Understanding the FAQs Related to Overhead Rate Audits for Growing A&E Firms

Article

May 9, 2024

For many architecture and engineering (A&E) firms, overhead rate audits are a critical aspect of financial management since they can be a great way for firms to recoup incurred costs necessary to run their business from the government.

An overhead rate, also known as an indirect rate, is the percentage of indirect costs that are allocated to a contract or project. These costs can include rent, utilities, insurance, and other expenses that are not directly tied to the production of a product or service within a contract or project. Overhead rates are used to determine the true cost of a product or service, and they can have a significant impact on an A&E firm’s profitability.

Typically, startup and small A&E firms do not have the relevant contract cost history to develop an overhead cost rate. However, firms that are growing or are seeking growth by winning government contracts and working with State Departments of Transportation (DOTs) in particular may benefit from having an overhead rate audit performed. In this article, we will answer some of the most frequently asked questions (FAQs) from A&E firms related to overhead rate audits.

Q: What is an overhead rate audit?

A: An overhead rate audit is an examination of an A&E firm’s overhead costs to determine the accuracy of the overhead rate used to allocate those costs to products or services. The audit ensures that an A&E firm is allocating overhead costs in a fair and accurate manner and complying with applicable regulations and requirements.

Q: What are the benefits of an overhead rate audit?

A: While not all A&E firms are required to undergo an overhead audit, the benefits of an overhead rate audit often outweigh the costs:

Overhead rate audits can confirm that an A&E firm is maintaining compliance with applicable regulations and requirements and accurately allocating overhead costs to products or services, which can lead to more accurate pricing decisions and, ultimately, higher profits.
An overhead rate audit can identify areas where the business can reduce overhead costs, which can also increase profitability.
An overhead rate audit can provide valuable insights into an A&E firm’s operations and financial health.
Overhead rate audits can put you in a better position to win contracts. Some contracts with government agencies or other clients may even require audits as a condition of doing business with them. Many will require an overhead rate audit to ensure compliance with contractual obligations.
Considering all the above benefits, an overhead rate audit can help A&E firms stay competitive in the marketplace. By providing accuracy and remaining compliant, A&E firms can demonstrate their commitment to financial management and reporting, attracting new clients who value these qualities.

Q: Who conducts an overhead rate audit?

A: An independent third-party auditor typically conducts an overhead rate audit. The auditor should be a qualified accounting professional who is experienced in auditing overhead rates and familiar with the intricacies of A&E accounting.

Q: How often should an A&E firm undergo an overhead rate audit?

A: The frequency of overhead rate audits can vary depending on the size and complexity of the A&E firm. However, most undergo an overhead rate audit on an annual basis.

Q: What is the process for an overhead rate audit?

A: The process for an overhead rate audit typically involves several steps. First, the auditor will review the A&E firm’s financial statements to gain an understanding of the business’s operations and overhead costs. Next, the auditor will review the A&E firm’s allocation of overhead costs to products or services. The auditor will then test the accuracy of the overhead rate by comparing the actual overhead costs to the allocated overhead costs. If there are any discrepancies, the auditor will work with the firm to correct the allocation of overhead costs.

Q: How can an A&E firm prepare for an overhead rate audit?

A: There are several steps that an A&E firm can take to prepare for an overhead rate audit:

The firm should familiarize itself with the latest guidelines and provide necessary training for internal accounting staff and management to ensure internal reporting is both accurate and timely.

Management plays a crucial role in preparing for an overhead rate audit as “management bears the sole responsibility for identifying, segregating, and removing unallowable costs from all billings to Government contracts,” according to the American Association of State Highway and Transportation (AASHTO) Uniform Audit & Accounting Guide to government transportation contracts.

The firm should ensure that its financial statements are accurate and up to date. Maintaining accounting records on an accrual basis in accordance with generally accepted accounting principles (GAAP) will be critical to the efficiency of the audit.
The firm should also review its allocation of overhead costs to ensure that it is allocating costs in a fair and accurate manner.
The firm should be prepared to work with the auditor to correct any discrepancies that are identified during the audit.

Q: Where can A&E firms find more information about overhead rates and the latest guidelines?

A: Designed as a tool guide for state DOT auditors, A&E firms, and public accounting companies that perform audits and attestations of A&E firms, the AASHTO Uniform Audit & Accounting Guide was recently updated in March 2024, superseding the 2016 edition. This guide is considered the leading source of information related to indirect cost rate schedules and overhead audits.

For A&E firms who want to propose or work on government contracts, management should also read through Federal Acquisition Regulation (FAR) Part 31, which contains the cost principles and procedures for 1) the pricing of contracts, subcontracts, and modifications to contracts and subcontracts whenever cost analysis is performed and 2) the determination, negotiation, or allowance of costs when required by a contract clause.¹

A&E firms working on government contracts may be asked to provide overhead rates in accordance with FAR Part 31. These regulations outline the specific rules and procedures that A&E firms must follow when calculating their overhead rates.

Q: What is a FAR overhead rate?

A: A FAR overhead rate is the percentage of general expenses that A&E firms can bill to contracted government agencies. To be more specific, the FAR overhead rate is the ratio of allowable indirect costs to total allocable direct labor costs based upon provisions set by the FAR and Cost Accounting Standards.

Q: Why is a FAR overhead audit needed?

A: If the DOT of a small A&E firm’s state headquarters performs a risk assessment to certify their overhead rate is FAR compliant, they may be exempt from a FAR overhead audit. Larger firms, on the other hand, will likely be required to undergo a FAR audit. Some DOTs also require them when a firm’s charges exceed a certain dollar amount, and other state and local governments may accept internally prepared statements.

It is, however, important to note that government agencies will base reimbursements to A&E firms on their audited FAR overhead rates. A&E firms must prove that costs incurred are allowable, reasonable, and allocable per the provisions for contracts with commercial organizations detailed in FAR Part 31.2.

The FAR audit also helps ensure A&E firms receive the best possible rate for government contract work because, unlike audited rates, provisional or estimated rates generally favor the state DOT and not the A&E firm. So, while not always required, increasing insight into internal control systems, profitability, and ability to bid and compete for other government contracts may benefit an A&E firm.

Q: What are some best practices for overhead rate allocation?

A: Overhead rate allocation is an essential aspect of financial management for A&E firms, and it’s important to ensure that it is done accurately and effectively. Here are some best practices for overhead rate allocation:

Understand the difference between direct and indirect costs: Direct costs are costs that can be directly attributed to a specific project or product. In contrast, indirect costs are costs that cannot be directly attributed to a specific project or product. Overhead rates are used to allocate indirect costs to projects.
Identify all indirect costs: It’s important to identify all indirect costs that need to be allocated to projects. This can include items such as rent, utilities, salaries of support staff, office supplies and equipment maintenance.
Use a consistent allocation method: Use a consistent method for allocating indirect costs to projects. This ensures that costs are allocated fairly and consistently across all projects.
Review and update allocation methods regularly: Business operations and expenses can change over time. It’s important to review and update allocation methods regularly to ensure that they are still accurate and effective.
Document allocation methods: It’s important to document the allocation methods that are used, including the rationale behind them. This can help ensure that the methods are applied consistently and can provide support in the event of an audit.
Maintain accurate records: It’s important to maintain accurate records of all expenses, including direct and indirect costs. This can help ensure that overhead rates are calculated accurately and can provide support in the event of an audit.

Q: What are some common errors in overhead rate allocation?

A: There are several common errors that A&E firms make when allocating overhead costs. One common error is using an outdated overhead rate. Overhead rates should be updated annually to reflect changes in the firm’s operations and overhead costs. Another common error is allocating overhead costs based on a single cost driver, such as direct labor hours. This can lead to inaccuracies in the allocation of overhead costs. Finally, A&E firms may allocate overhead costs to products or services that do not use those overhead resources, which can lead to distortions in the true cost of those products or services.

Q: What should an A&E firm do if it identifies errors during an overhead rate audit?

A: If an A&E firm identifies errors during an overhead rate audit, it should take immediate steps to correct them and ensure that they do not occur again. This may involve updating financial management processes, providing additional training to staff, or consulting with a financial professional to address the issues.

Let Us Guide Your A&E Firm Forward

By understanding the FAQs related to overhead rate audits, growing A&E firms can begin establishing accurately calculated overhead rates and complying with applicable regulations and requirements to achieve new levels of success.

Cherry Bekaert’s Professional Services team is well-versed in guiding A&E firms through overhead rate audits. We invite you to reach out today to see how we can help your firm improve its financial management processes and achieve new levels of growth.