Key Considerations for Federal Acquisition Regulation (FAR) Audits

March 11, 2025

In recent years, a growing number of architectural and engineering (A/E) firms have found it necessary to obtain audited overhead rates that comply with the Federal Acquisition Regulation (FAR). This shift stems from several factors, including the economic downturn that has led firms to pursue government contracts as private development projects declined. Additionally, the release of the updated AASHTO Uniform Audit & Accounting Guide (the “Guide”) in 2009 placed greater emphasis on properly calculated and audited FAR overhead rates, replacing the use of estimates and state-specific methodologies.

Understanding FAR Compliance

FAR is a federal regulation that governs the use of both state and federal funds in state Department of Transportation (DOT) projects. Many state DOTs have adopted rules for selecting and pricing engineering consultant contracts that align with or mirror FAR requirements. The Guide serves as a vital resource for state DOT auditors, A/E firms and CPA firms conducting audits for A/E firms.

The AASHTO Guide, first introduced in 2010 and refined in subsequent editions—including the most recent 2024 version—ensures alignment with the latest auditing standards, accounting principles and federal regulations. These updates address concerns raised by entities such as the Federal Highway Administration (FHWA), state DOT agencies and A/E design firms. The 2024 edition of the Guide incorporates several updates, refinements and clarifications to reflect changes in the statutory and regulatory framework applicable to A/E contracts that have occurred since the publication of the 2016 edition.

Key Features of the AASHTO Guide

The latest updates were intended to strengthen the Guide by providing additional guidance and clarification regarding the existing policies and procedures set forth in the FAR. Some of the significant features include:

  • Uniform Standards Across States: Most A/E firms will undergo a single FAR overhead audit by a CPA firm that will hopefully be recognized and accepted by all states. In addition, this has developed the concept of a cognizant audit, assigning primary responsibility for an audit to a single cognizant agency.
  • Exemptions for Small Firms: Some small A/E firms may qualify for exemptions from CPA audits if their home state DOT conducts a risk assessment and ensures compliance with FAR.
  • Compensation Analysis: Firms must conduct independent analyses of executive compensation to demonstrate reasonableness, using tools like the National Compensation Matrix (NCM).
  • Guidance for CPA Selection: The Guide provides criteria for selecting qualified CPAs, emphasizing expertise in FAR audits and the A/E industry.

Maximizing vs. Managing Overhead Rates

While accurately calculating FAR overhead rates is essential, focusing solely on maximizing them may not always be beneficial. In cost-plus-fixed-fee contracts, overhead is reimbursed but doesn’t generate profit, and in lump-sum contracts, higher overhead costs can reduce profitability.

A more effective approach is to minimize disallowances by ensuring compliance with FAR and controlling unnecessary expenses. Comparing overhead rates to industry benchmarks by region and firm size can also help firms remain competitive.

Identifying Disallowances Under FAR

FAR Subpart 31.2 outlines unallowable costs and establishes criteria for determining cost reasonableness and allocability. Costs are allocable to a contract as either direct costs specifically incurred for the contract or indirect costs if they are incurred for the overall operation of a firm. FAR 31.201-2 then provides that a cost is an allowable charge to a government contract only if it is:

  • Reasonable in amount;
  • Allocable to government contracts;
  • Compliant with Generally Accepted Accounting Principles (GAAP) and standards promulgated by the Cost Accounting Standards Board (when applicable);
  • Compliant with the terms of the contract; and
  • Not prohibited by any of the FAR Subpart 31.2 cost principles.

Determining which expenses included in a firm’s overhead costs are not allowable is essential in preparing a FAR overhead statement. Major disallowances for prohibited expenses under FAR Subpart 31.2 include:

  • Advertising
  • Bad debts
  • Charitable contributions or donations
  • Personal use of company vehicles
  • Fines and penalties
  • Lobbying and political activities
  • Interest expense

While some disallowances are straightforward, others, such as marketing costs, require careful interpretation. For instance, while promotional expenses are unallowable, direct sales efforts and bid proposal costs are generally allowable under FAR 31.205-18 and FAR 31.205-38.

In addition to the prohibited expenses listed above, another common and sometimes significant disallowance is based on the reasonableness of compensation. A/E firms are responsible for preparing an analysis to support the reasonableness of claimed compensation costs in accordance with FAR 31.205-6. Compensation at the executive level is closely scrutinized, as it often represents the highest cost component in overhead rates.

Another factor to consider is the Facilities Capital Cost of Money (FCCM). While interest expense is unallowable under FAR, firms may calculate and include FCCM in their overhead. FCCM is based on the average amount of fixed assets used in the firm’s operations multiplied by a published interest rate (the prorated average Prompt Payment Act Interest Rate set by the U.S. Secretary of the Treasury). Although FCCM is generally computed as a rate based on direct labor cost, FCCM should not be included as part of the overhead rate. Instead, it must be separately stated on the overhead schedule. FCCM can be part of the overhead charged to the customer if it is appropriately included in the terms of the contract.

Selecting a CPA for FAR Audits

Given the complexity of FAR overhead audits, firms must carefully vet CPA candidates. FAR overhead statements are unique, and FAR audits should be performed by a CPA who is experienced in working with A/E firms and performing FAR audits. Additionally, FAR audits must be performed in accordance with Generally Accepted Government Audit Standards (GAGAS), which are different from Generally Accepted Auditing Standards (GAAS) and require specialized training. The CPA that performs a FAR audit could be the CPA used by an A/E firm for other services, or if that CPA does not have the necessary experience, another specialized CPA may be employed.

The AASHTO Guide believes this matter to be so important that it has a section providing specific criteria to consider in selecting a CPA. Among other factors, the Guide indicates that the CPA should:

  • Meet all GAGAS requirements, including requirements for adequate continuing professional education (CPE) in governmental auditing;
  • Have received favorable peer review reports;
  • Be well-versed in GAGAS, the provisions of FAR Part 31, Cost Accounting Standards, related laws and regulations and the guidelines and recommendations set forth in the Guide;
  • Have a working knowledge of the A/E industry, including common operating practices, trends and risk factors;
  • Be well-versed in job-cost accounting practices and systems used by A/E firms;
  • Assign direct supervisory staff to the engagement who have prior experience performing overhead audits in compliance with FAR Part 31;
  • Have experience performing FAR audits and have knowledge of government procurement with regard to various types of contracts and contract payment terms affecting the development and/or application of an allowable overhead rate; and
  • Design and execute an audit program that meets the American Institute of Certified Public Accountants’ (AICPA’s) professional standards, as well as the specific testing recommendations described in the Guide.

Conclusion

Government contracts can be a profitable opportunity for A/E firms, but understanding FAR compliance is essential to success. Firms must stay informed about FAR regulations, the updated AASHTO Guide and best practices for calculating overhead rates.

Selecting a qualified CPA with FAR audit expertise is crucial to ensuring compliance and optimizing government contract opportunities. Consulting FAR compliance experts can also help firms navigate complex regulations and maintain a competitive edge in government contracting.

 

Contributing Author: Ryan R. Delao, CPA, is a manager at the firm who has a wealth of experience providing consulting services to a diverse range of clients. Ryan specializes in working with clients in the A/E and construction industries.