Overhead Audits — Key Strategies to Help You Prepare

Working on a government project can be an exciting opportunity for construction, engineering, and architectural firms. However, it comes with the responsibility of maintaining compliance with stringent regulations, including Federal Acquisition Regulation (FAR) guidelines and state by state regulations.

A crucial aspect of this compliance is preparing for an overhead audit. This audit verifies your overhead rates, or “indirect costs,” meet the federal and state standards.

During an overhead audit, auditors will review financial records, invoices, contracts, and other documentation related to overhead expenses. They also interview key personnel and perform analytical procedures to examine trends and variances in overhead costs.

Explore recommended practices to help your firm be ready for an overhead audit and set the stage for successful government collaborations.

Labor and non-labor expenditures for overhead audits

It’s important to maintain organized and complete support for all labor and non-labor expenditures.

• Keep personnel files complete, including pay rate approvals and proper support for time incurred and allocated to a project (timesheets, job cost reports, etc.).
• Maintain support for all invoices, including the invoice itself as well as proof of approval and payment based on your internal control processes. If adequate support for the expenditure is not provided, the costs could be automatically disallowed, which would directly reduce 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.
• Consider activity with related parties and how it might impact the overhead calculations. There are specific regulations and guidelines for related-party rent activities that require additional information and reporting.

Business development and marketing

Business development and marketing are examined during an overhead audit, as they can sometimes be mistakenly classified as either allowable or unallowable expenses.

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 a company’s general promotion are disallowed and considered marketing or advertising expenses. It’s important to be consistent and apply one approach year over year.

• Assign time entries to a separate detailed category or task within the time/billing system.
• Properly describe each labor posting so an independent reviewer can understand the nature of the posting and be able to identify possible unallowable costs.
• Maintain proper support for each charge, including reviewed and approved timesheets (when applicable).

Advertising and public relations

FAR disallows efforts related to advertising and public relations, including any internal labor costs. The FAR guidelines say 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.
• Expenses related to trade shows or other special events intended for educational purposes are allowed, but costs associated with general marketing activities at such trade shows or conventions are disallowed.

Other overhead audit disallowed expenditures

• Employee appreciation (retirement parties, holiday parties, etc.)
• Certain memberships (golf clubs, industry specific, educational, etc.) are specifically allowable under FAR only if they are educational, similar to event fees
• Legal settlement expenditures
• Owner expenditures for personal use only (radio subscription, personal vehicle, etc.)
• If your organization provides vehicles to employees, the amount of personal and company use must be tracked; personal use of a company vehicle is not an allowable expense
• Mileage and lodging costs can have different state regulations, so be sure to review allowable activity on state as well as federal levels
• Charitable contributions or donations
• Life insurance costs on owners
• Bad debt expense
• Professional services fees associated with preparing federal tax returns
• Fines and penalties
• Interest expense

Other overhead audit tips

• For purchases on a corporate credit card, provide the detailed receipt along with the credit card statement; giving more information to the accounting department as well as the third-party reviewer helps them determine what the costs relate to and if the costs are allowable.
• Review the rules specific to your state. Some states, like Florida, have different mileage reimbursement rates that need review and proper adjustment.
• Develop internal policies surrounding bonuses and document them. The State Department of Transportation (DOT) has been strict on reviewing bonus policies over the last few years.
• Create accounts specific to FAR and track unallowable items during the year. This can make the audit easier and cut down on the number of selections if proper controls are in place.

How CLA can help with preparing for overhead audits

If you own an architectural, construction, or engineering firm, and you’re looking to learn more about overhead audits, our team can help you can navigate the process with a more detailed and actionable understanding of overhead costs.

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