making
additional inquiries of management and/or the provider of the overhead
computation (e.g., a CPA or in-house accountant).
Risk factors to be considered
should include, if applicable:
·
The dollar volume of contracts with the State DOT.
·
The engineering consultant’s overall experience in working with State
DOT contracts.
·
The history and professional reputation of the engineering consultant.
·
The number of States in which the firm operates.
·
The date of the last audit.
·
The type and complexity of the accounting system used by engineering
consultant.
·
The size (number of employees and annual revenues) of the engineering
consultant.
·
The relevant professional experience of the CPA who audited the
overhead rate.
·
The engineering consultant’s responses to the Internal Control
Questionnaire.
·
Changes in the engineering consultant’s organizational structure.
Note:
Each State DOT may develop its own risk analysis, but documentation should be
maintained to support any decision involving the acceptance of an overhead
computation.
The following Q&A section
provides additional clarification of the cognizant audit requirements. Answers
are shown in italic text, below.
1.
May State DOTs employ a risk management framework in ensuring
compliance with Federal requirements for consulting firm indirect cost rates?
Yes. The primary objective
in providing oversight related to design and engineering firm indirect costs is
to ensure such rates are developed in compliance with the FAR cost principles.
In providing that assurance, a risk management framework in conjunction with an
appropriate internal control structure may be employed that includes the
following mix of tools and risk criteria:
·
FAR compliant audits (which may result in cognizant approved indirect
cost rates), desk reviews, other alternate procedures that provide effective
assurance of compliance with the FAR cost principles for the firms doing
business within their States
·
Dollar thresholds
·
History/reputation of the firm
·
The number of states in which the firm does business
·
Audit frequency (date of the firm’s last FAR compliant audit)
·
Experience of the CPA firm performing audits on the firm’s indirect
cost rate
·
Responses to the firm’s internal control questionnaire
·
Other risk criteria, as deemed appropriate
1.
Can a local government or an agency or some other sub-recipient of
Federal-aid funds be a cognizant agency?
No. The law requires the
cognizant agency to be either a Federal or State government agency.
2.
For an indirect cost rate audited by a CPA firm to be accepted as a
cognizant approved rate, is it necessary for the audit to be performed using
Generally Accepted Government Auditing Standards (GAGAS or “Yellow Book”)?
Yes. In defining minimum
standards for cognizant audits, AASHTO and ACEC agree that to be cognizant, an
audit must be performed to test compliance with the FAR cost principles, in
accordance with the Yellow Book.
3.
For an audit performed by a State DOT to be cognizant, must the same
Yellow Book standards be followed?
Yes, the same standards should
be applied if the audit is performed by a State, rather than by a CPA firm.
4.
What work must be performed by a State DOT to accept an audit performed
by a CPA firm and issue a cognizant letter of concurrence making the indirect
cost rate “cognizant approved”? Do the requirements change depending on whether
the CPA firm was hired by the consulting firm or was working under the State’s
direction?
In either case, the State
DOT must perform a review of the CPA’s workpapers,
using the CPA QCR Work Program, in order to issue a cognizant letter of
concurrence and make the rate “cognizant approved.” Inquiries, discussions or
other information provided by the CPA firm may be useful, but is not an
acceptable substitute to a review of the CPA’s workpapers.
5.
What may potentially trigger a request for a cognizant rate approval?
A consulting engineering
firm that has had an indirect cost rate audit performed by a CPA firm requests
one.
6.
Are States required to perform cognizant approvals of indirect cost
rates?
No. In addressing cognizant
audits, 23 U.S.C. 112(b)(2) states that recipients of Federal-aid Highway funds
must accept the indirect cost rates established by a cognizant Federal or State
agency, if such rates are not in dispute. There is no legislative direction in
23 U.S.C. 112 or 23 CFR 172 stating that the issuance of a cognizant approved
rate is required of any State. The interpretation of existing regulations
accepted by both AASHTO and ACEC is that, while beneficial, the issuance of a
cognizant approved rate is not required of any State or Federal agency.
7.
May a State DOT accept and use an indirect cost rate submitted by an
engineering consultant if such rate has not received cognizant approval?
Yes. Contracts funded in
whole or in part with Federal-aid highway funds are required to be performed
and audited in compliance with FAR cost principles. States may accept [adopt]
an audit performed by a CPA firm or another State, if a cognizant approved rate
does not exist. The contracting State DOT should take appropriate steps to
ensure the indirect cost rate was calculated in compliance with FAR cost
principles; Government Audit Standards (the Yellow Book), as applicable; and
the AASHTO Audit Guide. Each reviewing State DOT will perform a risk assessment
to determine the appropriate required level of review.
8.
When a cognizant approved rate exists, may a contracting agency use an
indirect cost rate other than the one established by the cognizant agency?
Not unless the rate is under
dispute. The regulations clearly provide that if an indirect cost rate has been
established by a cognizant Federal or State agency, the contracting agency must
accept that rate. Such cognizant rate must be applied for the purposes of
contract estimation, negotiation, administration, reporting, and contract
payment and shall not be limited by administrative or de facto ceilings of any
kind.
9.
May a contracting agency request a lower indirect cost rate than what
has been established by a cognizant audit?
No. The contracting agency may not request or start negotiations for a
lower rate. However, as either part of the original cost proposal or as part of
a negotiation point, the consultant may offer a rate lower than their FAR
audited rate, and the contracting State DOT may accept that rate. The
consultant’s offer of a lower indirect cost rate may not be a condition of
contract award. It should be noted that
in accordance with the Brooks Act declaration of policy, a contracting agency
may select the next qualified candidate if the contracting agency determines
that the total contract would not be awarded at a fair and reasonable price.
10.
What if no cognizant approved indirect cost rate has been established?
A State may conduct its own indirect
cost audit or negotiate a provisional indirect cost rate until an audit is
performed. (See also question No. 1, regarding the use of a risk management
framework.)
11.
What parties may dispute a cognizant approved indirect cost rate, and
under what conditions may a rate be disputed?
Except in the case of error
or the failure to follow Government Audit Standards, in which case the
contracting agency may raise concerns (see #13 below), only the consultant may
dispute an established indirect cost rate. If either an error is discovered in
the established indirect cost rate, or if Government Audit Standards were not
followed in the establishment of the rate, any contracting agency may dispute
the rate. The term “error” does not refer to differing and legitimate
interpretations of the FAR cost principles. Errors may consist of complete
misinterpretation or misapplication of the FAR cost principles or simple
mathematical errors of calculation.
12.
What steps may be included in a dispute resolution process?
In general, States should
work to develop a level of trust in the audit work performed by other States.
In the case where a contracting agency believes that there are obvious errors
in the indirect cost rate, or that Government Audit Standards may not have been
followed, that contracting agency should contact the cognizant agency to
discuss its concerns. The contracting agency’s objection to the cognizant
approved rate must be based upon objective criteria and must not be speculative
or without a reasonable factual basis. The cognizant agency, consulting firm
and its FAR auditor/CPA, as applicable, should work together to resolve any
issues. Involvement of the FHWA Division Office in discussions with the parties
to a dispute may be a final step in dispute resolution, if necessary. In
resolving such disputes, the FHWA Division Office may, at times, consult with
FHWA Headquarters, as deemed necessary. States may choose to employ either
formal or informal dispute resolution policies and procedures to establish the
dispute resolution processes within their respective jurisdictions. Such
processes likely will include provisions for appeal within the State DOT audit
organization, within the State DOT chain of command, and, as stated, to the
local FHWA Division Administrator. Those policies and procedures may either be
referenced or specifically cited within the provisions of a State’s procurement
processes, and/or they may be referenced specifically within the contract
document itself.
13.
How may an indirect cost rate be obtained if the cognizant approved
rate is under dispute?
If a cognizant approved
indirect cost rate is under dispute, for the reasons stated in Question 10, the
contracting agency does not have to accept the rate. The contracting State DOT
can conduct its own indirect cost rate audit or negotiate a provisional
indirect cost rate.
14.
May a firm elect to develop a national (corporate-wide) rate, a State
DOT rate, or business segment indirect cost rate?
Yes. The firm is responsible
for proposing an indirect cost rate, and the firm may choose the portion of its
business it wants the rate to cover. There may be multiple rates for a single
firm. Once the firm develops this rate (or rates), it should be consistently
and fairly applied.
15.
How long is an audited indirect cost rate valid?
One year. The one-year
applicable accounting period is defined in 23 CFR 172 to mean the annual
accounting period for which financial statements are regularly prepared for the
consultant.
16.
What happens if a cognizant approved cost rate expires during the
contract period?
In general and in accordance
with the FAR cost principles (48 CFR 31.203(e)), a new indirect cost rate
should be established by a cognizant agency. However, 23 CFR 172.7(b) allows an
indirect cost rate established for a contract to be extended beyond the one
year applicable accounting period provided all concerned parties agree. This
extension is only on a contract-by-contract basis where all concerned parties
agree and such an agreement shall not be a requirement of the contract.
17.
May a cognizant approved indirect cost rate be modified by subsequent
contracting agencies?
Generally no. The
regulations are clear that a cognizant approved indirect cost rate must be
accepted and applied for purposes of contract estimation, negotiation,
administration, reporting, and contract payment. Applying additional
limitations or reducing the indirect cost rate established in a cognizant audit
would constitute a violation of 23 U.S.C. 112(b)(2). However, States with
unique laws may request supplemental information from the consulting firm, in
order to make adjustments to fit its specific statutory requirements, as long
as they are in accordance with the FAR cost principles. Other Federal agencies
can and do perform cognizant agency audits for indirect cost rates and may not
share their audit background information. In these cases they normally give
several rates depending on the type of use. This still results in a cognizant
approved indirect cost rate and must be used, as long as the audit was
performed in accordance with the Yellow Book to test compliance with the FAR
cost principles.
18.
Do the cognizant audit requirements apply to sub-consultant indirect
cost rates?
No. Sub-consultants hired by
the prime contractor do not fall under the requirements of Section 23 U.S.C.
112(b)(2)(C-D) and as such, their rates would not be subject to establishment
via cognizant agency audit. However, as
stated in 23 U.S.C.(b)(2)(B), subcontracts must comply with the FAR Cost
Principles contained in 48 CFR 31.
19.
In what situations is it appropriate to cap or negotiate overhead?
Section 174 of the 2006
Transportation Appropriations Act removed the ability to cap or negotiate
indirect cost rates on Federal-aid funded A&E activities carried out under 23
U.S.C. 112(b)(2). Two states received an exemption from this legislation:
Minnesota and West Virginia. If a contract involves any Federal-Aid Highway
funds, it is not appropriate to cap or negotiate indirect cost rates.
Contracting agencies are
free to cap indirect cost rates on contracts for Preliminary Engineering
project activities/phases not funded with Federal-aid funds Since such a cap does not comply with Federal
law, however, the project costs borne by the grantee or subgrantee
cannot be applied toward the non Federal share
(in-kind match) on Federally funded projects or phases of work.
Note:
The following letter is an example only, actual wording may differ.
EXAMPLE OF COGNIZANT LETTER FOR CPA
WORKPAPER REVIEW
[Use State Letterhead]
Date
(Firm name)
(Firm Address)
Dear:
We have performed a cognizant review of the
examination, and supporting workpapers, of the
Indirect Cost Rate(s) of (_ENGINEERING CONSULTANT NAME_) for the year ended
[Month dd, 20XX] in accordance with our role as Cognizant
Agency as defined in 23 U.S.C. 112(b)(2)(c) and 23 CFR 172.3 and 172.7. The
examination was performed by the independent CPA firm of [Name of CPA firm].
The CPA represented that the examination was conducted in accordance with
Government Auditing Standards as promulgated by the Comptroller General of the
United States of America, and the examination was designed to determine that
the indirect cost rate(s) was(were) established in accordance with Cost
Principles contained in the Federal Acquisition Regulation, 48 CFR Part 31. Our
cognizant review was performed in accordance with the AASHTO Review Program for
CPA Audits of Consulting Engineers’ Indirect Cost Rates.
[Option 1:
unqualified language]
In connection with our cognizant review, nothing
came to our attention that caused us to believe that the examination, and
supporting workpapers for the Indirect Cost Rate(s),
and the related Accountant’s Report(s), we reviewed did not conform in all
material respects to the aforementioned regulations and auditing standards.
[Option 2:
qualified language]
In connection with our cognizant review, except for
the effect of the deficiency(ies) described below,
nothing came to our attention that caused us to believe that the examination
and supporting workpapers for the Indirect Cost
Rate(s), and the related Accountant’s Report(s), we reviewed did not conform in
all material respects to the aforementioned regulations and auditing standards.
Our cognizant review revealed that the CPA failed
to…
We recommend acceptance of the following rate(s):
Combined/Corporate:
Home Office:
Field/Project Office:
Facilities Capital Cost of Money (FCCM):
[STATE DOT AUDIT OFFICIAL]
[TITLE]
c: [As
identified]
.
[1] Government Auditing Standards, GAO-07-731G (Washington, D.C.: July 2007 Revision).
[2] See sample opinion letter in Section 11.2.
[3] See sample internal control report in Section 11.3.
[4] $72,800 divided by 2,080 standard hours.
[5] 2,600 actual hours minus 2,080 standard hours.
[6] $35 per hour standard wage rate multiplied by 520 uncompensated overtime hours.
[7] Dated January 2005. The DCAAP is available via the Internet at http://www.dcaa.mil.
[8] Techplan Corporation, ASBCA Nos. 41470, 45387, and 45388, 1996 ASBCA LEXIS 141. Techplan is the seminal case that established a methodology for applying the reasonableness provisions of FAR 31.205-6 to compensation issues.
[9] Information Systems and Networks Corporation, ASBCA No. 47849, 1997 WL 381263 (A.S.B.C.A.), 97-2 BCA P 29132.
[10] See prior discussion in Section 7.4.
[11] The position descriptions were taken from the PSMJ and ERI surveys; however, this Guide does not endorse the use of any particular survey.
[12] As discussed in the AICPA Publication, Accounting and Auditing for Related Parties and Related Party Transactions, A Toolkit for Accountants and Auditors. December 2001.
[13] See FAR 31.201-3, FAR 31.201-4 and FAR 31.205-6(a)(6)(ii)(B), respectively.
[14] This Guide uses the word “marketing” to identify unallowable types of selling, advertising, corporate image enhancement, and market planning costs.
[15] The same applies for any other tax status in which taxes on the pass-through income of the corporation must be paid by the individual shareholders (e.g., limited liability companies).
[16] FASB Statement 142 changed the accounting for goodwill from an amortization approach to an impairment-only approach. Thus, the amortization of goodwill, including goodwill recorded in past business combinations, ceased upon adoption of FASB 142 on January 1, 2002. FAR 31.205-49 has not been updated to recognize this distinction and therefore continues to make reference to “amortization.”
[17] Available on the Internet at http://www.coso.org/IC-IntegratedFramework-summary.htm.
[18] See Chapter 10 for additional details regarding minimum recommended audit procedures.
[19] Appendix B contains the standard internal control questionnaire used by State departments of transportation.
[20] These contracts are generally structured as cost plus fixed fee contracts. Such agreements provide that all the cost factors, except the fixed fee, are based on the engineering consultant’s actual allowable costs. The fixed fee is a specific, predetermined amount, as identified in the agreement.
[21] Note: As further discussed in this chapter, deviations from the recommended minimum audit procedures may be allowable, provided that these deviations are documented and adequately justified in the CPA’s audit workpapers.
[22] For the sake of brevity, in this chapter the term “audit” is used to encompass both audits and examination-level attestation engagements.
[23] See Sections 2.5.B and 2.5.C for further discussion regarding auditors’ responsibilities and factors that should be considered when selecting a CPA to perform an overhead audit.
[24] See the following sections for recommended testing procedures to be applied to large-dollar or sensitive (LDS) items.
[25] See Section 8.30 for additional cost items that are ineligible for reimbursement.
[26] DCAA CAM Appendix B-504 discusses precision and confidence level, two interrelated parameters used to develop reliability parameters for variable sampling.
[27] Per DCAA CAM Appendix B-503.1.b: “Stratification of the universe into several dollar ranges or strata can be used to improve audit reliability and reduce the overall number of items evaluated. Normally, the universe is stratified into a high-dollar stratum (for 100 percent evaluation) and several other strata from which samples are selected for evaluation. Audit effort is concentrated on the high-dollar items where the risk is greater. Samples are statistically selected from each of the other strata, which are used as the basis for projecting individual stratum sample results to the corresponding universe.”
[28] See https://www.cpa2biz.com/AST/Main/CPA2BIZ_Primary/AuditAttest/TopicSpecificGuidance/PRDOVR~PC-012530/PC-012530.jsp.
[29] If auditors have any questions or concerns regarding the adequacy of a sampling plan, they are encouraged to discuss the sampling plan with the cognizant State DOT.
[30] Precision level, also known as “sampling error,” is the range in which the true value of the population is estimated to be found. When using variable sampling, precision often is expressed as a dollar amount (materiality threshold); accordingly, when establishing a precision amount for a given account or line item of cost, the auditor should apply judgment based on the results of the risk assessment and internal control testing procedures described in Chapter 9 and in other sections of this chapter.
[31] In this context, “direct-charge employees” means any employees, supervisors, and/or principals who spend a portion of their time working on A/E projects.
[32] Large-dollar items should be selected based on a planning materiality level (PML) determined by the auditor. The PML will vary based on the facts and circumstances of each unique engagement, and auditors are advised to fully document their PML computations in the audit workpapers.
[33] A 95-percent confidence level with a precision level (materiality threshold) in the range of 2 to 5 percent.
[34] For example, the consultant might use single Travel account for both direct and indirect costs.