In yesterday's posting, we began a series on risk factors that contract auditors consider when beginning any evaluation of labor costs. Unfortunately, the tone of the audit guidance and the prevailing attitude of many auditors presuppose that Government contractors will deviate from accurate labor hour recording when certain conditions exist. That's not the case at all. Nevertheless, all auditors, whether they be contract auditors or financial statement auditors, will develop a set of risk factors to help them determine how much attention, focus, or testing they need to devote to certain areas.
Yesterday we discussed the first two factors, contract mix and overrun contracts. Today we'll address two more, restructuring costs and significant increases in labor accounts.
Most companies, at one time or another, will go through some form of restructuring - it just goes with the ebb and flow of business cycles. In the DoD world, the Department attempts to cap the amount of costs that can be charged to its contracts for restructuring activities (DFARS 231.205-70). As actual restructuring expenditures near the negotiated restructuring cost ceiling, there is a risk that restructuring costs may be mischarged to other accounts. The auditor is advised to determine if the incurred and projected restructuring costs are near or in excess of the negotiated ceiling.
Significant Increases in Direct/Indirect Labor Accounts
This heading should probably read "significant changes" instead of "significant increases". Downward trends are just as "interesting" to an auditor as upward trends. Auditors are fond of trend analysis. Trend analysis may disclose instances where charges to direct or indirect labor accounts have increased significantly. Auditors are required to perform sufficient analysis to determine the nature of the increase (or decrease). The auditor should evaluate changes in procedures and practices for charging direct/indirect cost for consistency with generally accepted accounting principles, the applicable contract cost principles, and any applicable Cost Accounting Standards requirements.
The auditor should also perform comparative analysis of sensitive labor accounts. When the comparative analysis indicates a possible misclassification of direct labor cost or some other condition that cannot be adequately explained, the auditor should pursue the matter further, (e.g. the contractor may be misclassifying direct contract costs to selling and marketing or IR&D/B&P costs.) Analysis in this area may satisfy the mandatory annual audit requirements relating to changes in charging direct/indirect cost (MAARs 7) and analysis of sensitive labor accounts (MAARs 8). An example of a sensitive labor account is standby labor. Standby labor is generally defined as the unproductive time caused by and limited to idle time, capability retention, and waiting for special customer security clearance.