In practice, it is generally the determinations of the Defense Contract Audit Agency that determine whether "the government" accepts or rejects the contractor’s handling of uncompensated overtime in both bidding and costing circumstances. It is important to understand DCAA’s guidance because (1) it is, by far, the most comprehensive and (2) is, by default, the primary basis of determining proper treatment of UOT.

DCAA’s Contract Audit Manual (DCAM) Part 6-410 addresses UOT. Its stated goal is to determine (1) whether a contractor accounts for all hours worked and if not, whether the government materially suffers (2) whether the contractor is allocating an "equitable share" of labor costs to government contracts (e.g. is not "gaming" the system) and (3) whether all work such as UOT is included in the base for purposes of calculating indirect cost rates.

The DCAM does not require total time reporting unless there is a "material" inequity from the contractor’s failure to record total time. CAM refers to DFARS 252.237-7019, and instructs its auditors to request a copy of the contractor’s policy addressing UOT and make sure that that the contractor’s method of bidding UOT is consistent with the way it accounts for UOT. If the contractor records only forty hours per week, the auditor is to conduct a floorcheck and/or interview exempt emploees to determine whether they work more than 40 hours. If there is UOT, the auditor is to suggest that full time recording is preferable. If the contractor refuses, the auditor is then encouraged to expand the floorcheck/interviews to determine whether the failure to record all hours results in a "material" difference in cost allocations to contracts. If they determines that the absence of total time reporting and/or their suggested methods of treating UOT results in material overcharging the government, auditors are told to cite contractors for noncompliance with FAR 31.201-4 and when covered by cost accounting standards, also CAS 418. (Editor’s Note. In effect, all contractors must comply with CAS 418 in this instance because even when not CAS covered, they will be cited for non-compliance with the FAR if CAS 418 is violated.)

CAS 418 requires that indirect costs bear a beneficial, causal relationship to the cost objectives to which they are allocated. In addition, the allocation base selected (i.e. direct labor, total cost, value added, etc.) must be representative of the total cost activity performed by the contractor. Since direct labor is usually at least one of the factors in the base, DCAA claims that failure to record all hours worked results in the exclusion of UOT hours from the base and thus the remaining hours in the base would not "bear its fair share of indirect costs" (e.g. since the denominator is lower, the resulting indirect cost rate would be too high).

(Editor’s Note. As consultants to contractors, we have, on occasion, successfully put forth a rebuttal to assertions of noncompliance with FAR 31,201-4 and CAS 418. Based upon an argument made by William Murphy, formerly a partner with Ernst & Whitney and Peterson Consulting, in a September 1992 article in CP&A REPORT, neither CAS 418 nor FAR 31.201-4 requires the recording of uncompensated overtime. Citing the historical promulgation of CAS 418 (too detailed to recount here), it was originally proposed to require full recording of all hours worked after which the CAS Board explicitly rejected the requirement and as a result it was not included in the standard. Thus the demand to require such recording is unfounded. Similarly, FAR 31.201-4 makes no mention of overtime, compensation, labor costs or any other statement that remotely require the recording of uncompensated overtime. It is rather, a one paragraph statement on allocation that contains a general statement that a cost is allocable to a government contract "if it is assignable or chargeable to one or more cost objectives on the basis of the relative benefits received or equitable relationship".)

DCAA, particularly recently, has emphasized that materiality must be considered when citing either a CAS 418 or FAR 31.201-4 noncompliance. Materiality, however, is not defined but is left to the auditor’s individual judgement. If materiality is asserted, DCAA is instructed to not only cite the contractor for noncompliance and require it to include all hours in its allocation base(s) but also recommends one of three methods for accounting for UOT to comply with CAS 418:

Method 1. Calculate an average rate for each pay period, based on salary paid divided by total hours worked and allocate costs to cost objectives based on that calculated rate. In the example cited above, if the pay period was bi-weekly and the exempt employee worked 100 hours rather than the standard 80 hours, the rate to be applied to each hour worked would be $20 ($2,000 salary/100 hours).

Method 2. Assign the total hours on a pro rata basis to all cost objectives worked during the pay period. In the example, the 25 hours worked on the government contract (50%) and the 25 hours worked on the commercial contract (50%) would result in applying the same percentages of salary to the respective contracts (50% of $1,000 salary or $500 to each contract).

Method 3. Allocate costs using an estimated annual rate and credit any variance to an indirect account. In our example, if the contractor expects the exempt employee to work 2,600 hours then his hourly rate will be $20 ($52,000 divided by 2,600 hours). If actual hours vary, then the difference is added to the indirect pool if less than 2,600 hours and deducted if more than 2,600 hours.

Two variations are sometimes accepted by DCAA under certain circumstances:

Alternative Method 1. Allocate employee’s hourly rate on a standard week and credit the indirect cost pool for excess hours at the same rate. In our example, charge all cost objectives at $25 per hour and if the standard work week is exceeded, credit the indirect account for each hour exceeded times the same $25 per hour.

Alternative Method 2. As a variation of Method 2 above, determine a pro rata allocation of hours worked each day and distribute the daily salary using the pro rata allocation. In a our example, if the exempt employee worked 5 hours on a government contract and 5 hours on a commercial contract today, their $200 daily salary would be apportioned 50% to each contract for that day.

In practice, DCAA’s reaction’s to these two alternative methods vary widely. We sometimes see complete acceptance of Alternative Method 1 while other auditors adamantly reject its use at similar type contractors, insisting on adoption of one of the three "acceptable" methods to avoid being cited for CAS 418. Sometimes one of the alternative methods are eventually accepted either after DCAA determines a lack of materiality or negotiations have demonstrated the difficulty and high cost of implementing one of the "acceptable" methods.

{TAG_FORM_TITLE}