We previously talked about uncompensated overtime and what it means. (If you missed that blog, check it out.) We also talked about a method (Option #1) to dilute the hourly rates. Now, let’s look at another method: Record the dollar value of overtime worked at the employee’s hourly rate as “accrued payroll.”
This method of accounting for uncompensated overtime results in the contractor allocating the employee’s labor hours and dollars using their standard hourly pay rate. So, let’s again assume that if John works 100% of the time (50 hrs) on government project #1, the direct labor charge to the project is $1,000 ($20/hr x 50 hrs). The total labor cost for this employee for the period recorded in the general ledger would be $1,000. However, the employee is only paid $800 ($20/hr x 40 hrs). The difference between what is recorded as expense and what is paid is considered uncompensated OT, and recorded on the balance sheet as a liability named “accrued payroll.”
A lot of contractors ask why the amount is a liability. Well, let’s go back to the underlying award vehicle – you have a cost reimbursable award regulated by the FAR. The terms state that the contractor can only bill the government for actual cost incurred. In the case above, the contractor has billed the government $200 more than its actual cost, so they owe this amount to someone. Who? It’s either the employee who worked the hours, or the government who was charged for the hours. How uncompensated OT is ultimately handled depends on what the contractors’ policy states. There are two ways to deal with this issue:
- The contractor can pay the employee for the overtime at a future date, if cash permits, or
- Not pay the employee, and credit the amount back to the P&L, thereby reducing the company’s overhead rate, and effectively giving the money back to the government
If you decide to use this approach, you need to understand the impact that this will have on your indirect rates. (And, if you’re confused about indirect rates, check out our videos here for some helpful information.)
Pros: This method improves cash flow initially since the contractor can bill for the OT, but doesn’t have to pay the employee for it immediately. In addition, the billing rates do not have to be adjusted each pay period to reflect the diluted pay rate.
Cons: Recording uncompensated OT makes monitoring indirect rates very tricky The contractor must include the uncompensated portion of accrued payroll as a reduction in labor cost each time indirect rates are calculated unless the contractor expects to pay out the OT.
Still have questions about this option? Comment below, and we’ll get back to you!