Federal single audits often report questioned costs; know what they are and how to avoid them

Imagine this scenario: A local government receives federal funding to construct a bridge. Without obtaining approval from its awarding agency, it decides to spend the federal award money on a different project. It’s not hard to imagine an auditor will take issue with this and report an audit finding citing internal control deficiencies and questioned costs.  

These are the stakes 

Here’s why this matters to you: If a federal single audit identifies unallowable costs that exceed $25,000, the auditor must report them as “questioned costs” in an audit finding. Additionally, the awarding agency may ask you to repay the funds. 

A questioned cost means an amount, expended or received from a federal award, that in the auditor’s judgment is noncompliant or suspected noncompliant with federal statutes, regulations or the federal award’s terms and conditions. Questioned costs might also include those that lack documentation, appear unreasonable or did not reflect the actions a prudent person would take in the circumstances. 

Some examples of commonly questioned costs include: 

• Payroll costs charged to a federal award based on budget estimates  

• Lack of support for payroll charges, such as missing timesheets 

• A duplicate charge to a federal award  

• Costs incurred before the award’s period of performance, without prior approval 

How to reduce your risks 

To reduce your risk of questioned costs, you should maintain a strong system of internal controls over your federal awards as covered in our new single audit guide: Essentials of Managing Federal Awards. We have found several internal control-related items commonly associated with questioned cost findings. Next, we will cover those items including steps you should take to understand federal award requirements, how to maintain the proper documentation, and some additional key controls you might put in place.  

Take steps to understand the federal award requirements 

• Obtain a complete understanding of all administrative (compliance) requirements. It’s critical to have a complete understanding of all compliance requirements, because in certain situations noncompliance can prompt the auditor to question costs. You should do this by reading your federal award and its terms and conditions, federal or pass-through awarding agency guidance, any applicable federal laws and regulations, and the Uniform Guidance. Another source to confirm your understanding of your federal award requirements is the Office of Federal Financial Management’s annual Compliance Supplement. It provides information for auditors but can help you, too. You might start by searching for your award, under the applicable federal agency.  

• Practice due diligence when you start anything new or unusual. If you do anything new, do your homework. You might receive a cash advance, give out subawards for the first time, or want to spend money on a new activity or expenditure type. Whatever it is, do your research first. You should consult your award’s terms and conditions, program guidance, applicable federal laws and regulations, the Uniform Guidance, and inquire with your awarding agency if needed.  

• Keep up with changing guidance. Assign staff to monitor awarding agency and other authoritative guidance for changing requirements, so that you may implement it. Even long-standing programs periodically impose new requirements. You may have to dedicate resources so staff have time in their work schedule to accomplish this important task.  

• Don’t be afraid to ask questions. Check in with your awarding agency when questions arise and document their response as well as any guidance used at the time of the decision.  

Maintain the right documentation 

• Support payroll charges. Auditors commonly question costs due to improper support for payroll charges. Take time to understand Uniform Guidance requirements for compensation and fringe benefits. Consider implementing policies and procedures for how you will charge payroll to a federal award, who will do what and when, and how you will document it.  

• Obtain prior written approval for certain costs. You must spend the funds consistent with your award application and agreement unless you have prior written approval from the awarding agency. You must also obtain prior written approval for certain cost types, as per the Uniform Guidance Cost Principles. You might also voluntarily seek prior approval for any costs you are unsure about to avoid any future disputes or disallowances.  

• Identify specific costs instead of using cost pools. If you must use a larger cost pool, make sure all costs are allowable under your federal award. For example, if your federal program covers $1 million of transportation costs, and you point your auditor to records consisting of $10 million of transportation costs, then you must ensure the federal award would allow all $10 million. Your auditor will sample from the $10 million cost pool, and question any unallowable costs they find. The fact that you have plenty of other eligible costs in the pool will not eliminate the identified questioned costs. A less risky practice is to identify the specific $1 million in costs you will charge to the federal award. 

Put some important controls in place 

• Create an award profile. Someone should carefully review the award agreement and applicable federal statutes and regulations and document all the key requirements. For example, staff should document the allowable (and unallowable) costs and activities under the federal award. Someone else should review their work and approve it. That way, you have a detailed profile for each federal award that you can refer to, even if you experience turnover. 

• Implement a robust expenditure review process. Someone knowledgeable should review expenditures before you charge them to federal awards, to ensure you only charge allowable costs to the federal award. A knowledgeable person should also review a detailed expenditure report before you submit a claim to the awarding agency. (Note: A knowledgeable person is an employee who understands the allowable and unallowable activities and costs for that specific federal program, as well as Uniform Guidance Cost Principles). 

• Ensure staff receive training. Staff managing federal awards should familiarize themselves with the Uniform Guidance, including the Cost Principles. Provide your staff ongoing training on the Uniform Guidance requirements. Our Office gives several trainings per year through the Washington Finance Officers Association; see information below.  

I’ve received a questioned cost finding; what now? 

If you receive a questioned cost finding, first work with your auditor to complete the corrective action plan and provide a finding response. Once you submit your reporting package to the Federal Audit Clearinghouse (FAC), the federal agency or the pass-through agency that provided the program’s funding will issue a management decision within six months of the FAC’s acceptance of the audit report. You will want to work with your awarding agency, to navigate their audit resolution process. During the next audit, your auditor will follow up and work with you to prepare a status of prior audit findings report – which will indicate whether you have fully resolved the finding.  

Your auditor will provide audit recommendations to you in the audit finding, to help guide you in improving your internal controls. Take a moment and consider the learning opportunity it provides. You have the chance to evaluate what went wrong and improve your controls going forward. 

Additional resources 

• The State Auditor’s Office Essentials of Managing Federal Awards - A Compliance Handbook resource is an overview of the Uniform Guidance requirements. Our Office uses this handbook during our six-hour training class, "Federal Award Requirements for local government recipients.” For more information about how to sign up for this class, see below.  

• The Office of Management and Budget’s annual Compliance Supplement, Part 4 provides, by federal agency, a summary of compliance requirements for many federal programs. Part 6, Appendix 2, contains illustrative controls for meeting the common administrative requirements.  

• The State Auditor’s Office Federal programs risk assessment tool resource can help you assess risk or challenges related to meeting the objectives of federal programs. For more information on how to use this tool, read this article. 

Additional help 

While your awarding agency is the best source for information about a federal program, you can also submit technical questions about federal awards to our HelpDesk in the client portal. 

We offer training on federal award requirements through the Washington Finance Officers Association (WFOA); our next class is May 20, 2025. You can sign up using the WFOA non-conference training schedule. Other organizations also offer training, such as Government Finance Officers Association, American Institute of Certified Public Accountants, and the National Grants Management Association. 

If you have other questions, comments or suggestions, feel free to email us at Center@sao.wa.gov.