Wednesday, August 20, 2014

Annual Incurred Cost Submissions - Optional Items - Part 3

Today we present the third installment in our five part series on "optional items" related to annual incurred cost submissions. Sometimes DCAA will pretend that these (or some of these) items are necessary in order to assess the adequacy of the incurred cost submission. We frequently encounter situations where the auditor is requesting the trial balance as part of their "adequacy" determination. The trial balance is an optional item and is not necessary for an "adequate" submission. These items are found in FAR 52.216-7(d)(2)(iv).

Although these considered "optional" items that may be requested at the time of the audit, we have some reservations about whether some of these items should be made available at all. We explain those reservations throughout this series.If you missed parts 1 and 2, you can catch up by going here and here.

Certified financial statements and other financial data (e.g. trial balance, compilation, review, etc). More imprecise terminology. Perhaps "certified" financial statements means "audited" financial statements prepared by a Certified Public Accountant. Perhaps it means something else. Who knows? If it means "audited" financial statements, most small businesses and many medium-sized businesses do not have "audited" financial statements. They might have a "review" (limited assurance) or a "compilation" (no assurance), or none of those. Maybe the best they can do is print out a Profit and Loss Statement and a Balance Sheet Statement from QuickBooks. The requirement is vague and very open ended and we've seen cases where auditors have used this provision to request all kinds of financial data that were not germane to their audit of incurred costs. Push back on their requests a little bit and you'll get a retort along the lines of "who are you to tell me what I need or don't need to conduct my audit. I'm the independent auditor and will make that determination on my own". Not necessarily. The auditor still needs to establish a nexus between the audit objectives and the data requested. Its certainly appropriate for contractors to inquire as to what any requested information will be used for, or what the auditor is trying to establish by requesting the data (if not obvious).

That being said, the contract auditor will need to reconcile the incurred cost submission back to back to the financial statement or perhaps the trial balance. This is a legitimate audit step. Be careful however about providing too much information or data that has no relevance to the audit of costs charged to Government contracts.

Management letter from outside CPAs concerning any internal control weaknesses. As we stated earlier, most small businesses do not have audited financial statements. Only audited financial statements will have such a letter, and may not even have that if the auditor didn't find any internal control weaknesses. In an audit, the auditor must concern himself with the adequacy and sufficiency of internal control systems. That is not the case in a "review" or a "compilation". Even if a contractor has undergone an audit and has received a management letter from their IPA (Independent Public Accountant) concerning internal control deficiencies, there is no requirement in FAR that requires contractors to furnish these letters to the Government. In fact, we would resist turning over such documentation. First of all, those internal control deficiencies probably have nothing to do with how costs are accumulated and charged to Government contracts (cost accounting or job costing). Usually such reports address the safeguarding assets or something totally unrelated to Government contracting. A financial "audit" looks at the financial statements as a whole. It is not concerned with job costing or how indirect costs are accumulated and allocated to Government contracts, or whether the contractor has good policies for identifying FAR unallowalbles and for excluding such unallowable costs from billings to the Government.

Actions that have been and/or will be implemented to correct the weaknesses described in the management letter from outside CPAs. This is related to the paragraph immediately above. Whenever an internal control weakness is identified, there is a corresponding action plan to fix it. Obviously, if a contractor is not going to provide "management letters" to the auditor, its not going to provide any corresponding corrective action plans either.

Continue on to Part 4 - Internal Audits, Audit Plans, Tax Returns, and SEC Filings

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