Labor Distribution and Payroll

This podcast is about the specifics of labor distribution and payroll for federal contractors.

There are five elements of the labor distribution and payroll process:

Organizing Employee Data: data to know who is working what job, and what information you have to get to report and bill on that job
Process for employee timesheets: including training employees the rules for completing and submitting timesheets, making sure they understand the requirements of federal contracting
Time Approval and reporting process: process must be fast, with minimal questions and errors, treated like a production line; consider special requirements for overtime and changing the charge numbers when one task ends and another begins
Labor Costing: discussion of simple situations where there is a single hourly pay rate and a more complicated one where there is a salary amount and variable number of hours; for example, anytime you have a semi-monthly payroll and salaried employees.
Payroll Processing: how you send hours to the payroll processor, how to account for special pays such as overtime, bonus, leave payoffs and pay rate changes.

Let’s start with Element 1 – Employee Data.  First, is the employee hourly or salaried?  Does the salaried employee have to account for all hours?  Are there conditions where some salaried employees get paid straight-time overtime?  Do you have Time & Materials contracts where the employee can select multiple labor category codes or do you assign it for them?  The labor category code should be on the timesheet, and actually any code that is required for billing should be traceable back to the timesheet.  We also recommend that you standardize and use codes, not descriptions, and set it up so the employee only sees the codes they are authorized to charge to, in order to reduce confusion and errors.

For new employees, you’ll want to make sure that they can be on-boarded quickly, so they have a timesheet they can use within the first day or so of starting.

For employee changes, especially pay rates, you’ll want a process that communicates updates quickly once they are authorized, so that everyone is using the correct information, and errors are minimized.  Whenever possible, you should set up your employee changes to start at the beginning of a pay period, or you will spend lots of time with retro-active changes and manual adjustments.

Now let’s talk about Element 2 – Timesheet Process.  Make it as easy as possible for your employees, the Program Manager and any reviewers or approvers.  Some timesheet systems have reports that can be reviewed on a daily basis.  You can run a “floor check” and make sure people are completing time daily.  It is a requirement that employees complete daily, and everyone in the company is required to complete a timesheet.

The timesheet process also needs to provide for how to complete the timesheet when the employees is out sick, on vacation or holiday.  Typically, you’d allow a supervisor to complete when the employee is out, and have the employee validate the interim timesheet, and signing it when they are back in the office.

On more advanced timesheet systems, the Program Manager can run reports to see who is charging to their contract and how many hours, on a real-time basis.  Giving the Program Manager access to these reports will help them identify and address issues early.  Some systems even allow budget hours to be loaded and will stop people from charging based on contract end date, by popping up error messages.

Having leave balances and tracking in the timesheet system can be beneficial, so that people cannot take leave when their balance is zero, or maybe you let them borrow leave up to a limit of say, 40 hours.

You will also need to make sure you have written instructions for employees and supervisor on how to complete timesheets.  New employees should be given these instructions and trained either by Human Resources, Payroll or the supervisor.  Some companies have found creating a new employee checklist helpful in this training.  The instructions should also document the process for correcting timesheets and adjustments.

Let’s talk about Element #3, Approval and Reporting process.  You need to get employees paid and you need to report time and also process billings, based on the timesheet dates and other cutoff dates.  Setting up your systems, you need to consider process for month end reporting, billing and payroll cycles.  For example, if you have semi-monthly payroll and monthly billing and monthly financial reporting, everything “cuts off” on the same dates.  Or, if you could have weekly timesheets, biweekly payroll and biweekly billing or billing on a cycle like 4-4-5 which is 4 weeks, 4 weeks and 5 weeks.  All of this should be synchronized if possible in order to streamline your processes.

You also care about this process because you want to get your billings out as fast as possible.  You want it to be accurate so it can be approved and accepted by clients and put into the system for payment, hopefully within 30 days.  If you are a subcontractor to a prime, it may be a “pay when paid” relationship, so you need to submit your billing to hit the billing cycle of the prime.  You will have to wait until their bill which includes your cost has been paid.  If you are late or miss their billing cycle, it will be much longer so be sure to focus on that schedule.

When you are setting up these processes, or considering making changes, take time to insert some “lag” in your payroll.  Many companies will have semi-monthly timesheets ending the 15th and the end of the month, and then pay day will be the 25th and the 10th of the month, respectively. Whenever you can, you should have at least 10 days between the end of the payroll period and the pay date.  But your time sheet data should be processed as quickly as possible for reporting and billing, even if you have a few days before payroll is due.  Most payroll services require a minimum of 2 days for processing, with an extra day to consider when there is a holiday.

The approval process should first be completed by the supervisor for that employee, someone who can confirm that the employee was working, and who knows their assignments are being completed.  It’s important to set submittal deadlines, such as noon EST on the first workday after the timesheet end, so that you can count on when the timesheets will be ready to process.

There will always be a few stragglers with the timesheets. Here’s a tip: if you have someone who is consistently late, you may be told “just short their pay” but we don’t recommend that.  Instead, just charge the hours needed to make up their full base pay to their Leave balance.  They will be motivated to correct it so they get their leave balance corrected, and they will still get paid.  Make sure the process is set up to work best for your employees, as simple as possible.

Let’s talk about Element #4, Labor Distribution.  The Labor Costing process is called Labor Distribution.  How do you show how much cost applies to each job?

In a simple case, let’s say Linda makes $20 per hour and the company has biweekly timesheets with biweekly payroll, so there should be 80 hours on Linda’s timesheet.  Linda has 8 hours of holiday for July 4, then 32 hours of vacation, then 40 hours to the Zombie Missile contract as a Junior Analyst.  For Linda’s costs, 8 hours of holiday at $20 per hour is $160 in cost charged to the Holiday Expense account.  Then, she has 32 hours at $20 per hour which is $640 in cost to charge to the balance sheet account Accrued Vacation.  The balance of 40 hours at $20 per hour which is $800 that gets charged as direct cost to the Zombie Missile job.

Let’s take another scenario with Sam the Program Manager, who is salaried and routinely works extra hours, but only gets paid his base salary.  The hours over 80 hours in the biweekly pay period are called Uncompensated Overtime.  Sam the Program Manager gets $4000 in salary every 2 weeks, so that would be $50 per hour when he works only 80 hours in a pay period.  When he works 100 hours in an 80 hour pay period, he has 8 hours of holiday and 92 hours of Zombie Missile testing.  Since Sam’s salary is a fixed amount of $4,000, his labor cost is charged as 8% to holiday (8 hours out of 100 hours) which would be $320 in labor cost, and 92% to Zombie Missile direct labor, which would be $3680 in labor cost.  Mathematically the same, but used more frequently is a “diluted hourly rate”, which is salary divided by total hours worked. So $4000 divided by 100 hours is $40 per hour as a diluted hourly rate.

You see that it can get complicated, because the diluted pay rates for your employees will fluctuate based on how many hours they work each pay period, especially if there is uncompensated overtime.  Another issue with salaried employees comes up with they are either hired or terminated in the middle of the pay period, or when they have leave without pay.  Whenever possible, it makes more sense to require salaried employees to take vacation or other paid absence time before allowing them to record leave without pay – because all of these exceptions require special handling and manual processing.

This is a topic that I could go on and on about because there are so many exceptions and special situations.

Let’s talk about Element #5 Payroll Processing.  How do you get the hours for your employees reported to your payroll service in time for payroll processing?  First off, you need to make sure you have a least a week lag between the end of timesheet period and payday period.  Setting up 2 weeks or 15 days is even better.

You really want to seamless upload or integrated process for payroll if you can. Think of it as a production line again. It needs to be as efficient and fast as possible, with no rework and no manual intervention, because errors and corrections can be costly.

Make sure you have accurate pay rates, show that your total labor distribution matches the gross pay on the payroll.  This is one of the first tests that DCAA (Defense Contract Audit Agency) will do when they are performing the PreAward Audit, which is your first hurdle to getting your accounting system approved.

By the way, do not do your own payroll processing and tax filings.  These should be outsourced for to a payroll service provider to make sure all the taxes are paid automatically.  Sometimes companies will look at the cost and think they are saving money by doing it on their own, but I’ve seen too many companies with incorrect tax reports and delinquent tax payment cause years of reporting issues and penalties.


Setting up the timesheet, payroll, billing and reporting systems are the most critical components of the accounting system.  We’ve covered just a few scenarios and there are many unique circumstances that require planning and discussion.