Audit Reports

February 05, 2009

FHWA's Oversight of Design and Engineering Firms' Indirect Costs Claimed on Federal-Aid Grants

Project ID: ZA-2009-033


On February 5, 2009, we issued our audit report on the Federal Highway Administration’s (FHWA) implementation of Section 307 of the National Highway Systems Designation Act (NHSDA). Section 307 of NHSDA requires the use of the Federal Acquisition Regulation as criteria to determine cost allowability when performing indirect cost rate audits of design and engineering (D&E) firms. Indirect rates are comprised of costs such as executive compensation; employee fringe benefits and wages; facilities charges; and insurance, legal, consultant, and travel costs. State departments of transportation (DOT) use indirect cost rates for reimbursing D&E firms for allowable costs incurred, establishing final contract costs, and negotiating new contracts. Our audit objectives were to evaluate the implementation of NHSDA Section 307 audit requirements, and test the allowability of executive compensation and other high risk indirect cost elements billed by D&E firms on state DOT contracts. Indirect cost rate claims from 21 of our sample of 41 D&E firms included unallowable costs–some expressly unallowable–totaling about $15.7 million. About $10.7 million of the $15.7 million were unallowable executive compensation and about $5 million were other unallowable costs. Of the total, state DOT contracts were charged about $5.5 million, of which about $4.4 million–the Federal share–was reimbursed with Federal–aid funds. Based on the sample test results, we projected that, overall, D&E firms overcharged state DOT contracts for unallowable executive compensation of $41.2 million (the Federal share charged to state DOT contracts is $32.9 million). Lack of accountability at D&E firms and insufficient transaction testing by Certified Public Accountant (CPA) firms were the immediate causes of unallowable costs we found. Further, FHWA and state DOT oversight did not ensure effective monitoring of D&E firms’ indirect cost rate claims or indirect cost rate audits performed by CPA firms. We recommended that FHWA: (1) require D&E firms to certify their claims and authorize state DOTs to assess penalties when D&E firms claim known unallowable costs; (2) assign responsibility to specific states for overseeing CPA audit work; (3) issue guidance on how to effectively procure audit services; (4) establish an oversight program and process for monitoring state DOTs’ implementation of Section 307 of NHSDA; and (5) recover the unallowable executive compensation costs and other unallowable expenses identified in this audit.