An overhead audit ensures that overhead rates—or, “indirect costs”—are compliant with the Federal Acquisition Regulation (FAR) guidelines, the primary regulation governing the acquisition of supplies and services with federal funds.
The FAR guidelines are complex and very specific in the rules and procedures firms must follow while calculating their overhead rates. Even though government agencies may not always require an audit before they hire an architectural or engineering firm, it’s a good idea to be prepared.
This article will list several best practices to help architectural or engineering firms successfully navigate the overhead audit process.
Labor and non-labor expenditures
It is important to maintain organized and complete support for all labor and non-labor expenditures.
Ensure all personnel files are complete: This includes approval of pay rates and proper support for time that has been incurred and allocated to a project (timesheets, job cost reports, etc.).
Maintain support for all invoices: This includes the actual invoice itself, as well as proof of approval and payment based on the Company’s internal control process. If adequate support for the expenditure is not provided, the costs are automatically disallowed, which directly reduces the total overhead rate.
Maintain contracts for individuals treated as 1099 consultants rather than W-2 employees, as well as documentation to support any indirect costs related to subcontractors or outside consultant services.
Business development and marketing
These are two areas that are reviewed in depth during an overhead audit and can be incorrectly classified as allowable or unallowable. Direct-sales type marketing, including bid and proposal costs, are generally allowable under FAR 31.205-18 and FAR 31.205-38. On the other hand, expenses related to the general promotion of a company are disallowed and considered marketing/advertising expenses. It is important to be consistent and have one approach that it is applied year over year.
Time entries should be assigned to a separate detailed category or task within the time/billing system.
Each labor posting should be properly described so that an independent reviewer can understand the nature of the posting and be able to identify possible unallowable costs.
Lastly, it is important to maintain proper support for each charge. This includes reviewed and approved timesheets (when applicable).
Advertising and public relations
Efforts related to advertising and public relations—including any internal labor costs—are disallowed by the FAR. The FAR guidelines state that “advertising and public relations” expenditures are those whose “primary purpose is to promote the sale of products or services for purposes of enhancing the company image to sell the company’s products or services.”
Disallowed labor includes general marketing, public relations, promotional and advertising efforts.
Costs related to trade shows or other special events where the purpose of the event is for educational purposes are allowed, but costs associated with general marketing activities at such trade shows or conventions must be disallowed per the FAR.
Other more common disallowed expenditures include:
Certain memberships (golf clubs, industry specific, educational, etc.). The FAR is specific about what memberships and dues are allowable. They must be educational. This is similar to event fees as well.
Legal settlement expenditures
Owner expenditures that are for personal use only (radio subscription, personal vehicle, etc.)
If the Company provides vehicles to the employees, the amount of personal and company use must be tracked. Any personal use of the Company vehicle is not allowable.
Charitable contributions or donations
Life insurance costs on the owners, partners and employees
Bad debt expense
Fines and penalties
If purchases are made through a corporate credit card, ensure the detailed receipt is provided along with the credit card statement. This will provide more information to the accounting department as well as the third-party reviewer to determine what the costs relate to and if the costs are allowable. You can learn more about the Federal Acquisition Regulation by clicking here.
If you own an architectural or engineering firm, and you’re looking to learn more about the overhead audit process, we urge you to contact your financial advisor now.