Are You Capturing and Billing Uncompensated Overtime Correctly?

In 1938, the Fair Labor Standards Act (FLSA) created the concept of overtime by establishing that a standard work week shall consist of 40 hours and anything in excess would be classified as overtime.  At that point in time, the concept of uncompensated overtime was created.  Uncompensated overtime are the hours worked in excess of 40 hours in a week by a salaried employee or employee who is otherwise exempt from additional compensation for the extra hours worked.

There is an important distinction however, between uncompensated overtime and unpaid overtime.  Unpaid overtime is when an employee that qualifies for overtime under FLSA is denied that extra pay which is owed; uncompensated overtime applies to employees who are exempt from  FLSA overtime rules and are already considered compensated through their salaries for all hours worked.

To prevent an imbalance in the determination of the cost of a Government contract, contractors should record all hours that employees work, commonly known as total time accounting.  If uncompensated overtime is worked but not captured correctly in the contractor’s timekeeping and accounting systems, and especially if a salaried employee works on more than one contract, there is a greater potential for contractors to manipulate their labor accounting system.  The Defense Contract Audit Agency (DCAA) Contract Audit Manual (CAM) (Section 6-410) provides for three different ways that a contractor can address uncompensated overtime:

  • Computing a separate average hourly, labor rate for each labor period, based on the salary paid divided by the total hours worked during the period, and distributing the salary cost to all cost objectives (contracts) worked on during the period based on this rate.
  • Determining a pro rata allocation of total hours worked during the period and distributing the salary cost using the pro rata allocation. For example, if an employee was paid on a weekly basis and worked 25 hours on one cost objective and 25 hours on another cost objective, each cost objective would be charged with one-half of the employee’s weekly salary.
  • Computing 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 distributing salary costs to all cost objectives worked on at the estimated hourly rate. Any variance between actual salary costs and the amount distributed is credited to overhead.

There are two additional methods allowed by DCAA but these methods would require additional evaluation by DCAA and must be tailored to the contractor.  The most common method that we see among our clients is the first option, which uses an effective rate per hour to allocate labor costs to contracts.  The problem that can occur with this method is evident in cost reimbursable type contracts.  If a salaried employee is paid $1,000 per week and works 40 hours on a contract, the contract is charged $25 per hour.  But if the same employee works 50 hours on the contract, the diluted rate is now $20 per hour.  The contractor does not get to claim any additional revenue for the extra hours worked, and the Government has essentially received 10 hours of work free of charge.

If instead of using the first method the contractor used the third method allowed by DCAA, the employee’s standard hourly rate would still be $25 per hour, but if the employee works 50 hours in a week, the contractor would be able to charge $1,250 to the contract instead of $1,000.  The uncompensated overtime, $250, is then credited to overhead.  This method allows the contractor to still account for all of the hours worked, to bill for all hours worked and see the difference in revenue, and to strategically decrease their overhead rate.

Recently a case came before the Armed Services Board of Contract Appeals (ASBCA) concerning the accounting of uncompensated overtime (GaN Corp., ASBCA No. 57834 (July 13, 2012)).  The contractor held a sole source contract that called for task orders to be issued as either firm fixed price or on labor hours based on already established labor rates on individual categories.  In their proposal, the contractor specifically stated that their labor rates were based on an employee’s annual salary divided by 2,080 non-overtime man-hours, confirmed they used total time accounting and confirmed that all hours worked, whether compensated or uncompensated, would be charged and billed to the contract.

The contract incorporated FAR 52.232-7, Payments Under Time-And-Materials and Labor-Hour Contracts, which in part, states that contractor submitted vouchers will be substantiated by evidence of actual payment.  The Contracting Officer used this clause to withhold payment for all hours worked and billed for which the employees were not compensated.  The Government erroneously argued that except for the labor rates being fixed, a labor-hour contract was a variant of a time and materials contract which is synonymous to a cost reimbursement contract.  The Government mistakenly concluded that if the contractor did not incur a labor cost, then it could not invoice for it.  But while the FAR does not provide a definitive answer on this, DCAA’s CAM does; the audit manual states that salaried or exempt employees are paid a salary to provide a service in whatever time is required, and the FLSA does not require employers to pay overtime to salaried employees.

The ASBCA made its decision based on the plain language of the contract, which established agreed upon labor rates, confirmed the contract was to be either firm fixed price or labor-hour, and the contractor clearly explained how its labor rates were determined.  The totality of the payment clause had to be examined and the Government could not read out or ignore the other portions and prohibit a contractor from collecting its hourly rates for work performed by salaried employees.

For the contractor, it can become a critical piece of information to state in your proposal how your labor rates are determined and how your employees record their hours worked.  Using a total time accounting system prevents mischarging and may mitigate the potential for labor mischarging and false claim allegations.  If you are interested in discussing whether your timekeeping procedures are in compliance with DCAA requirements or how you can better account for uncompensated overtime, please contact your local Cherry Bekaert representative.