Breakout Session 910 Beason & Nalley, Inc. Huntsville, Alabama April 12, 2006 2:25 PM – 3:25 PM

2. Can Your Accounting System Pass a Government Audit? Breakout Session 910 Beason & Nalley, Inc. Huntsville, Alabama April 12, 2006 2:25 PM – 3:25 PM NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

3. Objectives • Fundamentals requirements & expectations for cost accounting • Regulatory references • Three most important concepts • Segregation of costs by contract • Supporting invoiced costs (billing system) • Identification of unallowable costs • Issues that will most likely cause you to fail the audit NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

4. What is a job cost accounting system? System that allows identification of direct costs by contract, and equitable allocation of indirect costs to those contracts NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

5. When does Govt require an adequate job cost accounting system? Most important for: • Contracts requiring billings to be based on actual incurred costs • Bid proposals that require cost breakdown information NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

6. Why does Govt expect an adequate job cost accounting system? • Government wants to pay ONLY its fair share of allowable and allocable costs for its contracts • Government does not want to share in costs of other contracts or costs that are unallowable per law, regulation, or contract term • Demonstration of ability to manage costs incurred to budgets/bid values NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

7. Regulatory provisions • FAR Part 9.106—pre-award accounting system review (SF 1408) • FAR Part 31 Cost Principles • FAR 52.216-7, Allowable Cost and Payment Clause • Cost Accounting Standards • FAR Part 15.408 Table 15-2 NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

8. Important Definitions • Directcosts—amounts generated by or associated with only one contract or project • Indirectcosts—amounts that cannot be associated with one contract, but rather were caused by and/or benefit two or more contracts or projects • Unallowablecosts—amounts that Government will not pick up in bid proposals or billings—include cost categories named in FAR Part 31 as unallowable, costs not allowed per contract terms, or costs deemed unallowable by contracting officer determination NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

9. Three fundamental concepts for adequate cost accounting system • Segregation of costs by contract • Adequate billing system • Identification of unallowable costs NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

10. Segregation of cost by contract • General concepts • Identification of direct costs by contract • Grouping of homogeneous indirect costs in cost centers & allocation of those costs to contracts using equitable allocation base • Consistent application of practices in assigning direct and indirect costs to contracts (CAS 402) NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

11. Segregation of cost by contract • General concepts • Sufficient contract cost ledgers identifying: • Actual direct incurred costs by cost element • Direct Labor • Direct Subcontract • Direct Travel • Etc. • Optional—identification of indirect allocation costs • Costs incurred by period (current mo., YTD, CTD) • Contract amt/existing funding NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

12. Segregation of cost by contract • General concepts • Traceability of summary job cost ledger direct costs to supporting subsidiary ledgers • Reconciliation of subsidiary ledger information to detailed source data • Detailed source data provides basis for and nature of cost, and identifier to contract or job NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

13. Segregation of cost by contract • Labor cost charging: • Satisfactory labor collection & cost code/project identification systems: • Timekeeping system that: • Identifies employee’s labor by intermediate and final cost objectives • Includes adequate internal controls/processes to ensure reliable charges • Labor distribution system that charges direct and indirect labor to the appropriate cost objectives • Actual labor rates used to calculate labor distribution • Reconcilable to payroll NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

14. Segregation of cost by contractIndirect costs • Identification and assignment of indirect costs: • Indirect costs are charged to appropriate indirect cost center • Transaction journal entries traceable to source documents • Adequate source accounting data supports recorded costs—affords ability to understand nature and reasonableness of costs • Actual indirect rates can be determined on interim basis • Allocation bases for indirect cost centers are appropriate NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

15. Adequate Billing System • Depending on type of contract, company may be required to bill on basis of incurred contract costs • Invoiced direct costs must reflect actual costs posted to job ledger • Invoiced indirect costs must ultimately reflect allocation of actual allocable indirect costs to contract NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

16. Adequate Billing System • Attributes of adequate billing system: • Direct costs: • Invoiced direct costs represents summary actual amounts on job cost ledger • Billed amounts reconcilable to detailed transaction documentation • Transaction detail clearly identifies project to which assigned, and nature/purpose of direct contract expense NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

17. Adequate Billing System • Attributes of adequate billing system • Indirect costs • Invoiced amounts based on application of indirect rates X appropriate base • Indirect rates, during FY, represent reasonable forecast of indirect rates for that FY • Able to track/monitor actual year-to-date indirect rates and compare to projected rates • Make adjustments to reflect more accurate projected indirect rate during FY; adjustments required especially if evidence shows previous projections are overstated • Adjustments at year-end to actual indirect rates—presentation format: “Incurred Cost Proposal” NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

18. Adequate Billing System • System must facilitate detection of: • Potential contract overruns—compliance of Limitation of Funds contract clause • Errors in invoiced amounts • Overpayments by Government • Adequate billing system is contingent on adequate job cost system; otherwise, reliability of invoiced amounts is questionable NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

19. Identification of unallowable costs Unallowable costs are those that are: • Named as unallowable in FAR 31.205 • Previously determined to be unallowable by ACO written decision • Mutually agreed-to as unallowable • Directly associated costs if material in amount NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

20. Identification of Unallowable Costs • FAR 31.201-6/CAS 405 require: • Exclusion of any unallowable costs from bid proposal or billing • Sufficient record keeping that identifies and segregates unallowable costs in cost accounting system NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

21. Identification of unallowable costs Typical accounting methods for identifying & isolating unallowable costs: • Identification of unallowable costs during review of data generating recordation of expense • Capture of costs in separate series of accounts or spreadsheet • Tracking code/transaction number for unallowable cost item • Follow-up review of accts most often susceptible to incurrence of unallowable costs NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

22. Identification of unallowable costs Examples of unallowable costs: • Entertainment • Interest on borrowings • Travel exp above FTR/JTR ceilings • Recreational activities • Mergers & acquisitions NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

23. Identification of unallowable costs • Unallowable costs included within indirect expense billings/final rates most often carry certification requirement • If costs included upon certification, penalties could apply • Thus, diligence needed in timely identification & segregation of unallowable costs NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

24. Problems that will fail your cost accounting system during an audit • Core reasons for inability to receive passing grade for an adequate cost accounting system: • Lack of experience and/or knowledge of audit/regulatory requirements • Failure to actively monitor system for effective job cost practices NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

25. Problems that will fail your cost accounting system during an audit • Cumbersome system for extracting or identifying costs by contract: • Inadequate chart of accounts identifying direct and indirect costs • Job cost ledger non-existent • Job cost ledger amounts not readily traceable to transaction data NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

26. Problems that will fail your cost accounting system during an audit • Inadequate timekeeping and labor charging system • No viable vehicle/document for employees to record time as worked • Timekeeping system does not distinguish cost by contract or indirect code • Labor distribution system non-existent, or not easily reconcilable to timesheets and/or payroll data • Total labor costs identified to direct or indirect cost objectives not reconcilable to payroll NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

27. Problems that will fail your cost accounting system during an audit • Inadequate indirect cost allocation: • Indirect costs not captured into appropriate homogeneous groupings • Allocation bases selected not equitable • Inability to track actual YTD rates & monitor to billing rates NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

28. Problems that will fail your cost accounting system during an audit • Billing system not adequate • Billed costs not readily traceable to job cost or GL transactions at job cost level • Invoiced direct costs don’t match job cost summary information by cost element • Provisional indirect rates used for billings cannot be matched to actual rates • Inability to monitor costs to contract ceilings • System for removing unallowable costs inadequate NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

29. Problems that will fail your cost accounting system during an audit • Lack of consistency in charging similar costs in like circumstances as direct or indirect (FAR 31.202 & 31.203) to cost objectives: • Treating quality labor costs as direct contract one time, and as indirect another • Charging telephone bill as direct one time, and indirect another time NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

30. Problems that will fail your cost accounting system during an audit • Direct costs cannot be segregated from indirect costs • Contract costs are not accumulated at CLIN, WBS, or other sub-task level • System does not separate pre-contract costs from after award costs NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

31. Problems that will fail your cost accounting system during an audit • Accounting system not in full operation • Failure to use GAAP in recording P&L or balance sheet transactions • Accounting functions not under GL control • Some transactions not company related NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

32. Best Practices • Knowledgeable & competent accounting personnel • Pro-active attention to: • Functional accounting system • Setting up job cost ledger • Solid policies for distinguishing direct from indirect costs • Adequate supporting transaction documents NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

33. Best Practices • Adequate timekeeping records • Clear and convincing methods for identifying unallowable costs • Written policies and procedures: • Timekeeping/labor charging • Unallowable costs • Distinguishing direct from indirect costs • Billing functions/system • Capturing & allocating indirect costs NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management

34. Contact Information Beason & Nalley, Inc. 101 Monroe Street Huntsville, Alabama 256-533-1720 Darryl Walker, Owner dwalker@beasonnalley.com Scott Butler, Director sbutler@beasonnalley.com NCMA World Congress 2006 : Achieving High Performance in Global Business: Leadership, Outsourcing, & Risk Management