The Defense Contract Audit Agency has a section in its Contract Audit Manual on Purchased Labor in Chapter 7-2102. Unless purchased labor is used to meet temporary or emergency requirements, auditors are told to “carefully study” the contractor’s practice to determine whether additional costs are reasonable, necessary and properly allocated to government contracts.

Initially auditors are told to (1) review any written policies on treatment of purchased labor (2) analyze the practices of treating purchased labor in the current and most recently completed fiscal year (3) determine the number of purchased labor (4) ascertain theduration of engagement (5) compare number of employees in each relevant classification to purchased labor (6) compare the cost per staff-year with contractor’s comparable personnel (7) evaluate the reasons for using purchased labor especially for periods exceeding one year and obtained technical input if needed and (8) determine the extent of purchased versus employee labor on government versus commercial work and on cost type versus fixed price government work.

The guidance notes that contractors may treat purchased labor as either other direct costs (e.g. subcontractors) or as direct labor with the excess over employee labor charged to overhead. In determining whether the allocation of costs are “equitable” the guidance states auditors should follow the fundamental requirements of CAS 418 that states pooled costs should be allocated to cost objectives in a reasonable proportion to the causal or beneficial relationship of the pooled costs to cost objectives. Purchased labor should share in an allocation of indirect expenses when there is such a causal beneficial relationship and the practice should be consistent with the contractor’s disclosed or normal practices. The guidance states sometimes a separate allocation base may be necessary to allocate significant overhead costs to purchased labor such as supervision and occupancy costs or it may be necessary to eliminate certain costs that do not benefit purchased labor such as fringe benefits.

For example, consider the difference between inhouse and offsite purchased labor. When purchased labor is used in-house, the guidance states normal overhead costs excluding fringe benefits may need to be allocated to purchased labor. When purchased labor is performed offsite where supervision and control is by an entity other than the contractor, none of the contractor’s labor overhead costs may be allocable to purchased labor. When contractors use other practices they will need to show that either the impact is not significantly different or that it is  justified.

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