stores requisitions, summaries of returned materials, and scrap, may be grouped and those entries originating from journal entries or other adjustments can be segregated for special study.

80. Review of Purchase Distributions.

a. A representative portion of the individual entries originating from purchase distributions should be checked with such summaries.

b. A representative number of the individual summaries examined should be checked for clerical accuracy.

c. A representative number of the items appearing on the individual summaries should then be traced to the underlying invoices.

d. Part of the invoices should be reviewed to determine that they are properly supported by purchase orders and receiving reports.

e. The auditor should determine that cash discounts earned are being reflected as a reduction of material costs. Where these discounts are not specifically applied to the cost of materials, an average percentage of purchases may be used.

81. Review of Stores Requisitions.

a. A representative number of requisitions will be examined to determine that

(1) Prices used are properly supported by purchase invoices and that pricing is consistently applied on the basis of an acceptable method such as first-in, first-out, average cost, or last-in, first-out.

(2) Using department is indicated by receipt or other designation.

(3) Computations are accurate. (4) Requisitions are authorized by responsible personnel.

(5) Accounting distribution is proper.

b. Summaries of requisitions will be examined to determine that the summary footings are correct and the requisitions correctly listed.

82. Review of Materials Returned to Vendors. a. A representative portion of the individual returned materials credit slips should be reviewed to disclose material applicable to the contract.

b. A representative portion of items applicable to the contract should be checked with the summaries covering such items for accuracy of distribution.

c. A representative number of summaries examined should be checked for clerical accuracy.

d. Reference should be made to a representative number of underlying shipping documents to determine that material returned has been covered by debit memoranda which have been properly applied to costs.

83. Scrap.

a. When scrap is an important factor, the auditor should carefully survey the sources from which scrap originates, and should ascertain from engineering estimates and operating records, to the extent practicable, the quantities derived from the various operations. The recorded results should then be compared with these calculations and any significant variations investigated.

b. Quantities disposed of should be compared with quantities obtained from operations and with stocks on hand to determine that all scrap is accounted for within reasonable limits.

c. All sales or other disposition should be checked with the entries appearing as credits to direct material costs, to determine that recoveries from scrap have been fully recognized.

d. In cases where it is not practicable to physically segregate scrap applicable to the contract, the bases of allocation should be reviewed to determine whether they are equitable and accurately applied.

84. Over-All Checks as to Propriety of Total Direct Material Costs.

a. It is desirable that the auditor make certain over-all checks as to the aggregate direct materials costs stated as being applicable to the

contract.

b. Where practicable, the quantities indicated as required for each unit, or lots of units, as shown by the original bill of materials may be multiplied by the number of units, or lots of units, produced. The excess of quantities actually charged to the contract over the foregoing computation, after taking normal spoilage into consideration, should be approximately reconciled with stocks on hand and any significant discrepancies investigated.

c. Quantities purchased should also be reviewed in the light of the bill of materials, to determine whether unreasonable quantities were purchased and whether the contract has been charged with materials originally purchased for other work. In this connection, special attention should be given to standard parts which might be usable on other types of manufactured products.

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d. Where practicable, the bill of materials may also be priced and the computations and reconcilement outlined in b above carried out in terms of dollars.

DIRECT LABOR COSTS

85. General Objective. The auditor should determine that the amounts shown for direct labor costs represent direct labor services actually employed on the contract and at the costs incurred by the contractor.

86. Analysis of Direct Labor Control Account. As in the case of direct materials, the ledger account or the work sheet schedule covering the total direct labor costs applicable to the contract should be analyzed and the debits and credits to this account classified as to source of postings. The major source will be the pay roll distributions, but other entries may originate from miscellaneous sources.

87. Review of Pay Roll Distributions.

a. A representative portion of the entries in the general ledger account which have originated from pay roll distributions should be checked with the individual summary distributions.

b. Representative pay roll distribution summaries should be checked for clerical accuracy.

c. A representative number of items appearing on the individual summaries should be traced back to the underlying job tickets.

d. To the extent practicable, a representative number of job tickets should be checked with records of floor checks made by the timekeeping department or with other records which establish the accuracy of the job tickets used as a basis for preparing the distribution summaries.

e. A limited check should be made of related time cards, personnel records, and rates of pay, applicable to the job tickets reviewed.

88. Over-All Checks as to Propriety of Direct Labor Costs.

a. Where practicable, some check on the aggregate direct labor costs may be made by comparing labor costs with those incurred on previous contracts covering the same or similar products or, when available, with costs incurred by other manufacturers who are producing similar products, provided proper consideration is given to the circumstances which might justify differences.

b. Where practicable, the labor cost of each finished unit, or lots of units, as indicated by previous contracts or contracts with other manufacturers, may be multiplied by the number of units, or lots of units, of each type produced. The excess of total costs incurred to date over the amounts thus calculated should be approximately reconciled with the labor costs included in the inventory of uncompleted work and any significant discrepancies investigated.

OVERHEAD

89. General. The auditor should determine that the overhead totals, part of which have been allocated to the contract, are composed of items which are proper in the light of the cost principles set forth in paragraph 24, and that the allocation has been proper in terms of acceptable and accurately established bases.

90. Write-off of Prepaid Expenses and Deferred Charges. The auditor should make a sufficient examination of such accounts to determine that the bases of deferment and write-off are sound and in accordance with established policies.

91. Depreciation. The auditor should examine depreciation charges to such an extent as will provide reasonable assurance that the amounts subject to depreciation are proper; that the depreciation charges are stated on a basis consistent with the years preceding the contract; that the depreciation charges are calculated and handled in the accounts in an accurate manner. Where the rates have been reviewed and accepted for Federal income tax purposes, appropriate consideration should be given thereto.

92. Accrued Expenses. Sufficient examination. should be made of accrued expenses by the auditor to enable him to determine that the bases of accrual are sound and that the accounts are accurate.

93. Content of Overhead.

a. The overhead statements prepared by the contractor should be reviewed by the auditor to determine the types of items included.

b. Investigation will be made of important monthly fluctuations in the individual overhead

accounts.

c. Those overhead accounts which involve the greatest possibility of borderline decisions should be analyzed. Such analyses should put

the emphasis on the larger items charged to the accounts in question, but may be extended in the light of the findings.

d. Appropriate checks will be made to determine the accuracy and uniformity with which amounts or quantities used as the basis for proration (as, for example, direct labor dollars) are developed. Where possible, such amounts will be tied in to results obtained through other audit procedures.

e. The accuracy and propriety of the overhead proration computations should be established.

f. The auditor should determine whether physical inventories of supplies and indirect materials on hand in storerooms or on the floor have been taken at the date of termination and the relative overhead accounts appropriately adjusted. If such inventories have not been taken and there are indications that quantities on hand have increased during the overhead period, the auditor must consider the necessity of a suitable adjustment.

g. Where available and applicable to the contract, the results of year-end closings should be utilized. In this connection, use may also be made of Federal income tax returns, reports by independent public accountants, and internal financial reports.

h. Comparisons will be made between Federal tax returns and the books to ascertain major differences in accounting policies.

i. The auditor should determine that costs charged off in a renegotiated period have been excluded from the overhead accounts in accordance with paragraph 3(e) of the Statement of Principles for Determination of Costs. (See par. 24.)

MISCELLANEOUS

94. Credits. The auditor should ascertain that all miscellaneous income and other credits properly allocable to operations under the contract have been reflected in the settlement proposal.

SECTION V

DISPOSAL CREDITS

95. Introductory.

a. The auditing problem in connection with disposal credits is to establish the accuracy with which the amounts approved by the contracting officer for disposition of property have been reflected in the proposed settlement.

b. It is not the auditor's responsibility to pass upon the fairness of these values, or to question the judgment of the contracting officer. However, where there is evidence that incorrect or inadequate information was submitted to the contracting officer as a basis for his decision, such facts should be reported by the auditor.

96. Approvals of Disposal Prices. The auditor should ascertain that the disposal prices of the inventory items affected were approved by the contracting officer. For this purpose the auditor should obtain information directly from the files of the contracting officer.

97. Agreement of Detailed Disposal Credits With The Deduction From Proposed Settlement. auditor should satisfy himself that the disposal credits set forth on the inventory records by the contractor are accurately summarized and reflected as a credit in the proposed settlement.

98. Cooperation With Accountable Property Officer. The auditor should cooperate with the accountable property officer in the latter's determination that items to be taken over by the Government are accurately stated.

SECTION VI

SETTLEMENT EXPENSES AND COSTS OF PROTECTION AND DISPOSITION OF GOVERNMENT PROPERTY

99. Introduction.

a. The contractor's settlement proposal may include, in addition to costs incurred in connection with the performance of the contract, certain other costs of the type described in paragraph 1(k) and (1) of the Statement of Principles. (See par. 24.)

b. The audit procedures outlined in sections I to IV, chapter 3, generally are applicable to the costs discussed in this section. However, there are certain special phases of these costs which require further treatment.

100. Current Auditing Procedures. Since costs of the nature allowable under paragraph 1(k) and (1) of the Statement of Principles generally will be currently incurred, where appropriate the auditor will apply current auditing procedures, such as floor checking the presence of the contractor's employees on the job, and observation of receiving and material handling procedures.

101. Approval of the Contracting Officer. In addition to the applicable auditing procedures, the auditor will make checks to an appropriate extent to satisfy himself that, when required, the written approval of the contracting officer has been obtained by the contractor.

SECTION VII

CLAIMS OF SUBCONTRACTORS

102. Introductory.

a. When audits are made of subcontractor claims the principles and procedures set forth in this chapter are applicable.

b. This section deals with certain general relationships between Government personnel and the prime contractor with respect to the audit of subcontracts.

103. Government Auditor Not to Determine Subcontractor Claims. It is to be emphasized that the subcontractor has the responsibility of preparing his claim and the prime contractor the primary responsibility for the examination and approval of such claims. As in the case of the prime contract itself, the Government auditor is concerned with the accuracy of the accounting or other data relied upon by the contracting officer when this officer approves settlements which are made by the prime contractor.

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104. Consultation With Prime Contractor. the case of large terminations, as soon as the notice of termination has been given to the prime contractor, the Government auditor, where practicable, should consult with the prime contractor and assist him in formulating an adequate program for the review or examination of subcontractors' claims. The Government auditor can be of help to the prime contractor, although he should act only in an advisory capacity. During the subsequent period the checks made by the Government auditor may disclose weaknesses in the prime contractor's program, and those findings should be promptly transmitted to the prime contractor and discussed with him.

105. Audits to Check Effectiveness of Prime Contractor's Examinations. The Government auditor will consider the desirability of making and with the approval of the contracting officer will make independent checks to determine the effectiveness with which the prime contractor is carrying out his program. These checks will include, where practicable, field visits to representative subcontractors to determine whether the examinations and audits actually being made are carried out in an efficient and satisfactory manner.

106. When Audits May Be Made by the Government in First Instance.

a. In certain cases it may be advisable for the Government to make audits of particular subcontractors' claims. Such a case would exist when the desirability of an audit is indicated, but, because of geographical or other circumstances, it is clearly uneconomical for the prime contractor to make the audit. The Government auditor then might request that the audit be made by other Government auditors located in the area in question. In other special cases, the interests of the Government might require that audits be made by Government auditors.

b. When a field accounting representative has been appointed at a contractor's plant (see par. 126), he will perform all necessary reviews and audits of any claims forwarded by that contractor acting in the capacity of a subcontractor. 107. Checking Summaries Prepared by Prime Contractor. The prime contractor will present a schedule of subcontractors' claims, supported by the documents submitted by the claimants and other pertinent papers. The Government auditor will determine that all claims listed are in agreement with settlement proposals made by the subcontractors and agreed to by the prime contractor. The mathematical accuracy of all summarizations will also be appropriately checked.

108. Approval of the Contracting Officer. In addition to the applicable auditing procedures, the auditor will make checks to an appropriate extent to satisfy himself that, when required, the written approval of the contracting officer has been obtained by the contractor.

SECTION I

WORKING PAPERS

109. General Objectives. Working papers serve two major purposes: they are an essential historical record of the auditing procedures carried out and of all significant data and findings incident to and arising from the audit; and they are an important means of currently administering the auditing work. Working papers, therefore, should be prepared in such form as to achieve these objectives to the maximum extent.

110. Form of Preparation. Each sheet should show the name of the contractor, contract number, subject matter, date, and name of the staff member who prepared it. No more than one type of subject matter should be covered on each sheet. Wherever practicable, schedules available from the contractor should be incorporated in the working papers without recopying. In preparing working papers, the auditor should keep in mind that they will normally be reviewed by higher authority and may also be used as a source of reference and general information by other interested parties. The auditor, therefore, should endeavor to prepare his working papers in a manner which will facilitate their use by other persons.

111. Indexing of Papers. All working papers should be indexed, so far as practicable, by the major types of costs as listed in the contractor's proposed settlement. A copy of the proposed settlement, as presented by the contractor, should be included in the working papers for this purpose. Other papers, such as the review of internal control and other pertinent memoranda, should be separately grouped.

112. Preservation of Working Papers. The importance of carefully preserving the working papers cannot be overemphasized inasmuch as the auditor must be in a position to justify and support the facts included in his report. When

a. The auditor's report is the means by which the auditor summarizes the results of his work. In his report he sets forth the nature and extent of the representations made by the contractor in the latter's formal proposed settlement. The function of the auditor is that of investigating the factual accuracy of the contractor's representations, and his report should present the results of such investigation including comments upon the basis of the determination of profit. Information is thereby provided to assist the contracting officer in effecting a settlement with the contractor.

b. It is necessary that such reports cover all matters which will be of significance in determining appropriate settlements, and it is desirable that they follow a uniform pattern as to major types and form of content. The auditor should, however, avoid unnecessary detail in his report, limiting his presentation to main essentials and depending on his working papers as a source of further reference, should additional detail be necessary at some later time.

c. The report of the auditor covering a proposed settlement which requires only an office review may consist only of a memorandum to the contracting officer if the information has been presented in acceptable form by the

contractor.

d. Where the terminated contract has been classified as secret, the auditor should not include any description of the product in his report. In instances where this procedure is not feasible, the report will necessarily be classified as secret.