Tuesday, January 3, 2012

Purchase, Existence, and Consumption

Material costs are usually significant for any production type contract. Contract auditors have a special review they perform annually whenever material costs are significant on cost-type contracts. This is a mandatory review as well, meaning that the auditor must perform the review before approving final costs on a contract. It is also required to be performed annually. The purpose of the special evaluation is to verify that purchased direct materials were in fact received and ascertain that they were

  • needed for the contract
  • purchased in reasonable quantities
  • purchased at prudent prices
  • used on the contract, and
  • properly accounted for as to initial charge, transfer in or out, and residual value.

These reviews are a bit different from traditional audits in that the auditor will draw a sample of materials charged to Government contracts and then physically locate all items in the sample. The auditors will also obtain purchase orders for the sampled items and trace those purchase orders to receiving reports. Contractors that cannot physically locate sampled material items are at risk for internal control deficiencies and perhaps having some billings temporarily suspended.

To determine whether the item was needed for the contract, the auditor will compare purchase requisitions or purchase orders to contract requirements and/or bills of materials. Good internal controls would have all three of these documents (purchase requisitions, purchase orders, and receiving reports) prepared by different personnel.

Purchases should be made at optimum quantity levels. Contractors should not buy too few at a time and lose out on quantity discounts. On the other hand, sometimes, buying too many of a quantity will result in lower prices based on available quantity discounts.

When materials used on a contract come from inventory (as differentiated from purchasing directly for the contract) the auditor will be very interested in inventory valuation methodologies.

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