United States: Timekeeping: Best Practices To Ensure Labor Charges Withstand Audit Scrutiny

Over the past several years, contractors have witnessed the Defense Contract Audit Agency ("DCAA") becoming increasingly vigilant when auditing labor costs, timekeeping records, and associated data. Contractors are reminded that it is their responsibility to comply with all applicable government contract cost principles and to be able to demonstrate with appropriate accounting records that they have adequately documented the costs they have incurred in performing their contracts.

Those contractors required to prepare and submit annual incurred costs submissions ("ICS") for purposes of establishing provisional and final indirect cost rates, cost pools, and allocation bases are especially at risk of having to endure DCAA's seemingly limitless capacity to churn out requests for information ("RFI"). DCAA considers timekeeping to be a high-risk audit area because, unlike other direct (and indirect) operating costs, labor charges are typically and most readily supported by employee timesheets (no invoices, statements of account, bills of lading, or other forms of third-party documentation substantiating the incurrence of costs). In turn, many companies do not do a particularly good job of recording employee time, and that gives rise to missing or incomplete records, mistakes, unapproved changes, and many more timekeeping problems.

Stated differently, if the timekeeping records are not adequate on their face, it is a significant challenge for most companies to identify and provide contemporaneously maintained source documentation to substantiate the incurrence of labor costs and the accumulation and allocation of such costs between and among their government contracts. For this reason, contractors should never take timekeeping procedures for granted, and should err on the side of doing too much rather than too little when it comes to recording employee time, validating the accuracy of employee hours, preserving employee records, and scrutinizing the company's policies, procedures, and controls for accumulating and allocating labor costs between and among direct and indirect cost objectives.

For example, under a typical federal cost reimbursement– type contract, the government will reimburse contractors only for costs that are allowable, reasonable, and allocable to the contract. Under applicable cost principles, contractors are required to maintain records "adequate to demonstrate that costs claimed have been incurred." FAR 31.201-2(d). For timekeeping purposes, the FAR does not prescribe a particular timekeeping procedure – there is no one-size-fits-all approach to be taken for timekeeping purposes. What works in a small R&D laboratory would not necessarily work in a manufacturing facility with many employees. It is incumbent on each employer/contractor to formulate its own timekeeping system that adequately documents hours worked, projects (cost objectives) worked on, dates, duration, customer, direct and indirect activities, and the like. The contractor can better manage its audit risk in connection with labor costs if its timekeeping system records all hours for each employee – direct hours, commercial projects, government-funded projects, indirect activities, unscheduled absences, and the like.

Consider adopting some form of the following measures as means for better managing the audit risk associated with labor costs:

  • The timekeeping system should apply to all direct and indirect timekeepers.
  • Timekeeping records should be maintained contemporaneously, updated daily, capture actual hours worked by each timekeeper on each project (cost objective), and include a description of the activity or activity code that correlates to activities called out in each government contract, commercial order, or other governing agreement or procedure.
  • Record on the timesheet actual hours worked for direct and indirect cost objectives, identified by cost codes established in the company's chart of accounts. For example, the timekeeping system should capture time spent directly on other contracts or revenue-generating efforts, administrative time, vacation and sick time, and bid and proposal efforts, as well as time spent on efforts that benefit a contractor's operation as a whole (e.g., research and development and marketing).
  • Timesheets should be reviewed and signed by each employee and approved and signed by his or her supervisor before processing for payroll and billing purposes.
  • Whether you adopt a paper timesheet or an electronic timekeeping model, there should be a process in place for changing timekeeping entries, one that preserves the original time entry but allows for marginalia, end notes, and recordation of change date, with the approval (of change) by the supervisor.
  • Consider implementing a written timekeeping procedure explaining why records are created and needed; how they are to be created, maintained, and preserved; timekeeper and supervisor responsibilities; and the paramount importance of accuracy.
  • Develop a training module to educate all timekeepers about the timekeeping process.

Even with these best practices in hand, it is still possible for contractors to encounter an unexpected complication that raises questions regarding allowability, allocability, or reasonableness. Also in this issue, please see the related topic Common Problems in Timekeeping Systems, by the accounting team at BDO USA.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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