When your cognizant federal audit agency shows up at your facility with a list of employees that the auditors intend to interview that day, is that a floor check? Most contractors would say yes. If, however, you are a contractor for the Department of Defense (“DoD”), your audit agency is the Defense Contract Audit Agency (“DCAA”), and DCAA has refined its guidance such that the answer could be “yes” or “no” depending on the nature of the procedures conducted. Per the DCAA audit program for Major Contractor Labor Floor Checks or Interviews, the objectives of labor interviews are to evaluate the accuracy of contractor employee labor hour charges to contracts, indirect accounts, or other cost objectives while the purpose of floor checks is to verify the existence of employees and evaluate the timekeeping internal controls. The following is a review of the procedures for labor interviews and floor checks to determine the basic differences, and why DCAA may perform one versus the other.
Labor Interviews
Employee interviews are part of the audit of incurred labor cost and are one of DCAA’s mandatory annual audit requirements (“MAARs”). The DCAA Contract Audit Manual (“CAM”) stipulates that employee interviews must be conducted on a current basis and as close to the date of incurrence as possible when employees can better remember reasons for specific labor charges and sufficient evidential matter is more readily available.
Prior to conducting the interviews, auditors must assess risk by becoming familiar with the contractor’s organization, labor charging policies and procedures, current contract mix and employees per location. If, for example, a contractor performs fixed price and cost type contracts at the same location using the same employees, the risk of labor mischarging is much higher due to the incentive to charge cost type contracts for fixed price work. Auditors must also coordinate with government representatives such as the contracting officer’s technical representative (“COTR”) to avoid duplicative effort and with the contractor to set the ground rules for the interviews.
Auditors must also evaluate the adequacy of labor charging internal controls. The evaluation must include automated (IT) and manual processes used for recording labor costs. Inadequate controls increase the risk of labor mischarging and auditors will adjust the scope of employee interviews (the number of interviews and type of questions asked) accordingly.
In terms of risk, certain conditions such as the following, are more susceptible to labor mischarging and/or fraud than others:
Contract Mix
As noted above, when the contractor is performing both fixed price and cost type contracts, especially using the same employees, is conducive to labor mischarging due to the incentive to charge costs associated with fixed price contracts to cost type contracts to maximize profits on fixed price work while recouping all costs.
Overrun Contracts
Contractors who have overrun or are approaching contract ceiling or funding limits may consider moving costs from those contracts to those under ceilings or funding limits. Given that labor is the highest cost of many contracts, contractors may choose to transfer labor costs. Auditors may detect such behavior through unusual or numerous adjusting journal entries transferring labor from one job to another.
Significant Increases to Direct or Indirect Labor General Ledger (“GL”) Accounts
If a contract is close to being overrun, rather than transfer labor between contracts, a contractor may choose to charge direct labor costs to indirect labor accounts such as overhead, G&A, or B&P labor, thus distributing direct costs for a specific contract to multiple contracts.
Contract Provisions
Certain contract provisions restrict charging labor in specific instances. One of these may be overtime. If contract terms do not allow charging for overtime, the contractor may still do so either intentionally or unintentionally.
Labor Accounting by Funding
Contractors may choose to charge labor to contracts where funding is available rather than to the contract for which the labor was performed. Contractors may do so while awaiting funding, intending to transfer the labor to the appropriate contract once the funding modification is received.
Another situation where such labor charging might occur, is in the case of related or similar cost-type and fixed-price procurements. When contracts are very similar, contractors may consider them more or less the same contract and charge labor where funding is currently available.
Offsite/Secure/Restricted Locations
In some cases, significant labor costs are incurred at offsite or restricted locations where cognizant auditors do not generally have access. Contractors may choose to charge labor from other contracts to contracts performed at these sites believing that the likelihood of audit is low. In these situations, auditors will consider requesting assist audits for offsite locations and the assistance of cleared auditors for secure or restricted locations.
After completing the audit of internal controls and analysis of conditions of increased risk, auditors will identify areas with a higher risk of labor mischarging. The auditors will select employees to interview within these areas by reviewing employee labor charging patterns and documentation such as work authorizations and timesheets. Auditors will develop questions tailored to the circumstances of each group of employees and conduct interviews at the employees’ locations. The auditors will develop findings based on the interviews and evidence gathered and then calculate questioned costs.
Floor Checks
Compared to employee interviews, labor floor check objectives are relatively straight forward, i.e., an evaluation of contractor compliance with its internal controls to ensure the reliability of employee time records and physical observations (floor checks) of work areas to determine that employees are actually at work, that they are performing in the assigned job classification and that the time charged is to the appropriate job.
Floor checks are appropriate when there is limited government risk or vulnerability. If a high probability of mischarging exists, the comprehensive analysis of labor charging described above is appropriate.
Floor check procedures begin with obtaining an understanding of controls over timekeeping. Auditors will:
- Observe the contractor’s timekeeping system in operation including evaluation of the method for recording time and physical observations of the work areas.
- Determine how employee attendance is controlled – whether by clock cards, timecards, or other time and attendance records.
- Review the system by which employee time records are controlled including assignment of job numbers for tasks performed.
- Determine whether hours shown on time records are reconciled periodically with hours recorded on attendance records and total hours recorded on the payroll.
- Determine whether there is a division of responsibility between personnel responsible for the preparation of time and attendance records and those responsible for the preparation of payroll.
- Determine whether there is a division of responsibility between personnel having a part in the preparation of time and attendance records and those responsible for operating within budgets.
- Determine whether procedures have been established for coding and recording idle time. The auditor should review or prepare an analysis of idle time according to the reasons for idle time, such as waiting for inspection, lack of materials on hand, etc.
- Scan batches of labor distribution documents for errors or arbitrary allocations of time to contracts.
Floor checks should be conducted in a manner which least disturbs normal contractor operations. Typically, contractor representatives accompany auditors during floor checks. The extent and frequency of floor checks depends on the adequacy of the contractor’s system for controlling time, internal controls, the frequency of floor checks by contractor personnel and the results of previous government floor checks.
In choosing locations to floor check, auditors will consider the following factors:
- Results of prior audits
- Headcount at each site
- Pattern of direct vs. indirect charging
- Number and mix of contracts at the site
- Contract overruns
- Contract values at the respective sites
- Facility dedicated to a specific contract/program vs. a facility that supports multiple contracts/programs
- Audit leads
- Discussions with the cognizant contracting officer
Auditors will select employees to be checked using statistical sampling methods. Auditors will then floor check the employees to achieve the objectives described above. Auditors will usually collect a copy of the employee’s current timecard during the floor check.
After completion of the floor check, auditors will compare time charges on the copies of the current timesheets collected to payroll and labor distribution records to determine if any changes were made to the observed time charges and if time charged by checked employees matches the typical pattern for that employee.
When DCAA shows up unannounced at your facility with a list of selected employees located there in hand, ask them about the procedures they intend to perform. Are they going to conduct in depth employee interviews as part of a comprehensive review of labor or floor check interviews to test compliance with timekeeping controls? Ask if a representative from your company may accompany them during the interviews (they should say yes). Ask for a copy of the interview questions. Carefully observe each interview to make sure the auditor(s) asks only the questions listed and does not stray into more detailed questions unrelated to the audit. This would more likely occur during floor checks given the limited nature of the procedures and the somewhat natural tendency of auditors to ask additional questions of cooperating employees. Also, promptly provide requested supporting documentation or information.
Adequate preparation for comprehensive labor reviews and labor floor checks, especially in terms of internal controls regarding labor and employee training in timekeeping procedures, is essential.
If you have questions concerning any of these issues or other contracting matters, do not hesitate to contact Cherry Bekaert for advice and assistance.
