Government contractors are required to track uncompensated overtime worked by employees. This is often confusing for contractors, since there’s no additional cost associated with salaried employees who work more than forty (40) hours per week. In this article, we explore uncompensated overtime, and why it’s important when working with the Federal Government.
What is uncompensated overtime?
Uncompensated overtime occurs when salaried employees who are paid a fixed amount regardless of hours worked, and who are exempt from the Fair Labor Standards Act, work more than the standard 8 hour day or 40 hour week. Uncompensated overtime is measured by the number of hours worked in excess of the standard.
What is a T&M payment?
Time and materials (T&M) refers to when an employer pays a contractor based on actual time spent to perform work and for the materials used in the performance of the work.
Why does uncompensated overtime matter?
If uncompensated overtime is worked but not accounted for properly, and a salaried employee works on multiple contracts, it is more difficult to achieve equity in allocating costs to government contracts. This occurs because the actual hourly cost of the employee changes based upon the total number of hours the employee works for a given salary. If a contractor fails to account for uncompensated overtime, the hourly cost of the employee will be overstated, and costs allocated to contracts are likely to be distorted.
Even if uncompensated overtime amounts are insignificant, auditors will test to validate proper recording of time. Auditors test for uncompensated overtime by conducting timesheet testing, performing floor checks, and conducting employee interviews to determine whether all hours worked are being properly recorded by employees and approved by management.
Examples of non-compliant timekeeping that can rise to a level of fraud indicator:
- Professional staff routinely work unpaid overtime on projects
- Salaried employees routinely charge only for the first 8 hours per day worked
- Pattern of employees bonuses for unpaid overtime
- Cost-type government contract work performed during regular 8-hour workday, and fixed-price work performed as unpaid overtime
- Overrun contract work performed only during unpaid hours
- Employees are encouraged to work unpaid overtime without recording hours in direct conflict with written timekeeping policy
Federal auditors do not have the latitude to overlook any deficiency in a contractor’s timekeeping practices.
What is total time accounting?
Contractors will often hear references to total time accounting. Total time accounting is another term used to reference uncompensated overtime, and is the method used to record and bill for each hour worked by employees, whether paid or unpaid, and also refers to allocating the associated cost of labor to contracts. Any compensated personal absences during the normal work week like holidays, vacations, and sick leave are also included in reporting.
Does DCAA require total time accounting?
Total time accounting is the standard for defense contractors.
The DCAA audit manual, DCAM (Chapter 6-410.3), states “If it is determined that Government contracts are being materially over-charged due to an inequitable allocation of labor costs because the contractor does not record all time worked, the contractor should be cited as being in noncompliance with FAR 31.201-4 and, if applicable, CAS 418.”
What are DCAA timekeeping requirements?
Because labor costs and associated overhead are affected by total hours worked, whether paid or not, labor rate computations and labor overhead costs should reflect all hours worked. This practice impacts direct labor rates charged to contracts, and also impacts indirect rates and allocation of cost. DCAA cites CAS 418 that the exclusion of uncompensated overtime hours from timekeeping distorts the overhead base and corresponding overhead indirect rate. When DCAA reviews a contractor’s timekeeping system, they are trying to ensure it reports all costs in the base for distribution of indirect costs in accordance with CAS 418.
DCAA recognizes two acceptable methods for recording total time:
- Average Labor Rate Method – Calculates an individual average labor rate (effective rate) for each period by dividing the salary paid to an employee by total hours they worked and then distributing that rate to all cost objectives for that period. Uncompensated overtime is prorated at the effective hourly rate accordingly. For an employee who is paid a salary amount of $2,000 per week, their normal hourly pay rate would be $50 per hour or $2,000/40 hrs. When the same employee works 50 hours, their effective hourly pay rate is now $40 per hour, or $2,000/50 hrs. This is the most commonly used method.
- Pro Rata Allocation Method – Calculates the ratio or percentage of hours worked for the period for each cost objective and then allocates the employee’s salary based on that ratio.
Avoiding non-compliance associated with uncompensated overtime:
- Use consistent estimating and billing practices: Inconsistent estimating, accounting, and reporting for uncompensated overtime will be deemed inadequate and non-compliant with the allowable terms of your contract.
- Create and follow a consistent accounting practice for overtime hours worked by exempt salaried employees: Be consistent with method of estimating, accumulating, and reporting costs and uncompensated overtime.
- For competitively awarded T&M contracts, record and bill all qualifying hours worked: That is unless prohibited by specific contract terms. For these awards, no consideration of cost data or accounting practices for uncompensated overtime is given. Proposed hourly rates are evaluated against competitive offers.
- Use a standard billing rate: Estimate annual employee hours and divide the employee’s annual salary by the estimate. This is a standard cost application. Variances, like estimated hourly rate vs. actual hourly rate, are cleared at least annually and applied to cost objectives. The Payroll Variance method is commonly used to adjust the overhead credit. This method multiplies the variance of hours from a 40 hour week by the standard hourly rate and then charges the variance to an overhead “variance” account.
- Establish written policies and procedures for timekeeping practices: Include the company process for both pricing and accounting for compensated and uncompensated overtime hours detailing one of the accepted DCAA methods for total time accounting.
Compliance self-assessment for contractors
To ensure compliance with sound governmental contracting and accounting practices, contractors should conduct their own regular internal audits of timekeeping and labor distribution policies, procedures, and practices.
- Is there a written DCAA compliant timekeeping policy? Where does it live?
- Are all employees informed of the policy? How are they informed?
- Is time tracked daily?
- Is reporting accurate? How is accuracy ensured?
- How is time tracking information approved to ensure compliance?
- Where are any changes recorded?
- What is the process for keeping complete, accurate, timely records?
- Are administrative processes stream-lined to make compliance easier?
If you have questions, or need help implementing compliant total time accounting practices, please contact us for guidance and further expertise.