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March 2005
Current Government Compliance Events 
Professional and Consulting Fees: Documenting Allowability
By: Darryl L. Walker, CPA, CFE
Although the provisions of FAR 31.205-33 (e) and (f), discussing documentation requirements for professional and consulting fees, have been around for a long time, many government contractors still don't get it. Those provisions provide explicit documentation instructions that must be followed for those fees to be deemed allowable. Overlooking these provisions will certainly result in DCAA questioning these costs in your incurred cost submissions or in your cost proposals.
Very simply, you must be able to demonstrate the nature of the services provided and the reasonableness of the costs for those services, via adequate consulting company documentation. The FAR provisions state that fees are allowable when supported by evidence of the nature and scope of the services, to include:
- An adequately detailed consulting agreement, one that will define the specific task requirements, compensation rates/values, nature of other expenses to covered (travel, etc.), and relevant terms and conditions (delivery, payment terms, etc.). The services to be provided should not be vague or open-ended ("scope to be determined as needed").
- Invoices submitted by consultants should detail specific services provided, the dates or time frames in which those services were provided, and some expression as to the amount of time incurred for individual tasks. Invoices should mirror the terms of the engagement agreement, and actual services delivered as stated in the invoices should avoid verbiage such as "for services rendered", or "services as per purchase order no. XXX".
- A consultant's work product or deliverable, and related documents (trip reports, etc.), should be submitted to demonstrate that services were actually provided. The work product may be in the form of a periodic report of service accomplishments, or a defined engagement conclusion document such as an audit report or written legal opinion.
The use of consulting retainer agreements will invite more audit scrutiny because many retainer agreements do not have specific engagement deliverables defined, and often times invoices are not specific as to the "consumption" of an agreed-to monthly retainer amount. What I mean by "consumption" is that the actual use of the retainer value is not defined in the invoices that demonstrate the consultant's time expended for those services, nor the specific tasks performed for the monthly retainer amount.
Retainer agreements carry the same documentation requirements as discussed above. But in addition to the above requirements, contractors must also be able to demonstrate that (1) the services are necessary and customary, (2) level of past services under a retainer arrangement justify the retainer amount agreed to, and (3) retainer fee is reasonable in comparison to cost of maintaining an in-house capability for the same services.
It is noteworthy to mention that DCAA expects the documentation process to be "real-time". If invoices for services are not well documented when submitted for payment, the auditors will not readily accept your offer to go back to the consultants and ask them for supporting data to be created after the fact. Adequate supporting data justifying fees and services performed should be produced by your consultants as those services are performed.
For more information on the above topics, please contact Darryl Walker at 256-533-1720 or email at dwalker@beasonnalley.com.
Beason & Nalley, Inc. is a business-consulting group primarily focused on businesses in the government contracting industry. Beason & Nalley's professional team is committed to the delivery of services in the areas of government compliance services, full scope accounting services outsourcing, assurance and advisory services, accounting, estate and financial planning, business valuations, corporate and business tax, Deltek® Costpoint consulting, mergers & acquisitions, human resources consulting and litigation consulting. The company is headquartered in Huntsville, Alabama.
Driving Financial Results with Eyes Forward
Written by: Don Nalley, Jr.
I am convinced that we accountants have become 'unbalanced' if you will. We spend an inordinate amount of our day working on history or capturing and reporting on the past. Of course, there is nothing wrong with history. It is, and always will be, for those of us that cannot see the future (which happens to be all of us); the only way we can make any attempt at predicting the future.
Where can we enhance value? Where can we leverage our time? What can we spend a dollar doing and make two? Obviously the answer to any of these questions is not: controlling or accounting for costs. The answer to these 3 questions is: spending time on efforts that grow revenue and create efficiencies.
I am not advocating a change in positions. There is no need for any of us to become the business development "rainmakers" in our companies. Also, we do not need to become the plant managers or project managers on jobs. Rather, we can and should focus on providing a system of measurements and forecasts to management that allows them to see the weaknesses in the company and the location of highest return on each successive dollar spent. Like driving a car, eyes are forward on the future, with quick glances in the rear view mirror at history.
You, as an officer of your company are a value added component of that business. Yes, the books must be right, but isn't that a job for good employees that are well trained? Get that right, and when you do, you can start driving, just like you drive your car, with eyes forward and quick glances in the rear view mirror.
In fact, as we drive, when do we look in the rear view mirror? A look back is required when a change is contemplated and there is a need to know what is behind us to make that change without getting into danger. The same is very true of how we should drive our company. We need to look at historical results to determine if relationships exist that would indicate dangers associated with a contemplated move. As an example, consider the decision process of opening an office in another location. Should we lease or buy? Should we hire or outsource administrative issues such as HR or accounting or IT? What size space should we obtain? Obviously, these are times we can look at history to determine the result of those decisions. So we view the past for relationships and use those relationships to project or forecast the future under various assumptions.
That's one component of driving with our eyes forward. Using past relationships to forecast contemplated moves. We should be extremely proficient at this type of analysis. Remember the old advanced cost accounting analysis of asset purchase v lease, or rate of return analysis on the purchase of a piece of equipment or the expansion of a business, or a new product at what price? One of the components of that analysis was the known rate of return for the company as a whole. Maybe the IRR should be of the company or the division within which the analysis is being made. The point is that the purchase or acquisition should be analyzed on a forward focus basis and the resulting projected return should be compared to the required minimum. Will it enhance value or be nothing more than a consumption item, draining resources from the business? Do you know the rate of return for your company?
Some here are probably CFO's of government contracting companies where standard cost accounting is king. We live in the world of FAR Part 31 and CAS. The cost accounting principles contained in FAR31 and CAS are required for purposes of determining rates and complying with your customers accounting requirements. However, does that accounting model provide management with the information they need to make intelligent business decisions regarding new contracts, personnel, office locations, process changes, customer retention, commercial product development or sale, etc?
There may be an accounting alternative that does, and it is called "Lean Accounting." It is hailed as the pursuit of eliminating waste in information reporting. This concept proposes that no step or process is sacred. The first question is: can it be eliminated? If not, is there another method that will achieve the same results? In Lean Accounting:
- Value stream metrics (box scores) are utilized.
- Product costing is not based on standard costs or inventories.
- Profit and loss is defined by value streams.
Here is a quote from an article found on the Internet that says it best:
Kaplan and Johnson wrote in Relevance Lost , "Corporate Management Accounting systems are inadequate for today's environment." (Kaplan and Johnson.1987.) Business has changed dramatically since 1930. Accounting has not changed at all since that time! We need to move away from traditional Cost Accounting. "Cost Accounting is enemy number one of productivity." (Goldratt, E. 1992. The Goal. ) By the time you complete the first two principles of Lean (creating Value and Value Stream Mapping); it is time to start thinking, "What accounting system will drive my staff to make the right Lean decisions?" Certainly NOT Standard Costing and Absorption Costing.
Call it what you will, but the principals of Lean Accounting are the closest to the topic here of "driving with eyes forward" of anything I've seen in accounting in the 26 years I've been practicing. To drive with eyes forward, information to management should meet several criteria:
- Information must be daily and real time as opposed to monthly and late.
- Information must monitor the metrics that drive value and profitability. The standard accounting statements including the balance sheet, income statement and statement of cash flow are purely historical in nature and provide no management information concerning individuals, divisions, departments, products, plants or equipment and processes.
- The standard costing principals do not provide the guidance we need to determine profitability of a customer, a product, an employee or process. We must reorganize costs into the true costs of a product or customer. For example, in my business, do we actually make a profit on an individual tax return that takes 2 hours to prepare? Our traditional reporting would say yes. However, we must record and capture the costs of training, downtime during the off-season, cost of office space, equipment and software, etc., all as directs costs of our individual tax returns. Doing so might change our mentality regarding those returns. It might make sense to avoid the full time year-round cost of maintaining the capability to do tax returns, or to outsource the preparation, or to take on only that work that requires year-round services. It's a good example of how inaccurate traditional accounting is at estimating value of a service.
- Management must live in the world of more than just budgets. For example, in our business, we know and monitor daily going into a month expected revenue, budgeted revenue, and capacity. The typical budget is set based on prior year's numbers, and some growth rate for revenue. Utilizing a capacity measure keeps our focus on profitability. Much more effort should be put into the forecasting process. What processes could be changed to reduce costs? What should it take to achieve a given objective, such as awesome HR management, killer marketing, customer care, and what should that cost? Of course if viewed in this way, all costs associated with each process would be accumulated and viewed under a microscope. The accounting for those costs should be restructured to assist management in achieving that goal at the hoped for cost. Metrics would include actual to budgeted costs and also metrics related to the achievement of the goal. Is the HR group performing at expectation? Surveys, number of complaints, number of compliments, cost of HR administration per employee, etc., may become a standard component of the reporting process to measure achievement. Obviously these have never been a part of the historical accounting reporting process.
Another excerpt from an article on Lean Accounting provides additional insight:
Lean Accounting - Metrics
Our Metrics are another aspect of accounting that is interfering with Lean. In a traditional organization, we tend to measure whatever is easy, and it's always a financial metric. Today's business needs to measure what we want to improve, for example, Inventory Turns, Customer Service, and Productivity.
Forget ROI and EVA - they're too complex for real action! If the metric ROI is not good, which of the many 'knobs' do you turn to improve it? You don't know. Lean tells us to keep it simple. We want measures that are simple, fit the Plan for the Future State, are mostly non-financial, motivate the right behavior and measure processes.
Accountants today need to change the way they think! We need to lose old paradigms! We need to think in terms of processes, not transactions. We need to think Cost Management, not Cost Accounting. We need to be leading Teams, not reporting history. We are not going to go in after the war, count the dead bodies, and report that to top management. We are going to be proactive, and get into the trenches with the troops. We need to eliminate the myopic behavior created by Standard Cost, and the game playing associated with Absorption Accounting.
We need to concentrate on Managing by Value rather than MBO. It is 'how' we achieve success that really counts if we want our companies to sustain growth, improve the bottom line and remain competitive. That's real Lean Beans!
So how do you change the mentality in your company? I believe the start is you. You might consider obtaining some books or going to courses on Lean Accounting. However, I believe Lean Accounting is nothing more than just common sense. In its most basic form, it is simply looking at your business as a compilation of processes, and each should be streamlined to provide the highest quality at the lowest cost. In doing so, you will probably come to the logical conclusion that some of those processes (external and internal) are better deleted from your company. What you can do is arrange your system of reporting to provide information related to the value and cost of each of those processes. That information will lead management to the same logical conclusion. In altering your focus you will continually be shaping the future. You will be creating expectations of what you want a product to produce, a manager's goals, a given process to achieve. You will be establishing expectations and metrics to measure the achievement of those expectations and reward true advancement. You will be driving your business with eyes forward, with quick glances in the rear view mirror.
For more information on the above topics, please contact Don Nalley at 256-533-1720 or email at dnalley@beasonnalley.com. Consistency in Lease and Depreciation Accounting
SEC Staff Responds
Submitted by: Jodie Perez, CPA
The January 26, 2005 edition of The Wall Street Journal contained an article, "Restaurants Serve Up Restatements - More Scrutiny of Leases Is Leading Some Chains To Trim Their Past Profits," informing its readers of recent financial statement restatements reflecting a correction of accounting practices by certain publicly-held restaurant chains. Subsequently, others in the financial press have run similar articles on companies in other industries, including retail department stores. These restatements do not result from a change in accounting principles, but rather the failure to properly apply accounting principles that have been around for a long time.
Lessees frequently make improvements (e.g., offices, partitions, factory layout, etc.) to the facilities they are leasing. Lessees may also add equipment to leased facilities that may not be removed without incurring a cost that makes it uneconomical to do so.
The accounting issue is a lack of consistency in the depreciation period used for leasehold improvements and certain equipment referred to in the preceding paragraph and the period used for lease classification purposes. That is, a lessee may use the entire lease term, including all renewal options, for depreciating leasehold improvements, but for purposes of determining whether the lease is classified as capital or operating, use the lease term without renewal options. The useful life of the leasehold improvements for depreciation should be consistent with the lease term, unless the estimated useful life of the improvement is less, in which case the shorter period should be used.
Always evaluate the appropriateness of depreciable lives of leasehold improvements and certain equipment in a consistent manner with lease classification evaluations. Also, lives required for income tax purposes will rarely be appropriate for financial accounting purposes.
On February 7, 2005, the staff in the Office of the Chief Accountant of the Securities and Exchange Commission posted an open letter to the Chairman of the Center for Public Company Audit Firms responding to questions raised about public companies that have announced restatements of their financial statements for lease accounting issues. Those questions focused on amortization of leasehold improvements, rent holidays and landlord/tenant incentives. In responding to those questions, the staff emphasized their positions are based on existing accounting literature. If registrants determine their prior accounting is in error, they should state that the restatement results from the correction of errors.
Consistency in Lease and Depreciation Accounting was published in McGladrey & Pullen's February 9, 2005 edition of NA&A Insights.
For more information on the above topics, please contact Jodie Perez at 256-533-1720 or email at jperez@beasonnalley.com. Coffee Talk
Michael Woeber was the guest speaker at the "Entrepreneurial Training Series" luncheon in Birmingham, AL.
Beason & Nalley, Inc. hosted a seminar on "Ten Ways to Turbo Charge Your Business" on February 16, 2005 and attendance was great. Thanks for your support!
Beason & Nalley, Inc. will host a web cast on "Ten Ways to Turbo Charge Your Business" on March 15, 2005. This is due to the overwhelming response that we received on the seminar that was held in February.
Welcome back to SFC Al Fowlkes (Beason & Nalley's IT Manager) who has returned from being on duty in Iraq for over a year. Thanks for a job well done and we are all very proud of him!
Congratulations to Jennifer Blankenship for passing the CPA examination.
Congratulations to Katrina Rogers on the birth of her baby girl, Kandayce.
Welcome back to Mary Kay Sanders, Monica Wilhelm and Jaime Elmore who are assisting us through a busy tax season. Related Information:
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