AASHTO Audits of A & E firms & the NCM (National Compensation Matrix)

What is the 2010 AASHTO Audit Guide An audit guide for State DOT auditors, A & E firms and CPA’s that perform audits of A & E firms Recently revised in 2010 and we are anticipating another revision this year The guide covers the A & E firms’ “Statement of Direct Labor, Fringe Benefits and General Overhead” Also covers the A & E firms’ accounting systems, job-cost systems and labor charging systems

What is AASHTO? AASHTO stands for the American Association of State Highway and Transportation Officials AASHTO advocates transportation-related policies and provides technical services to support states in their efforts to efficiently and safely move people and goods. The AASHTO audit subcommittee is comprised of senior audit representatives from each State’s DOT In 2001 original AASHTO audit guide was approved In 2010 the revised AASHTO audit guide was approved and updated to address issues uncovered during a 2009 OIG audit and DOT Concerns

2009 OIG Audit What did they find? The Indirect Cost Rates of 21 of 41 firms selected for audit contained unallowable costs. Some of the areas found to include unallowable costs were: Automobile costs – Unallowable luxury leases Executive Compensation – Unreasonable or Excess compensation Social & Entertainment costs – Expressly Unallowable CPA’s were not performing adequate audits

What is the “Statement of Direct Labor, Fringe Benefits and General Overhead” Also referred to as the Overhead Rate or Indirect Cost Rate (ICR) Used as the basis for determining a firms overhead rate The overhead rate is generally computed as the ratio of allowable indirect costs to total allocable direct labor costs. Why is this so important… A & E firms are awarded contracts based on qualifications and not based on lowest price bid. The prices/fees they charge are not constrained by market forces Their billing rates are calculated using the overhead rate The overhead rate must comply with FAR cost principles and not included unallowable items.

Key Areas Covered in an AASHTO Audit Accounting system & Accounting records Job-cost system Labor charging system Allowable, Allocable & Reasonable Direct and indirect costs Allowable and unallowable costs Compliance with FAR Cost Principles

Accounting System & Accounting Records Management is responsible for maintaining an adequate accounting system Track Direct and Indirect Costs Track Allowable and Unallowable costs Track all labor as direct, indirect, allowable or unallowable Prepare an overhead schedule that reconciles to the general ledger Prepare job-cost reports and labor reports that reconcile to the general leger

Job-Cost System Must charge all job related costs to a job if allocable to the job Include all allowable and unallowable costs Include all costs whether billable or not Must reconcile to the general ledger

Labor Charging System Labor Charging System should: Reconcile GL to job cost system and IRS payroll reports If using Direct Labor (most common) as the base for the indirect cost rate then reconcile Direct Labor to job-cost system – this ensures that the base is correct The auditor must trace at least 26 direct-charge employees timecards through the system Payroll records Cost system General ledger

Is it Allocable…Allowable…& Reasonable? Allocable ~ Is it allocable to a job? Incurred specifically for the contract Benefits both the contract and other work Is necessary to the overall operation of the business Allowable ~ Is it in accordance with FAR Cost principles? First remove anything that has to do with FUN! Then determine if is it reasonable, allocable to a government contract, in compliance with GAAP, in compliance with the contract and NOT prohibited by the FAR Reasonable ~ Is it reasonable in its nature and amount? The nature and amount cannot exceed that which would be incurred by a prudent person in the conduct of competitive business Burden of proof is on the contractor

Reconcile… Reconcile the Overhead Statement to the general ledger Make sure all costs are accounted for, whether they are allowable or unallowable (show all and remove unallowable) Reconcile the Job-cost system to the general ledger Reconcile the Direct Labor to the Job-cost reports Reconcile all other direct costs to the Job-cost reports These reconciliations seem simple, but prove to be harder than you might think

Main areas of concern to state DOTs Executive Compensation Bid & Proposal Costs Selling & Marketing Costs Fringe Benefits Bonus & Incentive Pay Plans Related Party Transactions Automobiles – Luxury leases and personal use of vehicles Consulting Agreements Taxes For all audits I have been involved with, the government agency has asked for supporting documentation with at least ½ of the above accounts

Compensation Total compensation includes wages, salaries, bonuses, deferred compensation, and employer contributions to defined contribution plans. For an element of compensation to be allowable it must meet the FAR requirements specific to that element. It also must be reasonable in nature~ Similar to other firms of the same size, in the same industry, in the same geographical area and engaged in similar non- government work.

Executive Compensation The current procedure to determine reasonable Executive Compensation is based on two Armed Services Board of Contract Appeals decisions Techplan Corporation Information Systems Network Corporation Engineering firms need to evaluate the reasonableness of executive compensation based on the above rulings and prepare documentation to support the evaluation. If no analysis is prepared then the state DOTs have been instructed to use the NCM (National Compensation Matrix) to determine reasonableness. Oh Wait – There is NO NCM, at least not yet!

Procedure to perform a compensation analysis Examine compensation and remove FAR unallowable elements. Prepare a schedule for each executive listing the amount received for compensation including Wages, salary, bonuses, incentive compensation, deferred compensation, and employer contributions to a defined contribution plan. Obtain 3 nationally published compensation surveys These must represent similar firms in terms of revenue, industry, geographic location, and other relevant factors.

Procedure to perform a compensation analysis From these surveys develop a reasonable compensation range for each executive. Determine the survey median compensation amounts for each comparable position. Apply appropriate escalation factors to adjust survey data to a common date of July 1 of the same year. Develop a composite median amount by averaging the 3 survey’s median compensation amounts. Increase this composite median by 10% based on DCAA guidance to allow for a 10% ROR (range of reasonableness) Compare the results to actual to determine if an adjustment is necessary.

Flaws related to current method The procedures previously outlined follow existing DCAA methodologies, which have been recently challenged by the findings of the Taylor case. Taylor’s expert witness, a statistician, challenged the validity of the DCAA approach and successfully argued for the substitution of alternate statistical methodologies for determining reasonable compensation for his client. The results of this case continue to cast uncertainty upon the appropriate method for computing defensible overhead rates.

NCM Concurrently, FHWA, State DOTs and representatives from ACEC had been addressing the composition of a National Compensation Matrix, as prescribed in Chapter 7 of the guide. The resulting matrix diverges substantially from the previous DCAA methodology and utilizes extensive statistical tests and procedures to produce a more accurate and defensible result.   The NCM draft is available for review on the AASHTO website. http://audit.transportation.org/Pages/default.aspx?siteid=43

Bid & Proposal Costs B & P costs are expenses incurred in preparing, submitting, and supporting bids and proposals on potential Government or non-government contracts Generally allowable Firms are required to identify and accumulate B&P costs by individual contract and treat costs the same as other jobs Treat directly associated costs the same Allocate indirect costs the same

Selling & Marketing Generally allowable selling efforts Direct Selling – Person to person contact such as familiarizing a potential customer with your products and services Brokerage fees, commissions and similar costs – allowable when paid to bona fide employees or agencies for the purpose of securing business Generally unallowable selling efforts Open ended advertising Corporate Image enhancement & Public Relations related to the dissemination of information calling favorable attention to the firm’s products or services Trade shows/sponsorship of meetings

Fringe Benfits Fringe Benefits include costs for employees perquisites, payroll taxes & employee benefits ~ generally these are allowable Payroll taxes Pension plan contributions Paid time off Medical insurance Life Insurance

Bonus and Incentive Pay Plans Bonus Plans (Allowable if properly documented) Typically applicable to a broad class of employees Meets basic eligibility requirements Based on productivity, team or overall company performance Distributed based on a percent of compensation or available pool of money Profit-Distribution Plans (Unallowable) Distributions of net earnings to owners Based on some factor linked to ownership

Related Party Transactions Must identify and disclose related parties and transactions per GAAP Also review agreements and transactions for Where one party pays expenses of the other Transactions of products and/or services at greater than or less than current market rates Revenue transactions that lack economic substance Services or goods purchased at nominal costs Unusual or high value transactions particularly close to the end of the financial period.

Automobiles The cost of personal use of company vehicles is strictly unallowable Mileage logs should be maintained An adjustment to credit overhead for the portion of this cost is necessary Costs associated with luxury vehicles warrant additional attention to ensure costs are reasonable, allowable, and allocable.

Consulting Agreements Outside Engineering & Technical Consultants generally allowable Specific Documentation Required Details of all agreements Details of time expended and nature of the actual services provided. Consultant work products and related documents

Taxes Taxes Federal income taxes are unallowable Taxes on income passed thru to shareholders are unallowable Penalties and interest assessed on late payments are unallowable State and local income taxes are allowable

Other Labor Related Concerns Uncompensated Overtime for Salaries direct charge employees Incorrect recording of direct labor to the wrong project or to indirect labor Moving direct labor charges from one project to another –Audit Flag! Incorrectly recording B & P labor hours and/or selling effort hours

Expressly Unallowable Costs Interest Expense Bad Debt Expense Entertainment Alcohol Gifts Fines & Penalties Lobbying and Political Activity Costs Donations and Contributions Directly Associated Costs (must be allocated to job and not included in overhead) For all audits I have been involved with, the government agency has asked for supporting documentation with at least ½ of the above accounts

Selected Areas of Cost Determine high risk accounts Printing/ Reproduction Dues and Subscriptions Travel Seminars and Conventions Insurance Professional and Consultant Services Rent Depreciation Employee Morale “Miscellaneous” and “Other” Type Accounts Subconsultants / outside consultants Gain/Loss on Sale of Assets For all audits I have been involved with, the government agency has asked for supporting documentation with at least ½ of the above accounts

Facilities Capital Cost of Money (FCCM) Facilities Capital Cost of Money (FCCM) is an imputed cost related to the firm’s investment in fixed assets/facilities It is charged as a rate in a manner similar to overhead Must be shown as a separate line item or disclosed in the footnotes If the firm wants to claim FCCM it must be specifically identified in the cost proposal on a per contract basis No fee or profit on FCCM

Cognizant Agency What is a cognizant agency? A federal agency, The Home State DOT, or a Non-Home State DOT granted cognizance in writing from the Home State Cognizant approved rates may be established by Cognizant Agency performs, or directs the work of a CPA, who performs audit Indirect Cost audit performed by an independent CPA and home state reviews the CPA report and workpapers and issues a letter of concurrence Non-Home State reviews the CPA report and workpapers and issues a letter of concurrence with the CPA report (Home state has 180 days to concur, modify or reject)

Auditor Selection The CPA selected to perform the audit should: Meet GAGAS Requirements & have adequate GAGAS experience Have Favorable Peer Reviews Have Experience and knowledge of A & E industry Knowledge of accounting practices and systems used by A/E firms Have experience performing FAR audits and understand Government procurement contracts Design and execute an audit program that meets professional standards and the requirements of the AASHTO Audit guide

Informational Links 2010 AASHTO Audit Guide 2009 OIG Audit http://audit.transportation.org/Documents/UNIFORM%20AUDIT%20AND%20ACCOUNTING%20GUIDE%202010.pdf 2009 OIG Audit www.oig.dot.gov/sites/dot/files/pdfdocs/Overhead_FINAL_2-5-09_508.pdf2009 OIG Audit 2012 National Compensation Matrix Draft http://audit.transportation.org/Pages/default.aspx?siteid=43 2012 ASBCA Taylor Case Decision http://image.exct.net/lib/fefd167774640c/d/1/Decision.pdf

Jennifer D. Rios, CPA Goodsell & Company Inc Jennifer D. Rios, CPA Goodsell & Company Inc., CPAs 619-238-4343 Jennifer@goodsellcpa.com