Happy New Year everyone and welcome to our first blog post of 2019. As we begin this new year, the Government is in the midst of a partial shutdown. However, Defense, Energy, Education, VA, Labor, and Health and Human Services remain fully funded, open and are conducting business as usual. Agencies affected by the shutdown include Justice, Agriculture, Treasury, State, Interior, Transportation, Commerce, and HUD. Companies with contracts with those agencies might be feeling an impact, or soon will. No one is yet predicting how long the partial shutdown will last. If this one is like previous shutdowns however, all those furloughed Government employees will receive their full pay - they just get, what amounts to extra paid vacation.
But since contract auditors are, for the most part, open for business, this is not a time to sit back and let your policies, procedures, practices, and internal controls take a furlough. Those things are important - past, present, and future. They are important for supporting incurred costs, for supporting estimates of future costs, and used by auditors for trend analyses and comparative analyses. How do contract auditors employ trend/comparative analyses in their work and what are the results of those analyses used for? To answer those questions, we'll take a look at a standard audit program for evaluating labor costs using employee interviews. How do auditors decide who from hundreds or thousands of employees to interview? Their's is not a haphazard selection. Auditor's expend a lot of effort into a risk assessment, the results of which lead the auditor to select specific persons (or groups of persons) they need to check on. One of the steps in performing the risk assessment is the trend analysis/comparative analyses steps.
Auditors are free to and expected to exercise their professional judgment as to what kinds of comparative and trend analyses need to be performed. But there are two specific analyses called for in the standard audit program: ratio of direct to indirect labor and trend lines of sensitive accounts.
1. Ratio of direct to indirect. Auditors will perform trend analyses to disclose any significant increases in the ratio of direct to indirect labor accounts. If disclosed, contractors will be requested to explain those fluctuations. If there is no apparent (or satisfactory) explanation, auditors are instructed to further evaluate those fluctuations.
There was a not-so-famous case years ago - back when there were caps on IR&D/B&P expenditures - where such an analysis showed that indirect costs increased significantly in the last couple of months of the fiscal year. Further investigation disclosed that this increase coincided with the contractor reaching its maximum IR&D expenditures. A criminal investigation and subsequent settlement disclosed that employees were instructed to mischarge their time once the IR&D budget was exhausted. The contractor ended up sending a lot of money back to the Government.
2. Comparative analysis of sensitive labor accounts. Auditors are instructed to perform comparative analyses of sensitive labor accounts. What are sensitive labor accounts? That's not stated but probably includes any labor accounts that are charged directly or indirectly to Government contracts - especially cost-type (or reimbursable) contracts. Again, contractors will need to be able to explain significant fluctuations. Auditors are looking for situations where labor is being excluded from an indirect allocation base or mischarged from the direct labor base to the indirect cost pool. By omitting a project or product line from the indirect allocation base, the resulting rate will be increased and the Government overcharged.