FAR Overhead Audits – “The Good, the Bad, and the Ugly”

1. FAR Overhead Audits –“The Good, the Bad, and the Ugly” Presented by: G. Antonio (Tony) Kenon, CPA, CGMA

2. Poll Audience • Auditors • Controllers/CFO’s, CEO’s or management of a Company • Contracting officers, procurement officers, other Government Officials • Of the auditors in the room (Government and private) how many of you assist the audited contractor with at least preparing certain aspects of their OH schedule?

3. Learning Objectives • Enhance your understanding of the applicable authoritative guidance • Enhance knowledge of the fundamentals in performing an overhead rate audit • Understanding of some common types of findings and disallowances

4. Agenda • Overview of Authoritative Guidance – “Conceptual Framework” • Accounting and Allowability Standards • Auditing Standards • Fundamentals of an OH Audit – From Planning to Reporting • Common Issues and Findings Noted When Performing OH Audits • Q & A • In the interest of time, general overview of many topics versus an in-depth on one or two topics

5. Polling Question: Phoenix was originally known as: Stonewall Pumpkinville Hohokam Salina

6. Answer: It was first called Pumpkinville, due to the large pumpkins that flourished in fields along the canals. Finally, Lord Darrell Duppa suggested the name “Phoenix”, as it described a city born from the ruins of a former civilization.

7. Authoritative Guidance • Two Worlds: • Accounting and Allowability • Auditing

8. Authoritative Guidance - Accounting Polling Question: Which of the following is considered authoritative guidance for private, for-profit contractors when preparing their overhead rate schedule? IRS Tax Rules for Cost Deductibility Governmental Accounting Standards Federal Travel Regulations Federal Acquisition Regulations

9. Authoritative Guidance - Accounting • Generally Accepted Accounting Principles “GAAP” – codified in the Accounting Standards Codification (ASC) by Topic • Federal Acquisition Regulations “FAR” • Cost Accounting Standards “CAS” • We will look at each one in more depth

10. Authoritative Guidance - Auditing Polling Question: Which of the following is considered authoritative guidance for auditors when auditing an overhead rate schedule? DCAA (Defense Contract Audit Agency) Audit Manual ASCE (American Society of Civil Engineers) Audit Manual Government Auditing Standards International Standards on Auditing

11. Authoritative Guidance - Auditing • Generally Accepted Auditing Standards “GAAS” • Generally Accepted Government Auditing Standards “GAGAS” (also know as the “Yellow Book”) December 2011 Revision • AICPA Attest Standards

12. AASHTOAudit & Accounting Guide • Non-authoritative practice aid brings together accounting and auditing concepts found in authoritative guidance into a convenient format • Tool that consolidates relevant FAR and CAS principles as well as auditing standards

13. GAAP and the Codification

14. Brief Overview of the Codification Polling Question: Have you heard of the Accounting Standards Codification (“ASC”)?

15. Brief Overview of the Codification • What is the Codification?  • The source of authoritative US GAAP recognized by FASB • An effort to reduce the complexity of accounting standards and to facilitate international convergence: • The effort resulted in a major restructuring of accounting and reporting standards • Topically organized format (approximately 90 topics)

16. Brief Overview of the Codification • What is the Codification (continued)? • It is NOT intended to change U.S. GAAP • It superseded existing sources of U.S. GAAP, and any prior sources of U.S. GAAP not included in the Codification or grandfathered are not authoritative • It is the authoritative source for U.S. GAAP in addition to guidance issued by the SEC • If it is not in the Codification, it is not U.S. GAAP for Non-Governmental Entities

17. Codification Structure

18. Brief Overview of the Codification How is the Codification Structured?  Areas Topics Subtopics Sections Subsections

19. Brief Overview of the Codification • How is the Codification Structured? (continued) • Topics: • Broadest categorization of related content (for example, FASB ASC 405, Liabilities) • Correlate with IFRS / IAS standards • Subtopics: • Represent subsets of a topic (for example, FASB ASC 405-20, which discusses the extinguishment of liabilities) • Generally distinguished by type or scope

20. Brief Overview of the Codification • How is the Codification Structured? (continued) • Sections: • Represent the nature of the content in a subtopic • Examples are recognition, disclosure, and subsequent measurement

21. Brief Overview of the Codification • How is the Codification Structured? (continued) • Subsections: • Allow further segregation and navigation of content • Occur in a limited number of cases • Unlike sections, subsections are not numbered

22. Brief Overview of the Codification • Note: • There is a proposal to amend the FAR to update references to GAAP due to the codification

23. Brief Overview of FAR/CAS What is the FAR? Polling Question: What is the FAR? What is the purpose of the FAR?

24. Brief Overview of FAR/CAS FAR: Background • The Federal Acquisition Regulation (FAR), which had its beginnings in the Armed Services Procurement Regulation established in 1947 governing the federal government’s purchasing process • The FAR was codified in Title 48 of the Code of Federal Regulations (CFR) in 1984 to create a uniform structure for many federal agencies • Its purpose is to ensure purchasing procedures are standard, consistent, and conducted in a fair and impartial manner

25. Brief Overview of FAR/CAS FAR: Cost Principles Contracts Polling Question: What three elements must a cost have to be recoverable?

26. Brief Overview of FAR/CAS FAR: Cost Principles Contracts • The FAR Cost Principles: • Before a contractor may recover a particular cost, it must be: • Allowable (per FAR Part 31 and Contract) • Allocable • Reasonable • FAR Part 31 defines when and to what extent costs can be recovered under a government contract • The government can recover costs found not allowable, reasonable, or allocable to the contract

27. Brief Overview of FAR/CAS FAR Cost Principles (continued) • FAR Part 31.205 Contains about 50 selected costs • Expressly Allowable • Expressly Unallowable: • Costs specifically classified as unallowable: • Government won’t pay under any condition

28. Brief Overview of FAR/CAS FAR Cost Principles (continued) What Are Some Examples of Expressly Unallowable Costs • alcoholic beverages • entertainment - games, shows • contributions / donations • legislative lobbying • fines & penalties • bad debts • club dues - social or health • flowers (any reason) • golf, tennis, fishing • dinner tickets • over per diem expenses • traffic tickets • non business subscriptions

29. Brief Overview of FAR/CAS FAR: Cost Principles Contracts Polling Question: True or False: If a cost is not mentioned in FAR Part 31.205, it is automatically allowable

30. Brief Overview of FAR/CAS FAR Cost Principles (continued) • FAR Part 31.205 does not cover every element of cost • If a cost is not mentioned it does not imply that it is either allowable or unallowable • Determination of allowability is analogously based • Use cost principle that most specifically addresses or best captures the essential nature of the cost at issue

31. Brief Overview of FAR/CAS What is the CAS? Polling Question: What is the CAS? What is the fundamental objective of the CAS?

32. Brief Overview of FAR/CAS CAS: History • The CASB (“Cost Accounting Standards Board”) was established as an agency of Congress in 1970, dissolved in 1980, reinstated in 1988 • Authorized to develop cost accounting standards • The CASB has issued 19 costing accounting standards (“CAS”) that have the full effect of law

33. Brief Overview of FAR/CAS CAS: Objective • Uniformity and consistency in cost accounting

34. Brief Overview of FAR/CAS • CAS: CAS is concerned with three areas in cost accounting: • Measurement of cost • Assignment of cost to cost accounting periods • Allocation of cost to cost objectives

35. CASB Standards

36. CASB Standards Polling Question: True or False: All Contractors must follow all 19 Cost Accounting Standards?

37. CASB Standards Answer: False Full CAS Coverage: All 19 Standards apply only to Contracts subject to “Full” CAS Coverage ($50 million award or net CAS covered awards of $50 million or more in the preceding cost accounting period) “Modified” CAS Coverage The following 4 Standards apply “Modified” CAS Coverage ($7.5 million federal award): 401 - Consistency in Estimating, Accumulating and Reporting Costs 402 - Consistency in Allocating Costs Incurred for the Same Purpose (FAR 31.202) 405 - Accounting for Unallowable Costs 406 - Cost Accounting Period

38. CASB Standards Exempt from CAS Coverage: 48 CFR 9903.201-1 summarizes those contracts and contractors that are exempt from all CAS Standards For example: Contracts and subcontracts with small businesses. FAR Subpart 19.3 addresses determination of status as a small business Contracts or subcontracts less than $7.5 million

39. Brief Overview of FAR/CAS CAS: CAS and Cost Principles Are Not One and the Same • CAS addresses cost accounting on government contracts (“cost allocability”) • The cost principles “FAR” - address cost allowability • Cost allowability is a procurement matter and is a function of law, regulation, or contract • Question: Can an unallowable cost be allocable? • Answer: Yes, costs may be allocable but unallowable

40. Brief Overview of FAR/CAS FAR V. CAS • What’s the difference? • FAR = Cost Allowability/Procurement • CAS = Cost Allocability

41. Auditing World

42. Authoritative Guidance – Auditing • Generally Accepted Auditing Standards (AICPA) • Attestation Standards (AICPA) • Government Auditing Standards (GAO – “Government Accountability Office”) • We will look at each one in more depth

43. Auditing World –Generally Accepted Auditing Standards

44. Brief Overview of Generally Accepted Auditing Standards • General standards: • Audits are to be performed by a trained and proficient auditor • All matters relating to the assignment should be addressed with an independence in mental attitude • Due professional care is to be exercised

45. Brief Overview of Generally Accepted Auditing Standards • Standards of field work: • Work is to be adequately planned and properly supervised • To assess the risk of material misstatements, a sufficient understanding of the entity is necessary • Appropriate audit evidence is to be obtained through auditing procedures performed to afford a reasonable basis for an opinion

46. Brief Overview of Generally Accepted Auditing Standards • Standards of reporting: • Report whether the financial statements are presented in accordance with generally accepted accounting principles • Report the circumstances in which principles have not been consistently observed in the current period • Informativedisclosures in the financial statements are to be reasonably adequate

47. Auditing World –AICPA Attestation Standards

48. AICPA ATTEST STANDARDS •  Three levels of service: • Examination • Review • Agreed-Upon-Procedures

49. AICPA Attest Standards • There are currently 13 Attestation Standards • Attest Engagements AT sec. 101 • Establishes a framework for attest engagements and outlines general attestation standards, including examples of examination reports and review reports • Note: The Examination Standards (AT sec. 101) are incorporated in GAGAS Chapter 5, “Standards for Attestation Engagements”. Nice bridge back to AICPA Standards.

50. AICPA Attest Standards • SSAE No. 10 (as amended by SSAE No. 11) AT sec. 201 • Agreed-Upon Procedures EngagementsOutlines attestation standards and guidance applicable to practitioners performing and reporting on most types of agreed-upon procedures engagements • Compliance Attestation AT sec. 601Provides guidance applicable to practitioners performing engagements related to an entity's compliance with requirements of specified laws, regulations, rules, contracts, or grants or engagements related to the effectiveness of an entity's internal control over compliance with specified requirements