UNCOMPENSATED OVERTIME AND TOTAL TIME ACCOUNTING
-- Eric S. Sobota

As the United States continues to expand its service-based economy, the cost of labor has been an exceedingly crucial element of managing the overall costs of projects. In the realm of Federal contracting, it is not only critical, but a regulatory mandate. Most government contractors know the drill well: timecards, approvals, project charge codes and cost accounting by contract. However, the idea of recording all hours worked during a day has not been a hugely important issue to many companies, especially given the use of specialized, yet salaried employees. The use of total time accounting ("TTA") and its resultant impact on contract costs is more important than ever. But how should you effectively manage its use at your organization?

Total time accounting, in its most simplistic form, is accounting for the cost of labor utilizing ALL hours worked. It sounds easy, but many contractors do not record and track all hours worked. Instead, some business accounting systems only allow employees to charge labor costs for a maximum of 8 hours of work per day. For many employees covered by the Fair Labor Standards Act (FLSA), this poses no problem because they are statutorily limited to 8 hours of work per day. However, for employees who are exempt from the FLSA, working more than 8 hours is common and increasingly the norm.

What happens to the weekly hours that an exempt employee works in excess of the 40 hours that can be recorded and charged by a 40-hour-only accounting system? The answer is that companies often differ in their methods for handling this "uncompensated overtime," and the varying methods have different effects on revenues and ultimately a company's bottom line. Given this real potential for contractors to manipulate revenues, government auditors are understandably wary of accounting systems that do not account for all hours worked. The following example further illustrates the point:

Assume John Doe is an exempt employee earning a fixed salary of $50,000 per year from his employer. John works on two government contracts. One is a fixed-price contract and the other is a cost reimbursable contract. John works 12 hours per day: 6 hours on the fixed price contract and 6 hours on the cost reimbursable contract. John's employer's accounting system only allows John to enter 8 hours of labor per day. Which 8 hours of John's 12 hour days does John record?

If John records 2 hours to the cost reimbursable contract and the remaining 6 hours of the day to the fixed-price contract, his employer will be compensated for 2 hours of time on the cost reimbursable contract. However, if John instead charges 6 hours to the cost reimbursable contract and 2 hours to the fixed price contract, John's employer will be compensated for 6 hours on the cost reimbursable contract. Since his employer will receive the same revenues on the fixed-price contract regardless of how many hours John records, his employer would clearly rather be compensated for 6 (instead of 2) of John's hours on the cost reimbursable contract. John's salary is fixed at $50,000, and the excess revenue gained by John charging 6 hours to the cost reimbursable contract is added revenue. The judgment involved in such a system of time charging results in the ability for an employer to potentially game the system.

A slightly different scenario presents the same problem. Assume John is only working on a cost reimbursable contract. He works 2 hours on the contract in the morning then spends the next 6 hours working on non-billable activities. After those 6 hours, he spends 4 more hours working on the cost reimbursable contract again. How does he charge his time if the system only accepts 8 hours? As in the example above, it would be most advantageous to his employer if John chose to charge all 6 hours worked on the contract despite the fact that 4 of those hours are worked using uncompensated overtime. To gain this advantage, companies will sometimes schedule cost reimbursable work first or simply allow employees the ability to choose which cost objectives to charge.

Last, in situations where an employee is only required to charge 8 hours of work per day, there may be no incentive to charge non-billable time worked in excess of 8 hours per day. (Why would the employee be motivated to charge the time if the company will not receive compensation for it?) There may be a similar disincentive to charge time in excess of 8 hours per day on a fixed-price contract that is over budget. If the hours are not recorded, however, then the effective hourly rate charged to the government will be unjustifiably high.

To illustrate how this occurs, assume an employee receives an annual salary of $52,000 per year ($1,000 per week). If this employee works 40 hours per week on a government contract the effective hourly rate, the government would pay for that employee would be $25 ($1,000/40 hrs). However, if the employee actually works 40 hours per week on a government contract and 10 additional hours per week on non-billable activities the employee's actual effective hourly rate would instead be $20 ($1,000/50 hrs). If the employee did not record the excess 10 hours, either because the time was non-billable or because it was spent performing on an over-budget fixed-price contract, the government will be overcharged $5 per hour, the difference between the $25 hourly rate and the $20 hourly rate.

Total time accounting prevents companies from gaming the time charging process. The Defense Contract Audit Agency ("DCAA") considers TTA a requirement of FAR 31.201-4 and CAS 418. The DCAA audit manual recognizes the following three acceptable methods of accounting for uncompensated overtime:

1. Average Labor Rate Method. Calculate a separate average labor rate for each labor period. That is, the salary paid divided by the total hours worked during the period, and distribute the salary cost to all cost objectives worked on during the period using the average rate.
   
   
2. Pro Rata (Percentage) Allocation. Calculate a percentage of total hours worked over a period of time on each cost objective and allocate an employee's salary during that time period according to the pro rata distribution of work performed.
   
   
3. Estimated Hourly Rate Method. Compute an estimated hourly rate for each employee for the entire year based on the total hours the employee is expected to work during the year and distribute salary costs to all cost objectives worked on at the estimated hourly rate. At the end of the year charge/credit any variance between actual salary costs and the amount distributed to overhead.

These methods are simple, effective and most importantly, required by government contracting regulations. Accordingly, all government contractors should ensure that their time charging system is capturing all hours worked and allocating the cost to all hours worked using one of the aforementioned methods. Doing so not only requires investment in compliant accounting and timekeeping systems, it is also requires the implementation of effective policies, procedures and employee training programs.

Eric Sobota is a manager in our Consulting Practice. For additional information, please contact Eric at 703-923-8607 or esobota@beersandcutler.com