How to Prepare for a TxDOT Indirect Cost Rate Audit

A TxDOT indirect cost rate audit can move more efficiently when the accounting records, cost classifications, and supporting documents are organized before the CPA begins testing. Waiting until fieldwork to identify unreconciled schedules, inconsistent labor coding, or unsupported adjustments can create delays and increase the cost of the engagement.

Preparation should begin with the general ledger—not with a rate copied from a prior-year schedule. The goal is to produce a current-year indirect cost rate schedule that reconciles to the firm’s accounting records, reflects appropriate direct and indirect classifications, excludes unallowable costs, and is supported by documentation that can withstand CPA and TxDOT review.

This guide outlines the practical steps engineering firms and consultants can take before a TxDOT indirect cost rate audit begins.

Confirm that a CPA audit is the correct pathway

Before preparing an audit package, confirm that your firm actually needs or has elected an independently audited rate.

TxDOT’s PEPS administrative-qualification process may involve an accepted audit, self-certification, or—for an eligible firm pursuing qualifying federally funded work—the Texas Federal Safe Harbor Program. The appropriate pathway depends on the firm’s circumstances, the work pursued, the applicable funding and solicitation requirements, and TxDOT approval.

A CPA audit of an indirect cost rate is also different from an audit of financial statements used for contractor prequalification. Firms should identify the applicable TxDOT process before engaging a CPA or building the submission.

If you have not yet made that determination, begin with Does Your Firm Need a CPA-Audited Indirect Cost Rate for TxDOT? and confirm the intended path and deadline.

How to prepare for a TxDOT indirect cost rate audit

To prepare for a TxDOT indirect cost rate audit, organize the work in eight areas:

1. Establish the audit period and submission timeline.

2. Close and reconcile the accounting records.

3. Build the indirect cost rate schedule from the trial balance.

4. Review direct, indirect, and unallowable cost classifications.

5. Reconcile labor and payroll records.

6. Complete executive-compensation and bonus support.

7. Document internal controls and accounting practices.

8. Assemble the TxDOT submission files and perform a final quality review.

   
   

Each area is discussed below.

1. Establish the audit period and timeline

The audit must be based on the provider’s fiscal year. TxDOT states that an approved rate becomes effective six months after fiscal year-end—or immediately if filed more than six months after fiscal year-end—remains effective for no more than 12 months, and expires 18 months after the fiscal year-end on which it is based.

Work backward from the applicable qualification or solicitation deadline and allow time for:

• Closing the fiscal-year accounting records;

• Preparing the rate schedule and related analyses;

• Providing requested support to the CPA;

• Completing audit testing and resolving questions;

• Correcting schedules or accounting classifications;

• Finalizing the audit reports and required certifications; and

• TxDOT’s submission and review process.

Do not treat the 18-month expiration point as a preparation deadline. Beginning shortly before the existing rate expires may leave insufficient time for the audit and TxDOT review.

2. Close and reconcile the accounting records

The rate schedule should be built from finalized books for the applicable fiscal year. Before fieldwork, reconcile material balance-sheet and income-statement accounts and address unresolved or suspense items.

At a minimum, review:

• Cash and bank reconciliations;

• Accounts receivable and unbilled revenue;

• Accounts payable and accrued expenses;

• Payroll liabilities and payroll reports;

• Fixed assets, depreciation, and disposals;

• Prepaid expenses and other deferrals;

• Credit cards and employee reimbursements;

• Related-party balances and transactions;

• Revenue and direct project costs; and

• Year-end journal entries.

The final trial balance should agree to the general ledger and to any issued financial statements. If adjustments are made after the rate schedule is prepared, update the schedule and retain a clear record of the changes.

3. Build and reconcile the indirect cost rate schedule

The indirect cost rate schedule should connect the firm’s accounting records to the proposed rate in a transparent way. TxDOT requires direct labor cost as the allocation base for administrative qualification.

The schedule generally should show:

• Direct labor forming the allocation base;

• Indirect labor and other overhead costs;

• Fringe-benefit costs, when separately presented;

• Facilities, technology, insurance, administrative, and similar indirect costs;

• Adjustments and exclusions for unallowable costs;

• Reconciliation to the trial balance or general ledger; and

• The resulting rate calculation.

Create a mapping from every relevant general-ledger account to its treatment on the schedule. The mapping should identify whether an account is direct, indirect, excluded, or partly allowable and partly unallowable.

A difference between the trial balance and the schedule should never be left as an unexplained plug. Document reclassifications, eliminations, and adjustments so the CPA and TxDOT reviewer can follow the reconciliation.

4. Review direct, indirect, and unallowable costs

An indirect cost rate audit is not limited to verifying arithmetic. The CPA must consider whether costs are classified and treated in accordance with the applicable criteria, including 48 CFR Part 31 and the AASHTO Uniform Audit and Accounting Guide.

Focus on areas that commonly require judgment or additional support, including:

• Advertising and public relations;

• Alcohol, entertainment, and social activities;

• Contributions and donations;

• Fines and penalties;

• Interest and other financing costs;

• Lobbying and political activity;

• Legal and professional fees;

• Travel, meals, and employee reimbursements;

• Personal or owner-related expenses;

• Related-party rent or other transactions;

• Vehicles and mixed business/personal costs;

• Direct project costs recorded in overhead;

• Indirect costs charged directly to selected projects; and

• Costs that contain both allowable and unallowable components.

Do not rely solely on account titles. An account called “marketing,” “travel,” or “professional fees” may contain transactions with different treatments. Review transaction-level detail, segregate unallowable amounts, and retain support for the conclusion.

Costs that are expressly unallowable—and directly associated costs when applicable—should be identified and excluded. The firm should also consider whether penalties or other consequences may apply when expressly unallowable costs are included in a submission.

5. Reconcile labor, payroll, and project records

Labor is central to the indirect cost rate because direct labor is the allocation base and labor-related costs often form a significant portion of overhead.

Before the audit, confirm that:

• Total labor recorded in the timekeeping system reconciles to payroll and the general ledger;

• Employees record all hours worked under the firm’s established policy;

• Direct project time is assigned to the correct project or job code;

• Indirect time uses defined and consistently applied codes;

• Corrections to time records are documented and approved;

• Paid leave and uncompensated overtime are treated consistently;

• Payroll taxes and benefits reconcile to supporting reports; and

• Owners and executives follow the same timekeeping requirements applicable to their work.

Investigate unexplained differences before providing the records to the CPA. A reconciliation prepared during the audit is usually slower and more difficult than one completed by personnel familiar with the payroll and project systems.

6. Prepare executive-compensation and bonus support

TxDOT requires an annual compensation analysis for all executives. Its current CPA-audit submission instructions permit an analysis using the National Compensation Matrix or qualifying compensation surveys. If surveys are used, TxDOT requires three acceptable surveys and supporting copies; the analysis must follow the applicable FAR and AASHTO requirements and be signed and dated by a company officer.

Prepare:

• A complete list of executives and their total compensation;

• The role, responsibilities, and relevant characteristics of each position;

• The selected compensation-analysis method;

• The underlying matrix data or acceptable surveys;

• The calculation of any allowable or disallowed amount;

• Reconciliation to payroll and the general ledger; and

• The signed and dated analysis.

For bonuses, assemble the detail by employee or identification number, the calculation and amount paid, and the written bonus plan. Evaluate whether the plan and the compensation are adequately supported under the applicable requirements.

7. Document internal controls and accounting practices

TxDOT’s current CPA-audit submission list includes an internal-control report and a completed AASHTO Internal Control Questionnaire. The firm should be ready to explain how its accounting system identifies, records, reviews, and reports contract costs.

Document controls over:

• Timekeeping and time-record approval;

• Project setup and direct-cost coding;

• General-ledger account creation and mapping;

• Expense reports and employee reimbursements;

• Credit-card activity;

• Payroll processing;

• Related-party transactions;

• Fixed assets and depreciation;

• Journal-entry preparation and approval;

• Identification of FAR-unallowable costs; and

• Preparation and review of the indirect cost rate schedule.

Written policies should reflect actual practice. If the documented process and the way personnel perform the work differ, resolve the gap before the audit.

8. Assemble the audit and TxDOT submission files

TxDOT currently lists the following items for a CPA-audit submission:

• CPA’s indirect cost rate report and schedule;

• Certification of Final Indirect Costs;

• Overhead audit report;

• Internal-control report;

• Completed AASHTO Internal Control Questionnaire;

• Executive-compensation analysis;

• Trial balance;

• Organization chart;

• Chart of accounts;

• Depreciation schedule and asset listing;

• Bonus detail and calculations;

• Written bonus plan; and

• Audited financial statements, if any.

TxDOT specifies Excel format for the CPA’s rate schedule, trial balance, depreciation schedule, and bonus detail. The documents should be submitted as separate, clearly labeled files rather than one combined package.

TxDOT may request a detailed general ledger and requires unrestricted access to the CPA’s audit workpapers, records, and other information requested by the PEPS Administrative Qualifications Group. Organize the supporting records so they can be retrieved promptly.

Perform a final audit-readiness review

Before fieldwork begins, ask someone other than the preparer to verify that:

• The fiscal year and entity name are consistent across all documents;

• The trial balance agrees to the general ledger and financial statements;

• The rate schedule mathematically recalculates;

• Direct labor agrees to the labor reconciliation;

• Each general-ledger account is mapped;

• All exclusions and adjustments are documented;

• Executive compensation and bonuses reconcile to payroll;

• The depreciation schedule agrees to the general ledger;

• Related-party transactions are identified and supported;

• Required signatures, dates, and notarization—when applicable—are complete; and

• The file names and formats follow the current TxDOT instructions.

A good readiness review does not guarantee that the CPA or TxDOT will have no questions. It does reduce avoidable follow-up and makes it easier to respond when additional information is requested.

Common mistakes that delay a TxDOT indirect cost rate audit

The most common delays occur when:

• The books are still changing after fieldwork begins;

• The rate schedule does not reconcile to the trial balance;

• Labor reports do not reconcile to payroll;

• Direct and indirect classifications are inconsistent;

• Unallowable costs remain mixed with allowable expenses;

• Executive-compensation support is incomplete;

• Related-party transactions lack documentation;

• The firm cannot produce transaction-level support;

• Policies do not match actual practice; or

• The submission is assembled without allowing time for CPA and TxDOT review.

Addressing these issues before the audit is generally more efficient than resolving them one request at a time during testing.

How JConner can help

JConner helps engineering firms and consultants prepare reliable indirect cost rate schedules and supporting records for TxDOT administrative qualification.

Our TxDOT services include:

• CPA audits of indirect cost rate schedules;

• Indirect cost rate development and general-ledger reconciliation;

• FAR Part 31 unallowable-cost reviews;

• Labor and payroll reconciliation;

• Accounting-system and internal-control assessments;

• Executive-compensation analysis support;

• Audit-readiness assistance; and

• TxDOT submission support.

We can begin with a readiness assessment, identify gaps before fieldwork, and coordinate the rate-development and audit process based on the firm’s circumstances.

Discuss Your TxDOT Requirements

For a practical pre-audit review, download the TxDOT Indirect Cost Rate Readiness Checklist from the firm’s resource library.

View TxDOT Resource Library

Official resources

• TxDOT — Certified Public Accountant Audit

• TxDOT — Submittal Format for a CPA Audit Report

• TxDOT — Submittal and Review Process

• Federal Acquisition Regulation — Part 31

• GAO — Government Auditing Standards, 2024 Revision

• FHWA — Certification of Final Indirect Costs

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This article is provided for general educational purposes and does not constitute legal, accounting, or contracting advice. Requirements may vary based on the solicitation, funding source, services, entity structure, and current TxDOT guidance. JConner is an independent CPA firm and is not affiliated with or endorsed by the Texas Department of Transportation.