Indirect Cost Rate Audits: The Basics
As a contractor or engineer you may have considered bidding on projects at some point in time that required an indirect cost (or overhead) rate audit. The information below will provide you with a basic understanding of what to expect during an indirect cost rate audit. Often times if you are working with a federal, state, or local government agency that allows recovery of indirect costs, you will be required to have an indirect cost rate audit.
The American Association of State Highway and Transportation (AASHTO), defines an audit as a formal examination, in accordance with professional standards, of accounting systems, incurred cost records and other cost presentations to verify their reasonableness, allow-ability, and allocate-ability for negotiating agreement fees, and for determining allowable costs to be charged to government contracts. As the independent CPA, we are responsible for performing the audit in accordance with Government Auditing Standards (GAGAS), to obtain reasonable assurance that the company has complied with Federal Acquisition Regulation (FAR), Part 31 and applicable Cost Accounting Standards.
Similar to a financial statement audit, the audit process will begin with gaining an understanding of the systems and processes in place at your organization. It especially includes the systems and processes that support the generation of your indirect cost rate schedule and related disclosures. As a contractor, you will have direct costs and indirect costs. We will want to understand how the various costs are identified, and what controls you have in place to make sure costs are properly recorded as direct or indirect. In addition to direct or indirect costs, we will understand the systems, processes, and controls in place to identify unallowable costs. A best practice is to identify costs as unallowable as they are processed and accounted for in separate general ledger accounts.
Our understanding of systems, processes, and controls will dictate the extent of our remaining audit procedures. Our remaining audit procedures will primarily focus on costs included in your indirect rate calculation and the disclosures to your rate schedule. Substantial time will be spent sampling and testing the allow-ability of indirect costs included in your rate. Examples of unallowable costs include alcohol, certain related party transactions, and personal use of company vehicles. Supporting documentation should be maintained to support any and all costs included in your rate schedule as well as evidence of internal controls (i.e. approval of each disbursement).
To discuss indirect cost rate audits in further detail please contact McKonly & Asbury. You may also reference the AASHTO Audit & Accounting Guide. The AASHTO Audit & Accounting Guide is an industry wide resource that helps bring consistency to these audits and provides very useful information and tools to both auditors and organizations that calculate indirect cost rates.
If you have any questions about this article or would like to talk to one of our experts, please contact us.