2

2014 AASHTO Audit Conference

Savannah, GeorgiaAugust 11, 2014

Performing Effective Contract Closeout Procedures

Victor W. Vaccaro, Jr., CPA/ABV, CFF, CDA, Partner

Provides auditing, accounting and consulting services to A/E Firms on a national basis.

Specializes in FAR Overhead Rate audits and advises A/E Firms on their overhead rate calculations.

Performs valuations of A/E Firms and assists with ownership transition.

4

Dannible & McKee, LLP is a New York-based firm of Certified Public Accountants and Consultants.

Experienced working with hundreds of professional architecture, engineering, planning and environmental consulting firms across the country.  

We handle financial analysis and tax planning for architecture and engineering (A/E) firms in addition to providing FAR audits, reviews, and compilations for clients who contract with dozens of Federal and state agencies nationwide.

We provide outsourced contract closeout audits and other services to the New York State Department of Transportation (NYSDOT).

Who is Dannible & McKee, LLP?

5

Overview

Why are contract closeout procedures performed?

What procedures should be performed to meet the state’s objectives?

How can these procedures be performed most effectively and efficiently?

Who should be performing these procedures?

6

Goals for Contract Closeout Procedures

Verify that the Consultant is billing in accordance with the terms of the contract.

Determine if the Consultant’s financial system is sufficient to account for direct and indirect costs.

Consider whether there may be concerns that would lead to questions about awarding future contracts to the Consultant.

Save the state money!

7

Overall Focus for Contract Closeouts

Recalculate and test contract costs to determine proper amounts for each type of cost.

o Audit adjustments may increase or decrease recommended costs.

Verify that costs submitted by the Consultant are allowable under the contract.

o If costs are not submitted, they would not be awarded to the Consultant.

o Therefore, any audit adjustments would result in a decrease to recommended costs, which would result in cost savings to the state!

8

Contract Closeouts – A Team Sport? Consider all of those involved with consultant contracts, including

contracting officers, project managers, accounting personnel and auditors, possibly both internal and external.

Contract closeout procedures will be most effective if all departments and personnel work as a cohesive team!

All departments have a role, as contracts should be written to allow for effective auditing. Some oversight and testing might be more effective during the performance of the contract.

The entire process should be circular, with auditors providing feedback to other departments in order to make things work better next time.

9

Is it Really a Contract Closeout Audit?

This presentation is intentionally titled “Contract Closeout Procedures” to be more all encompassing.

In different states, contract closeout procedures may be referred to as field audits, desk audits, interim audits, quick closeouts, cost testing, etc.

These different names are generally used to describe different levels of services, with field audits being the most comprehensive.

Procedures might be similar to a financial statement audit where internal controls are also evaluated or the testing might be more in the nature of agreed upon procedures engagements that would be performed by a CPA.

10

Contracts with Consultants

We are discussing Contract Closeout Procedures, so it all starts with the Contract!

It is critical that accounting and auditing personnel have a thorough understanding of the contracts.

For ease of use and understanding, key financial terms should be in the same place in the contracts.

Auditors should also have a mechanism for summarizing these financial terms so that they can be most effectively tested while performing contract closeout procedures.

11

An effective audit cannot be performed if costs are vaguely defined or if proper records are not maintained! The contract must clearly explain the types of allowable costs and the requirement to maintain supporting documentation. 

The contract should explain the state’s rights for auditing the contract, including the length of time that an audit can be performed following the final payment and/or following the date that individual costs are incurred.

Auditors should identify areas where contract language can be improved and communicate with contracting officers.

Contracts with Consultants

12

Sooner is always better!

So why are contract audits delayed, sometimes for years?

o Probably due to manpower concerns.

o But will you really have more manpower in the future???

o And audits will actually take more time as time passes from the completion of the contract.

It is critical to monitor how long you are allowed to audit costs from the end of each contract and/or from the date costs are billed to make certain you don’t lose the opportunity to audit contract costs.

Timing of Audits

13

Consider additional cost verification procedures that can be performed over the life of the contract.

Consider what can be done at the completion of the contract.

o Consider doing mini-closeout with last estimate.

o Get things set up for eventual audit.

Do not just pay requested amounts and then try to get money back years later!

Timing of Audits

14

The contract should specifically indicate the Consultant’s responsibilities:

o What records to maintain and in what format.

o Cooperation in an audit, including amount of time to provide information.

Consider having consultants prepare, in a standard format, a summary of contract costs with each payment request that will eventually be used as the basis for an audit of the contract.

What leverage does the state having in obtaining cooperation from the Consultant?

o Cooperation should be considered in awarding future contracts.

o Holding back some form of retainage or final payment is even more effective!

Cooperation from Consultants

15

It is better to avoid major audit adjustments rather than find changes during the audit and then try to get money back.

Consider what can be done to help the Consultant bill more accurately under the terms of the contract.

At start of contract, verify that the Consultant understands all contract provisions and requirements.

Make sure you have access to communicate specific messages to the right level of employees at the Consultant.

Send reminders regarding changes in overhead rates, specifically hourly rates, etc.

Coordination with Consultants

16

Paperless audit software is a must!

Consider whether internal audit software or the software packages utilized by CPA firms would work best considering your specific audit process.

Evaluate whether you are utilizing your audit software in the most efficient manner, including:

o Obtaining information from consultants in a paperless format.

o Rolling information forward from previous audits done for the Consultant.

o Using all of the relevant features of the software.

Audit Software

17

Comprehensive standard audit programs should be maintained for various types of contract closeout procedures, including field audits and desk audits.

The standard programs should include a comprehensive listing of audit steps. The programs can be tailored to select the specific steps needed based on the types of costs and the risks for a specific audit.

The standard audit programs or an audit manual should provide guidance as to materiality levels and sample sizes for various tests of costs.

Steps would only need to be added for unusual tests that are not a part of the standard programs.

Audit Programs

18

Looking at the Consultant’s financial statements can identify when there is greater risk.

Key industry ratios from the financial statements, such as the Net Multiplier, Utilization Rate, and Profit as a Percentage of Net Revenue, can provide important information.

Financial statements should support that the Consultant is financially stable so that there is confidence they will have the ability to fulfill their obligations under the contract.

However, if a consultant is too profitable, this could be an indication that they are billing more than allowed under cost plus fee contracts.

Analytical Review

19

The contract should be clear regarding the overall maximum cost for the contract and also limits for phases of the project as applicable.

Mechanisms must be set up to consider maximum amounts as payments are made to the Consultant. This should not be left for testing during the contract closeout!

Additional verification should occur with the last estimate or payment request.

Final testing during the audit should then be just a formality as (hopefully) there should be no way payments exceeded limits per the contract!

Testing of Total Costs

20

The contract should be specific in terms of the use of various labor rates, including actual rates by employee, rates by class of employee, maximum rates and overtime premium.

Testing should address possible errors in labor hours, employee classification, labor rates, and special items like the application of premium rates for overtime, night work, etc.

Testing and selections should be set up to address each of these areas with additional focus on areas of higher risk based on concerns from prior audits or areas of additional complexity based on the terms of the contract.

Testing of Direct Labor Costs

21

Exceptions should be evaluated to determine if they are isolated errors or systematic in nature such that testing should be extended or errors should be extrapolated to the overall contract.

For higher risk consultants or those not subject to a FAR audit, consider verifying not only support for direct labor hours and dollars, but also testing to make certain that it has been charged to direct labor on the general ledger.

Consider whether the submission of annual salary rosters would improve the process for billing and testing labor charges.

Testing of Direct Labor Costs

22

The billing and testing of all inclusive hourly rate agreements should be easier, but many errors still occur!

The contract should be very specific as to the employees included in each category and how the billing rates adjust from year to year.

Consultants should be reminded as rates change.

Testing should focus on the hours incurred along with the proper classification of employees and the application of updated rates.

Errors are often systematic such that corrections must be applied for all time charges for an employee that has been misclassified or all billings for a year if rates are not updated.

All Inclusive Hourly Rate Agreements

23

These costs are often minor compared to the total contract. However, this is an area where errors are often discovered.

Consider applying limited initial procedures and then extend procedures if errors are discovered.

Use prior audits for the Consultant to evaluate risk in this area and focus testing on specific types of costs.

Obtain the Consultant’s job cost report and general ledger to verify that direct costs have been charged to the contract and not included in overhead costs on the ledger.

Testing of Direct Non Salary Costs

24

Contracts must be very clear in defining overhead rates for the Consultant and all subconsultants.

o Whether rate should be an overall rate, field rate or office rate.

o Explanations for the initial overhead rate, actual overhead rate and maximum overhead rate.

Should communicate with consultants to make sure they understand the initial overhead rates and also when updated rates must be applied.

o Verify with the first estimate or payment request that overhead is billed properly.

o Verify that overhead rates are updated when required.

Testing of overhead should be done on an overall basis, verifying the calculation of overhead each year based on the appropriate rate.

Testing of Overhead Costs

25

When do overhead rates adjust to the new rate?

o At the deadline for submission of the prior year’s overhead rate, for example June 30th or July 1st for a Consultant with calendar year-end?

o At the time the new rate is submitted, whether before or after the deadline?

o When the new rate is approved and accepted by the DOT?

o Retroactively back to the 1st day of the year, such that there will always be an adjustment?

There is no “right” answer to this question, but whatever approach is taken, it must be explained in the contract, consistently applied and communicated to the Consultant and subconsultants.

Testing of Overhead Costs

26

Overhead rates should be submitted annually by a specific deadline and in a standardized format, along with supporting information, including the executive compensation analysis.

Should establish requirements for when overhead rates must be audited and when separate field and office rates must be determined.

o Thresholds can be set based on a consultant’s gross or net revenue, the value of contracts, or other such factors, either for the most recent year or possibly the last few years.

o There should be no grey area! Requirements must be specific and consistently applied.

Testing of Overhead Costs

27

For FAR audits, the CPA should be required to submit specific workpapers to verify that the audit was performed in accordance with AASHTO Audit & Accounting Guide and that the CPA understands FAR.

A schedule of approved overhead rates by year for each consultant should be maintained, including information such as:

o When the rate was submitted and when it was approved.

o Whether it was prepared internally or audited.

o If audited, name of CPA firm that performed the audit.

When overhead calculations and FAR audits are not submitted as required, specific penalties should result such as no further contract awards or an adjustment to a lower overhead rate until filings are brought up to date.

Testing of Overhead Costs

28

The contract should specify how profit is determined and paid to the Consultant.

If there is a fixed fee amount, contract payments should be monitored so that this amount is never exceeded!

For profit that is paid on a percentage basis, easy tests can also be set up to monitor this over the term of the contract and with the last payment.

Still, there will be cases where additional amounts are paid. Profit should be verified and adjusted as necessary during all contract closeouts.

Testing of Consultant’s Profit

29

The same tests for Consultant costs can also be applied to subconsultant costs.

While subconsultant costs might be less significant, there is often greater risk as subconsultants are generally smaller and have less sophisticated accounting systems.

Contracts with subconsultants must clearly indicate their responsibility for submitting annual overhead rates, maintaining supporting documentation, and cooperating with audits.

There also must be a clear understanding of the Consultant’s responsibility for subconsultant costs both over the life of the contract and at the time of audit.

Testing of Subconsultant Costs

30

There should be specific requirements as to the procedures required prior to contract awards and/or prior to the start of the contract.

These are potentially more important than the contract closeout!

You should be evaluating things such as:

o Should we begin or continue to do business with this consultant.

o Is the Consultant’s accounting system sufficient to properly segregate direct and indirect labor and other costs.

o Does the Consultant understand and can they comply with the financial terms of the contract.

Preaward and Precontract Procedures

31

For new consultants, preaward testing should be more extensive and will generally require an analysis and approval of their FAR overhead rate.

Procedures for continuing consultants will be more abbreviated unless a consultant has been identified as high risk.

o Follow up on concerns from previous audits should be a key component of the procedures.

o Analytical review of financial statements and FAR audits should be used to evaluate potential risks.

o Preaward procedures generally would not include approval of the overhead rate for the latest year. For continuing consultants, this should be done following the overhead rate submission!

Preaward and Precontract Procedures

32

Estimates (payment requests) should not cross fiscal years.

The most critical estimates are the first and the last!

o Make sure the Consultant starts billing in accordance with the terms of the contract.

o Use the last estimate to make corrections for overhead and make certain that total costs and the Consultant’s fee do not exceed maximums.

Require the Consultant to maintain a cost summary schedule, in standard form, that must be submitted periodically and with the last estimate.

Other Recommendations

33

Special consideration is needed when a Firm is acquired.

o Costs under outstanding contracts should tested through the time of the acquisition.

o Completed contracts that are still open should be closed out immediately while information is still available.

Remember that looking into 10% of information often uncovers 90% of problems!

Get your closeouts done currently by allocating available time based on your assessment of risk. Do not put off closeouts hoping you will have more time in the future!

Other Recommendations

34

Remember the goals for contract closeout procedures and focus most on the specific goals that are more important in your state.

Coordinate efforts among the various departments that contribute to and utilize contract closeout procedures. Remember that it is a circular process!

Consider whether changes can be made to make your state’s contract closeout procedures more efficient and more effective.

Conclusion

35

Victor W. Vaccaro, Jr.CPA/ABV, CFF, CDA, Partner

Email – vvaccaro@dmcpas.com

Web – www.dmcpas.com and www.dmconsulting.com

Address Financial Plaza 221 S. Warren St. Syracuse, New York 13202-2687Phone – 315-472-9127

.

Contact Information

36

Any tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

Circular 230

37

This presentation is © 2014 Dannible & McKee, LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Dannible & McKee, LLP. Any reproduction, transmission or distribution of this form or any material herein is prohibited and is in violation of U.S. law. Dannible & McKee, LLP expressly disclaims any liability in connection with the use of this presentation or its contents by any third party.

Disclaimer