How to Prepare for a Government Audit

Are Potential Tax Changes Impacting M&A Prices for Government Contractors?

We have spent some time during the past year on audit issues at both the federal and state levels, and thought it would be helpful to remind government contractors about the support that government auditors are expecting when they audit your company’s overhead rates.

Automobile Costs

In almost all cases, costs for company-owned vehicles are being questioned by the government auditors. It is no longer acceptable to say that a company car is used 70 percent for business and 30 percent for personal use. Auditors will want to see daily travel logs of at least the business use of the vehicle, including the client or prospect visited, and miles traveled. Some auditors also want to see the reason for the visit (this recently became an issue with PennDOT).

If you have a “luxury vehicle,” the lease cost and/or the depreciation of the vehicle should be reduced to that of what the average person in that position would drive. Again, PennDOT has interpreted this to mean a Ford Taurus, and we are currently debating that determination. With the introduction of Tesla and other battery-fueled cars, we have successfully argued that the lease cost should be increased by the gas savings the government is receiving in determining a “fair lease price” for the vehicle.

Entertainment Costs

We tell our clients, if it is “fun,” it is probably unallowable. Entertainment costs include not only the cost of the entertainment itself, but also the salary and fringe benefits for those who attended. Also, the business mileage should not be included on your auto travel log.

If you are meeting a client and/or prospect for a meal, obtain the original receipt (the credit card receipt is not acceptable), and note the reason for the meeting and all the people in attendance.

Most companies have written policies and procedures for submitting these types of reimbursements and we encourage our clients to do the same. In addition, your timekeeping system should have a code for employees to enter any time they incur for entertainment and your written policies should explain the types of time that should be recorded to this code.

Travel Costs

Justification of travel costs needs to comply with FAR 31.205-46 and be within the Federal Travel Regulation limits. The costs also must be “reasonable.” The Federal Government recently challenged an out of town board meeting because, in its view, the meeting could have been held locally at a much lower cost.

If you are incurring travel that an auditor might determine unreasonable, document your reasoning when the travel is approved. Trying to remember two to five years later why travel was authorized can be difficult. Again, the original invoice needs to be maintained (the credit card receipt is not sufficient evidence).

Government Site Rates

We often have clients call us with questions about a specific solicitation that requires a company to have a government site rate in order to respond. In these cases, the government is assuming that if the client does not have a government site rate, the indirect costs are not being allocated fairly. In some cases, these employees would only be at government sites for limited periods of time. In these cases, a written policy stating when you will calculate a government site rate would be very helpful. In two recent cases, auditors suggested that clients had to retroactively change their cost allocations. We successfully challenged the findings but there were a lot of wasted resources spent because, in both cases, there was no written policy.

CLIN Billing 

We have had two cases in the past week in which CLIN billing has been an issue with a federal government contractor. Since federal contracts are typically funded by contract line (i.e., CLIN), the contract ceiling is determined at the CLIN level and not at the contract level.

When submitting billings, it is important to bill under the correct CLIN and to verify that the ceiling on the CLIN has not been exceeded. Even though the contract has sufficient funds, the government received the goods or services at the price proposed. If you exceed the funded amounts at the CLIN level, DCAA is asserting that those funds should be returned to the government and they may also deem your accounting system deficient for government billing.

Dealing with government auditors can be difficult but if you are properly prepared you can reduce the time of the audits, limit their findings, and sleep better knowing that you have done everything you can to comply with the federal regulations. If you disagree with a finding, plead your case before the report is issued. Once issued, it will be much harder to successfully argue your case.

David E. Shaffer can be reached at dshaffer@kmco.com or 215.441.4600.

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