Accounting for Overtime
Recently, our Firm presented a webinar on overtime. Because of time limitations, we were not able to address the proper accounting treatment of overtime costs. This blog will fill this gap. For purposes of this blog, overtime costs are those additional costs a contractor incurs to compensate an employee for working more than 40 hours in a workweek. The hours may be compensated at the employee’s normal hourly rate or at a premium rate of pay. We are not concerned with uncompensated overtime here.
There seems to be some confusion and disagreement over the proper accounting treatment for overtime costs. For instance, some people contend that overtime costs should not be charged as a direct cost of a contract. Others believe that the contractor’s fringe benefit rate should not be allocated to overtime costs, and others assert that the fringe rate should only be allocated to the base rate component of an overtime premium rate. We will address these issues below.
In regard to whether overtime costs should be treated as a direct cost of a contract or considered an indirect cost, the normal rules of cost allocation apply. For example, Federal Acquisition Regulation (FAR) 2.101 states “’Direct cost’ means any cost that is identified specifically with a particular final cost objective. . . . Costs identified specifically with a contract are direct costs of that contract.” Similarly, FAR 2.101 provides “’Indirect cost’ means any cost not directly identified with a single final cost objective, but identified with two or more final cost objectives or with at least one intermediate cost objective.” FAR 31.201-4 implements these definitions by stating that a “cost is allowable if it is assignable or chargeable to one or more cost objectives on the basis of relative benefits received or other equitable relationship.” The Cost Accounting Standards (CAS) contain similar guidance.
These are universal rules and do not contain exceptions for overtime costs. Accordingly, overtime costs must be accounted for as described above (i.e., based upon which contract(s) benefits from the overtime cost). Thus, if overtime is incurred in regard to performance of a specific contract(s), the overtime costs must be charged as a direct cost of the contract(s). On the other hand, if the employee works on a contract and also performs a function the cost of which is charged as an indirect cost, the contractor must determine which hours were worked in an overtime capacity. In this example, if the overtime was incurred performing the function charged as an indirect cost, the overtime pay would be charged as an indirect cost. Thus, overtime pay is not treated differently from regular time pay in this regard.
However, a word of caution is appropriate here. FAR 31.202 states that for practicality, “the contractor may treat any direct cost of a minor dollar amount as an indirect cost if the accounting treatment — (1) Is consistently applied to all final cost objectives; and (2) Produces substantially the same results as treating the cost as a direct cost.” The key points here are that the costs accorded this treatment must be of a minor dollar value. No further guidance is provided as to what is meant by minor dollar value. Thus, this term is somewhat vague and subjective. Second, this practice must produce substantially the same results as treating the cost as a direct cost. This is clearly tied to the minor dollar value requirement and indicates that if this practice is followed, there must still be an equitable allocation of costs to contracts.
Looking now at whether fringe benefit costs or overhead costs can be allocated to overtime pay, this is generally a matter for the contractor to decide. As a general rule, the FAR does not mandate the use of any particular base for the allocation of indirect costs such as fringe and overhead. Thus, contractors have broad discretion in this regard. Specifically, FAR 31.203 states that:
The contractor shall accumulate indirect costs by logical cost groupings with due consideration of the reasons for incurring such costs. The contractor shall determine each grouping so as to permit use of an allocation base that is common to all cost objectives to which the grouping is to be allocated. The base selected shall allocate the grouping on the basis of the benefits accruing to intermediate and final cost objectives.
Therefore, the base chosen must permit the allocation of indirect costs to contracts using a common base that results in indirect costs being allocated to contracts on the basis of the benefit received by the contract from the indirect cost. If including overtime pay in the base permits achievement of this objective, it may be included in the base. On the other hand, if excluding the overtime pay from the base would achieve the objective, then it may be excluded. For contractors, the key would be what accounting treatment permits the full recovery of indirect costs, particularly fringe benefit costs. Thus, the contractor’s accounting practice should follow its practice regarding how fringe benefits are earned.
There is an exception to this broad discretion afforded contractors concerning providing fringe benefits for overtime work and that relates to contracts covered by the Service Contract Act (SCA). Under the SCA, a service employee working on a service contract is entitled to be paid not less than the wages and fringe benefits called for by the applicable wage determination (WD) for the first 40 hours worked on that contract in a week. Therefore, if an employee works five hours in a week on other than an SCA covered contract, but also works forty hours on an SCA covered contract, some of which are in an overtime capacity, the employee would be entitled to receive the WD mandated fringe benefits for the full forty hours, including the overtime hours, even if the contractor’s general policy is only to provide fringe benefits for non-overtime hours.
If you have any questions, feel free to contact your Cherry Bekaert GovCon professional.