Be Prepared to Justify Your Capital Expenditures

Government contractors, like any business, have a responsibility to maintain their competitiveness and increase productivity by making capital investments. There might be a few contractors out there without significant capital investments in facilities, machinery, and equipment - like companies providing staff augmentation services - but most companies need to invest or they quickly find themselves at a competitive disadvantage.

Contract auditors are always interested in capital investment decisions and the process for budgeting capital improvements because expenditure for capital improvements turn in to depreciation expense which are charged to Government contracts. The auditors' concern is not so much with need for contractors to investment in capital projects but that the decision on what to invest in will somehow work to the Government's detriment.

Auditors will be looking to see that there are tangible benefits accruing to the Government from capital expenditures. They will examine cost-benefit aspects to see which investments produce cost benefits equal to the original cash outlay over the shortest time frame. If the investment is necessary for non-financial reasons, the auditor will be looking for improved qualify, mobilization capability, or enhanced competitiveness.

Contractor decisions in this regard are affected by a myriad of factors, some of which may not result in the most equitable treatment of Government work. For example,due to limitations on funds available for capital investments, the contractor might be required to choose between purchasing a piece of equipment for a commercial division or for a division working primarily on Government cost reimbursement type contracts. The contractor will undoubtedly attempt to produce increased profits and cash flow. Since the contractor will continue to recover its incurred costs in the Government division, it may be less inclined to increase the efficiency of that division. Thus priorities will be audited carefully.

To avoid audit related issues arising from capital expenditure decisions, budgeting, and implementation, it is important to have written procedures. It seems like we always begin recommendations with a need for written procedures but having (and following) written procedures is a basic internal control function. Such procedures should provide for the following:

• a well-defined organization with established decision authority and responsibility for pursuing capital investment opportunities which will improve the efficiency of operations, affect long-term economies, and make timely identification and replacement of deteriorated and obsolete items.
• a systematic approach for auditing processes, organizations and methods affecting improvements and detecting deteriorated, obsolete, and underutilized items.
• a standard procedure for identification of potential capital budgeting projects, estimation of project benefits and costs, evaluation of proposed projects and development of the capital expenditure budget based on project acceptance criteria
• a documented review and approval process which assures that the assumptions are correct, all relevant factors have been considered, and proposals are consistent with organization objectives
• a systematic follow-up to insure that project implementation is prompt and withing estimated costs
• a system for tracking and comparing planned to actual benefits.