INTERNAL CONTROLS AND WRITTEN POLICIES AND PROCEDURES

Good internal controls and established, written policies and procedures are the backbones of a good accounting system. Although government cost regulations do not prescribe specific internal control procedures, the CAS require the establishment and use of written procedures for several areas of cost accumulation and allocation. Some of the cost areas include depreciation, capitalization of tangible assets, accounting for acquisition of material costs, and allocation of direct and indirect costs.

In addition, government auditors evaluate the strengths and weaknesses of contractor internal control systems by measuring the contractor’s adherence to its written policies and procedures. Auditors review these written policies and procedures to determine the overall adequacy of a contractor’s accounting system. If auditors find significant deficiencies, they qualify their audit reports by stating that the contractor’s record keeping system is inadequate for government contract costing purposes. This type of audit response obviously works against an organization’s efforts to establish itself as a responsible contractor.

The more significant internal control features of an acceptable accounting system for government contract costing purposes include the following:

1. Separation of authority between key accounting functions (e.g., payroll vs. timekeeping; requisition of materials and services vs. purchasing; purchasing vs. an accounts payable function; billing function vs. accounts receivable)

2. Written policies and procedures establishing the purpose and requirements of the accounting system (e.g., timekeeping, payroll, purchased services and materials, direct and indirect cost control, asset capitalization and utilization, post-retirement benefits and deferred compensation)

3. Internal reviews by management to ascertain employee compliance with the policies and procedures

4. Periodic reconciliations of cost control records from the point of original entry through cost accumulation summaries to billing records and accounts receivable

5. Management authorizations of critical accounting activities (e.g., issuance of payroll checks, signing of timesheets) and requisitioning/purchasing of materials and services

6. Budget control procedures for comparing actual cost to budget and contract financial status

7. Productivity measurement techniques to allow management to focus on problem areas and improve overall economy and efficiency (e.g., engineered or estimated standards)

8. Organizational charts to define lines of authority and responsibility and to provide for division of responsibility in operating, recording, and custodial functions

In-house suggestion boxes and hot-lines to encourage employees to make recommendations and ask questions about proper procedures or to inform management of possible areas of employee wrongdoing or fraud.

The extent of internal controls depends on the size of the organization. Obviously in a one-person organization, internal controls are very limited. This does not mean that the accounting system is unacceptable. It just means that an auditor will likely want to perform additional tests to obtain assurances.

Contractors are are advised to have written policies and procedures in the following areas:

• Definition of direct costs

• Description of indirect cost structure

• Job cost accumulation process

• Labor recording

• Cost transfers between segments

• Interim invoicing

• Preparation of incurred cost submission

• Final invoicing

• Asset capitalization

• Contract briefs

• Documentation of expenses

• Incentive compensation plans

• Paid time off

• Consultant costs

• Employee travel expenses

• Monitoring indirect costs

• Employee benefits

• Limitation of cost clause requirements

• Segregation of unallowable costs

• Adjustment vouchers

• Cash discounts

• Severance pay

• Closing statements

• Uncompensated overtime.