Monday, March 15, 2010

Capital Construction (Cost Type) Projects Contract Administration

A. Office Review Preliminary
1. Review and brief the contract. Take note of special contract provisions, rates, clauses, etc.
2. Review system surveys, prior audit reports, prior audit working papers and permanent files. Note areas of weakness.
3. Evaluate adequacy of the contractor's accounting practices, costing procedures and internal controls.
4. Review progress and/or final cost estimates.
*           Check cost statements for mathematical accuracy, as appropriate.
*           Verify final cost to job cost ledger.
*           Compare contract costs with proposal, contract estimate, bid documents and/or other related data.
5. If necessary, explain billing procedures, record keeping requirements, Government regulations and directives to contractor.
6. Indicate items requiring Contracting Officer's (Grantee) approval and unallowable costs that the contractor should omit from its billing.
7. Consider use of random sampling techniques for representative audit conclusions to the extent that cost element transaction universes are conducive thereto.

B. Audit Of Direct Elements Of Cost
1. Wages and Salaries
*           Determine if the responsibility for payroll activities such as time keeping, payroll computation, payroll preparation and payroll distribution is divided among several organizational units.
*           Determine that time tickets, distribution records, payroll, checks, personnel action, etc., are signed and/or approved by duly authorized Contractor personnel.
*           Examine personnel records to determine authority for employment and rates used.
*            Ascertain that overtime, wage and salary rates and classifications are approved by the Contracting Officer (Grantee) or, are in accordance with terms provided in the contract.
*           Check hours and rates billed to basic time records, distribution records and payroll. Check labor distribution summary for total hours worked during payroll period for each employee selected.
*           Determine that labor costs claimed are properly classified as direct labor and allocable to the contract.
*           Verify computations, extensions and footings.
*           Compare total dollar amount of payroll with total dollar amount of labor distribution summary and trace posting of direct labor (both contract and other work) to general ledger and/or subsidiary ledger accounts.
*           Selectively examine cancelled checks to determine that payments have been made by the Contractor.
*           Prepare a listing of unclaimed wage and salary checks and follow through for proper disposition.
*           Fringe benefits can be treated as part of the direct labor costs if the accounting system so provides. The auditor should assure himself or herself that such treatment is equitable to the contract since some charges, such as social security taxes, apply to only a portion of annual salaries of wages.
*           When practical, observations should also be made to determine whether employees are performing in assigned job classifications and whether they are being correctly charged to the benefiting contract project or activity.

2. Purchased Material and Services
*            Ascertain approval of procurement procedures. Check contract terms for specific Contracting Officer's approval requirements.
*           Selectively review purchases to determine:

(1) Mathematical accuracy and propriety of price, quantity, and description of items procured.
(2) Propriety and existence of source procurement documentation (from purchase requisition to receipt and   payment of purchase).
(3) That codings are correct and posting are being made to cost distribution records, properly controlled by general accounts in Contractor's ledgers.
(4) That an internal system has been set up to control credits to contract costs.

Note: When the total costs of material or service is significant, the auditor should include large and sensitive items of cost in his or her test selection.)

*           Review description of materials to screen overhead type materials from direct charges.
*           Determine that Contractor has appropriate property control records.

3. Materials Withdrawn From Contractor's Stores

*           Compare a representative portion of invoices covering items charged to stores to the stores' records to determine accuracy of the posting of quantities and prices.
*           Examine a representative number of material requisitions to determine:

(1) That pricing is consistently applied on the basis of an acceptable method, such as first-in-first out, etc.
(2) That the requisitions have been posted to the stores' records.
(3) That the using department is indicated by receipt or other designation.
(4) That computations are accurate.
(5) That requisitions are au- thorized and receipt of materials is acknowledged by responsible personnel.
(6) That the accounting distribution is proper.
(7) That quantities are not excess to requirements and have been approved by a County Inspector.

*           Review summaries of requisitions to determine:

(1) That requisitions are correctly listed and that summary totals are correct.
(2) That the total distribution is approved by a responsible executive.

*           Review the requisitions to disclose the inclusion of items similar to those charged directly from purchase invoices. Investigate all such items to disclose possible duplication. Materials charged from stores directly to a contract should be screened to eliminate overhead type materials.

4. Travel Expenses

*           Review and evaluate the Con- tractor's travel policies for reasonableness and consistency. In the absence of Contractor policies or specific contract terms, County travel regulations should apply.
*           The auditor shall determine whether:

(1) Required original travel reports include employee's name, purpose of trip, points of travel, dates of departure and arrival, mode of transportation, details of expenses or per diem rates in accordance with the terms of the contract and related directives, executive approval of the travel, employee's receipt if paid in cash, or check number if paid by check.
(2) The reports are accurate as to computations.
(3) By selective examination of cancelled checks and/or receipts, payments have been made by the Contractor.
(4) Charges are verified to general ledger and/or job cost ledgers.
(5) The expenses claimed are allowable in accordance with generally accepted accounting principles (GAAP) or applicable federal regulations.

5. Other Direct Costs

In addition to direct labor, material, and travel, there are other types of expenses which may be directly costed. These expenses are generally referred to as "other direct costs", and include such items as subcontractor charges, consultant fees, equipment, reproduction printing, etc.
*            In reviewing other direct costs, the auditor should:

(1) Determine that the contractor's cost representations are reliable and adequately supported.
(2) Determine that the amounts charged to the contract are reasonable and allowable.
(3) Determine whether the Contractor has been consistent in allocating such costs between the subject contract and other work.
(4) Verify costs to the general and/or job cost ledger.
(5) Selectively examine can- celled checks to determine that payment has been made.
(6) Ascertain if the Subcontract costs are subject to audit by reason of dollar threshold or contract terms.

*           If equipment costs are claimed, determine if there is government or County control over use and location of equipment. If government furnished equipment is involved, ascertain that items are controlled and identified.

C. Indirect Charges

1. Background

Overhead, Fringe Benefits, and General and Administrative (G&A) rates are methods of distributing indirect costs. An indirect cost is one which, because of its incurrence for common or joint objectives, is not readily subject to treatment as a direct cost. The direct costs are accumulated into logical cost groupings (1) common to all the costs and (2) reasonably indicative of the benefits provide by the indirect costs. Burden rates should not be based on cost factors that do not, per se, generate overhead. Thus, direct materials generally should not be included in the base for distributing a single overhead pool. However, direct materials may be used as a base for distributing a limited cost center, such as a Contractor's procurement department. The same type of expense may be charged as direct or indirect. However, the auditor should ensure that a cost item is not charged as a direct expense and also built into the overhead rate.

The major differences among Overhead, Fringe Benefit and G&A rates is the base upon which each is distributed. Fringe benefit rates are generally based upon direct and indirect labor. Overhead rates (including G&A overhead) are usually based on direct labor; however, overhead rates can also be based on direct labor including fringe benefits. G&A rates generally are based on total direct and indirect field expenses including direct and indirect labor, fringe benefits, overhead and material. The principles for evaluating all of the aforementioned rates are substantially the same.

Note: The extent of audit effort required in this area will normally depend on the significance of the overhead factor in relationship to total contract costs. DPW as well as selective Housing and Community Developments (HCD) contract General Conditions provide for a maximum 15 percent markup on all change orders. The 15 percent markup Compensates for all types of overhead, including job-site, G&A, supervision, bonds and insurance. Change orders on DPW contracts should not include a separate amount for overhead.

2. Preliminary Steps (For jobs where overhead is not fixed per contract)

*           Review contract or contracts involved for all provisions pertinent to audit. Note particular elements of cost to be reimbursed as direct charges but which are ordinarily treated as overhead. Also note types of overhead such as manufacturing, engineering, general and administrative, etc., and rates of overhead such as actual, fixed rate redeterminable, fixed rate for life of contract, etc.
*           Obtain the following from the Contractor:

(1) Chart of accounts with appropriate explanation of items to be charged to each account.
(2) Copies of leases and other pertinent documentation.
(3) Trial Balance and financial statements for period under review.
(4) Schedule indicating a breakdown of overhead proration bases by jobs or contracts.
(5) Accounting and corporate policies.

*           Review corporate minutes of meetings of directors and executive committee for any information that would affect accounts under audit.
*           Review internal audit reports and external audit reports, tax returns, etc.
*           Compute the amount by which overhead pools or the distribution base would have to be adjusted in order to change the rate by one percent. Use this data as a comparative device to determine the amount of time to spend on questionable items.
*           Where the contractor has followed a policy of charging items ordinarily treated as overhead directly to the contracts, the auditor should make sufficient tests to satisfy himself or herself that the contractor has not duplicated any direct or indirect charges.
*           Review scrap, purchase discounts, and all miscellaneous income accounts to determine that credits to contract costs are being properly applied, either directly or through overhead.
*           Review changes in surplus account to determine whether a credit should be applied to contract costs.
*           In determining allowability of costs, check for compliance with provisions of OMB Circular A-87 and the Federal Acquisition Regulations, Part 32, when applicable.
*           Ascertain that costs requiring approval have been approved by the Contracting Officer/Grantee.
*           Examine all significant year end or period end adjustments and all accrual accounts for propriety and effect on the overhead examination.
*           Notify Contracting Officer/ Grantee of all deviations from approved accounting policies.
*            Compare Federal Tax returns with the books to ascertain any major differences in accounting policies.

3. Overhead Expenses Review

*           Foot trial balances and verify account balances with general ledger and/or subsidiary ledgers.
*           Schedule overhead expenses by months so that unusual month to month fluctuations can be readily detected and analyzed, if practical.
*            Analyze accounts on a test check basis for unallowable or unallocable items.
*           Perform adequate test checks of indirect labor accounts to ascertain that direct type labor is not being charged to overhead accounts.
*           Perform analysis of all sensitive accounts such as travel, legal and accounting expenses, etc.

4. Basis of Proration

*           Direct Labor Dollar Base
(1) Reconcile that portion of the direct labor base, pertaining to the Grantee's contract or
(2) Determine that no inequities exist, as a result of using a direct labor dollar base.

*            Other Bases
(1) If a basis for prorating overhead expenses, other than direct labor dollars (as indicated above) is used, adequate tests should be made to determine the accuracy, equity and propriety for the use of such base.
(2) There are many other bases which can be used to distribute overhead pools, for example:

Direct Labor Hours
Costs of Goods Manufactured
Direct Prime Dollar Costs
Costs of Sales
Total Expenditures
Machine Hours Base
The base chosen should be the most equitable base for allocation of the particular expense pool or category.

(3) Determine that each allocation base used includes all applicable costs, hours, or other units since this factor has an important effect on the distribution ratio.

5. Final Steps

*           After the indirect expense pools have been verified and the bases for distribution have been accepted, determine the accuracy of the overhead rate calculations and the accuracy of the related distribution of indirect costs to County contracts.
*           Summarize results of audit.
*           Discuss findings with Contractor.
*           Prepare appropriate report.


The audit report is the end product of the audit effort, and quality is of utmost importance. The ultimate success of a proposal evaluation report is dependent on how well audit information is conveyed to contracting personnel. Therefore, the report should be clear, comprehensive, concise, and convincing. It must be written in generally understandable terms since it is unlikely that users will be professional accountants. Finally, the report should avoid arbitrary and unreasonable determinations since they can result in the disregard of sound audit exceptions.

Auditors are encouraged to discuss audit determinations with Contractor personnel during and upon the completion of audit assignments. Such discussions are useful to confirm factual data, confirm findings, and identify areas of controversy. However, specific amounts of audit findings need not be disclosed. Audit findings pertaining to forecasts should not be discussed since these are a matter of judgment, the disclosure of which could impair the County's negotiation position

Completion of Audit

*           After the auditor has completed the field audit work, he/she is to ensure that working paper files are prepared in accordance with the audit manual concerning audit working papers. This is to include the preparation of lead schedules, summary of results of audit, indexing the working papers, cross-referencing all working papers and making sure that all pertinent working papers are filed and in the proper sequence.
*            Discuss audit findings with the Audit Supervisor during the course of the audit and then again at the conclusion of the audit.
*           Prepare a draft audit report summarizing the audit findings.
*           The Audit Supervisor will review the draft audit report and the working paper files and make appropriate review notes and comments.
1. Discuss the Audit Supervisor's notes and comments.
2. Do additional work as requested by the Audit Supervisor

*           After the auditor has completed all necessary work requested by the Audit Supervisor and the draft report and the working paper files have been approved by the Audit Supervisor, the Audit Supervisor will schedule a closing conference with the Contractor to discuss the audit findings.
*           A summary of the closing conference with the Contractor will be included in the audit working paper files with all pertinent comments by the Contractor.
*           The Audit Supervisor will then schedule a meeting with the applicable County personnel to discuss the preliminary results of audit. Include any comments made at the meeting in the audit working paper files.

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