Screening Unallowable Costs - Areas scrutinized by government auditors
1) General policies and procedures. These should be in writing and should provide that direct and indirect costs are properly classified as allowable or unallowable (including associated costs). The policies and procedures should demonstrate that unallowable costs are identified and segregated from contract costing, billing and pricing when the contract amount is not completely based on commercial item pricing. These written procedures should address, at a minimum:
a. General ledger accounts for unallowable costs. One account is acceptable for a very small business but other separate accounts should be created where cost categories may contain significant unallowables (e.g. travel, legal, advertising etc.).
b. List of unallowable costs. All unallowable costs should be identified with relevant FAR references. A brief discussion of conditions that make an unallowable cost allowable (e.g. product or service advertising is unallowable while advertising for employees is allowable) should be included. (We intend to prepare an article for the GCA DIGEST that will summarize FAR 31.205 unallowable costs.)
c. Internal controls. Normal internal controls for financial accounting should be included in efforts to screen unallowable cost. A list of duties by position, management review evidenced by signature requirements, separation of duties to ensure unallowables “don’t slip through”, and flowchart or narrative of the screening process.
d. Communication and training. Describe how appropriate personnel are informed and what, if any, training is provided. For example, do traveling employees and their supervisors know about travel and entertainment rules and are key accounting and contracts personnel knowledgeable about all relevant cost principles?
e. Adequate documentation and record keeping. Do procedures exist on how to brief a contract, document reasons why a specific cost is allowable, and identify relevant forms (e.g. travel expenses with space for purpose of travel and excess travel costs)?
2) Attention to “Hot” Areas. Though they change depending on areas highlighted by GAO reports and media attention, we find auditors currently seem to be focusing on the following areas:
a. Entertainment (FAR 31.205-14). Distinctions contractors make between unallowable entertainment costs and allowable costs such as certain travel, public relations, employee morale and health, etc.
b. Independent Research and Development and Bid and Proposal (FAR 31.205-18 and CAS 420).
c. Legislative Lobbying (FAR 31.205-22).
d. Professional and Consultant Services (FAR 31.205-33).
e. Relocation Costs (FAR 31.205-35).
f. Selling Costs (FAR 31.205-38). Are selling costs distinguishable from bid and proposal costs and are they properly segregated by class of customer (e.g. government, foreign, commercial)?
g. Travel (FAR 31.205-46). Excess travel and associated costs of unallowable activity.
h. Trade, Business, Technical and Professional Activity. Procedures should be in place that adequately describe the business purpose of the meetings or conferences.
i. Excess Compensation (FAR 31.205-6).
Though government auditors can be expected to focus on the areas described above, contractors should be alert to other potential areas. These are most likely to include high cost categories as well as “favorite” areas each auditor tends to have.
3) Point of Entry Screening. The organization should screen for unallowable costs up front rather than after the fact when cumbersome and expensive screening is required for certification or incurred cost submittals. Individuals incurring the expense and reporting it on a document should identify the unallowable cost. Personnel reviewing expense reports and vendor invoices should clearly identify the unallowable cost on the document and enter the cost into the appropriate account in the general ledger. These point of entry practices not only save time and money but can reduce the perception of your organization being considered a high audit risk requiring extensive transaction testing.
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To discuss your needs, contact Bill Lennett, Principal, at 1-925-362-0712 or email him at
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