Labor Costs: Timekeeping, Direct Labor Base, Labor Transfers & Direct to Indirect Labor Ratio
External Audits – Architectural and Engineering (A&E) Contracts November 6, 2015

This Document will address labor costs. Architectural and Engineering (A/E) consulting firms’, both Prime consultants and Subconsultants (consultants) accounting records for labor costs must be accurate and supported. Labor is typically the most significant cost on the Indirect Cost Rate (ICR) schedule. Further, Direct Labor is the allocation base for calculating the ICR. This Document will focus on four specific areas relating to labor:

I. Timekeeping
II. Direct Labor Base
III. Labor Transfers
IV. Indirect to Direct Labor Ratio

I. Timekeeping

Requirements for Timesheets

All employees of an A/E firm must keep timesheets and are required to record all labor hours worked. This includes Executives, Principals, Owners, and Senior Managers. These requirements apply to very small firms, as well – even firms with only one person. Firms should have clear, established guidance that emphasizes that employees are responsible for accurately recording all labor hours, and management is responsible for ensuring the established guidance is followed by all employees. This guidance should include the firm’s best practices and should be shared with all employees of the firm.

Internal Controls

All consultants should have labor charging and accounting system internal controls in place that are evident and well defined. Internal controls should be regularly maintained, updated as necessary, and should verify effectiveness.

Internal controls should be designed to provide reasonable assurance for accurate and proper labor accounting and charging objectives:

Labor Charging System

Reliability and accuracy of a firm’s labor charging system is essential. Whether a firm has an automated or manual timekeeping system, there must be procedures, controls, and an audit trail of documentation to support the labor costs. The AASHTO Uniform Audit & Accounting Guide for Transportation Consultants 2012 Edition (AASHTO Audit Guide) and the Defense Contract Audit Agency (DCAA) Pamphlet No. 7641-90 are resources that should be incorporated into the labor charging system.

The following is a list of some elements that must be provided for in the labor charging system:

Bid & Proposal, Direct Selling, and Public Relations Labor

Employees must identify and segregate labor hours on their timesheets associated with Bid & Proposal, Direct Selling, and/or Public Relations activities.  Each of these should be shown as a separate line item on the ICR schedule.  Timesheet coding and training should be provided to all employees regarding segregation and allowability of the labor associated with these activities, as identified in Part 31 of the Federal Acquisition Regulations (FAR).

Source Documents

Timesheets are source documents and are used to support labor hours worked, in part, on California Department of Transportation (CA DOT) agreements.  CA DOT standard agreement language states that the all consultants must keep cost records and accounts for three (3) years after receipt of final payment.4 These records include timesheets.

For example – A subconsultant provided services in 2008 and they billed their final invoice for those services in July 2008.  The agreement with the prime did not close and final payment was not made to the prime, however, until October 2014.  In this example, the subconsultant must keep all documentation to support billed costs, including labor, until October 2017. Reference AASHTO Audit Guide (2012), Chapter 8, Pages 69-84 4 Reference 48 CFR 4.703 (a) (1)

II. Direct Labor Base

Direct labor charges reported on timesheets are generally accumulated into Labor Distribution Reports (LDR) and the ICR schedule. The direct labor amount on the ICR schedule must be supported by a consultant’s LDR and internal accounting system.  Reconciliation of the labor costs should be performed between the LDR, ICR schedule and Year-End Payroll report.  These amounts should also tie to the general ledger labor accounts and the financial statements.  If applicable, upon review or audit, CA DOT Audits & Investigations may request a copy of the reconciliation to be provided as an aid in the review of a consultant’s labor cost.

Direct Labor costs must be computed for salary personnel based on the standard 2,080 hour work year.  Direct labor hours includes all labor hours worked (whether billable to the client or not), including hours both paid and unpaid.  For further information regarding uncompensated overtime, please refer to the CA DOT Uncompensated Overtime Interpretive Guidance. 

III. Labor Transfers

The term labor transfers refers to the movement of labor hours/dollars from one charge number to another charge number.  These transfers typically take place after timesheets have been posted for the period, but prior to invoicing.

It is best practice for a consultant to have a written Labor Transfer Policy that details the established policies and procedures for labor transfers.  This Labor Transfer Policy will detail the internal controls and support documentation we should expect to see from the consultant regarding labor transfers, and that we will need to be able to verify the consultant’s labor.

As noted in Section I of this document, we emphasized that CA DOT’s standard agreements and the AASHTO Audit Guide require that all labor must be documented and supported.  This includes any labor transfers.

It is expected that consultants will have some transfer of labor hours/costs.  In our experience, the most common type of labor transfers are due to employee error, such as hours miscoded to an incorrect project number or a transposition error.  Labor transfers can also occur when multiple hours over a pay period need to be adjusted, and possibly for multiple employees.  These can occur, for instance, due to project numbers closing out and being replaced with new project numbers.  When these transfers occur, consultants should thoroughly document the transfer, the related purpose/reason, and the employee should initial and date the changes made to his/her timesheet.  Labor that is billed on monthly invoices should be what was reported on the employee’s timesheets, with very few exceptions for transferred labor.

The need for a labor transfer is usually found in the review of the preliminary labor report (prebilling report) that details an employee’s total labor hours for each project.  This report is typically prepared after labor cutoff but before client invoicing.  While labor transfers are

expected, they should not be pervasive.  A large amount of labor transfers can signify labor system weaknesses and be cause for concern for internal control measures.
For example, monthly meetings conducted by managers or owners to move labor hours between charge codes are considered unacceptable. This practice would appear to be tampering with employee time charges and considered a management override of time charging internal controls. 
Labor transfers should be completed as documented in a Labor Transfer Policy.  The Labor Transfer Policy is often a part of a firm’s timekeeping policy and should include:   

An official labor transfer form should be developed to document the elements of the labor transfer.  Two examples of transfer forms are attached.  Supporting documentation is the key to all labor transfers.  The most common allowability challenge that we find regarding labor transfers is lack of sufficient documentation.  Reminder, per the AASHTO Audit Guide, labor must be supported and this includes labor transfers.
Following is a typical list of unallowable transfers; however this list is not inclusive 8: 

For further guidance on determining allowability and reasonableness, please refer to the AASHTO Audit Guide, Chapter 8, Pages 69-84.

IV. Indirect to Direct Labor Ratio

State DOT’s consider a high indirect to direct labor ratio as a risk indicator. We customarily perform an analysis of the indirect to direct labor ratio as part of our audit and review processes.  We will continue to do this analysis to check for significant increases or decreases in direct labor with correlating increases or decreases in indirect labor.  Further, we may verify that the indirect to direct labor ratio is in-line with accepted industry standards and/or make further inquiries of the consultant, perform additional analytical procedures, and/or may conduct intensive labor testing.  
The decrease in direct labor and the correlating increase in indirect labor may cause concern related to a firm’s efficiency and the extent to which government should reimburse indirect labor costs through the ICR.  It also causes concerns regarding staffing levels and, specifically, the maximum utilization of employees to minimize excess or idle staff.  When we note that a consultant that has had a decrease in the direct labor pool, with an increase in the indirect labor pool, we will provide our analysis with the consultant and discuss the issue for better understanding.  
During times of business slowdowns, consultants attempt to keep experienced staff on board until the conditions improve, and they have sufficient work for all staff.  Some of the areas that we will explore with the consultant are: 

If we determine that the indirect labor to direct labor cost ratio is above industry standard for a significant period (i.e. greater than one year), with no justification, a consultant may be asked to make the adjustment to their indirect labor cost to ensure it is in line with industry standards. Further, a potential additional cost of the underutilization of employees, is idle facilities due to labor fluctuations in a firm. This could require more adjustments.


External Audits – Architectural and Engineering (A&E) Contracts 05/25/2016

In the normal course of business, Architectural and Engineering (A&E) consultants incur costs for meals for a variety of reasons.  The purpose of this document is to clarify existing Federal Acquisition
Regulation (FAR) requirements and guidance provided in the AASHTO Uniform Audit & Accounting Guide for Transportation Consultants, 2012 Edition (AASHTO Audit Guide) in order to help consultants and CPA firms to better understand the proper treatment of meals costs.  The requirements for meals costs incurred in the performance of direct projects are different from the requirements for the treatment of meals costs in the development of indirect cost rates.  The requirements for both types of meals are discussed in this document; it is important to note, however, that the requirements differ.

Classification of Meals Costs

Depending on the business purpose for which meal costs are incurred, the costs should be classified into various categories in the consultant’s accounting records.  The first and most important distinction is whether the cost was incurred in relation to a direct project.  Meal costs incurred in support of or as a result of currently ongoing direct projects (as opposed to bid and proposal efforts or project pursuits) must be classified as direct costs in the consultant’s accounting records, and excluded from overhead.  In making this determination, the important question is “why was the cost incurred?”  If the consultant would not have incurred the cost had it not been for the project, then the cost should be treated as a direct cost.  Project-related meals costs must be treated as direct costs, whether billable or not.  Meals incurred for non-project related activities must be treated as indirect costs and may not be invoiced as direct costs.

Project-Related Travel Meals 

Meals associated with project-related (direct) travel on Caltrans or California local government agency contracts are subject to the requirements published in the Caltrans Consultant Travel Reimbursement Guide. For local government agency contracts this requirement will be found in Chapter 10 of the Local Assistance Procedures Manual. Those requirements specify that such meals are reimbursable on the basis of actual costs, not to exceed the Caltrans state per diem limits.  Costs for such meals may be subject to additional limits established in the contract.  These requirements are available at the following link: 

Treatment of Indirect / Overhead Meals Costs

The focus of the remainder of this document will be on meals which are for indirect (non-project) activities.

Indirect meals costs may be classified in various ways.  Because the FAR provides for specific requirements for travel meals, it is appropriate to categorize meals costs into travel meals and non-travel meals.  We will discuss both categories in more detail.

Overall FAR Requirements

FAR Part 31 establishes certain overall requirements for allowability of costs, including meals.  To be allowable, meals costs must be:

The concept of allocability was discussed above.  As noted, the focus of the remainder of this document is on indirect/non-project meals.  Because FAR provides for specific restrictions on costs for travel meals, we will discuss reasonableness separately for travel and non-travel meals.  The requirement to account for meal costs properly under GAAP includes the need to account for the costs in the proper period.  The requirements for supporting documentation and other restrictions of FAR 31.205 will be discussed below.  

Documentation Requirements for Indirect Meals

FAR Part 31 establishes a requirement that consultants must provide adequate supporting documentation of costs incurred.  For meals costs, this documentation should include the following items:

Consultants must maintain receipts as documentation for meals costs, with the exception of travel meals that are paid based on an established per diem policy of the consultant.  Credit card statements are not considered acceptable as a standard form of documentation of meals costs.  While a credit card statement might be accepted in unusual circumstances, such as when a receipt is lost, actual meal receipts are considered the acceptable form of documentation.  
If a consultant does not have a policy of requiring itemized receipts which show all of the food/beverage items purchased, the consultant should have a policy that addresses the risk of unallowable alcohol costs.  For example, the consultant might require such itemized receipts for costs exceeding a certain dollar amount, or for certain types of meals.  The consultant should also clearly communicate to staff the importance of properly identifying and segregating alcohol costs on the receipt or expense report. 

Indirect Travel Meals

FAR 31.205-46 states that costs incurred for indirect travel meals “shall be considered to be reasonable and allowable only to the extent that they do not exceed on a daily basis the maximum per diem rates at the time of travel as set forth in the Federal Travel Regulations (FTR).” These maximum per diem rates are available at: To obtain the applicable per diem limits:

Consultants should establish separate general ledger accounts for FAR-allowable and FAR-unallowable indirect meals costs.  The portion of cost in excess of the FTR limits must be classified as FARunallowable.  To comply with this FAR requirement, consultants must use one of the following methods, and should include in their documented policies and procedures which method they have chosen to use:

Indirect travel meals are subject to the same requirements for documentation as described above.  If the consultant has an established policy of reimbursing meals costs to employees based on daily per diem rates, the costs are considered allowable, subject to the following: 

Indirect Non-Travel Meals

Meals costs incurred for certain non-travel indirect activities are allowable, subject to the requirements that the cost must have a valid business purpose, be supported by proper documentation, and be reasonable in amount.  
In determining reasonableness of costs, the following FAR requirement applies:

FAR 31.201-3 Determining reasonableness

Meals not associated with travel are allowable if they are properly supported, have a valid business purpose, and are reasonable in amount.  Non-travel business meals are governed by FAR 31.205-43(c), which provides that incidental meal costs incurred during business meetings are allowable if the principal purpose of the meeting is the dissemination of trade, business, technical, or professional information. Some examples of non-travel meals which may be considered allowable include meals associated with:

For indirect non-travel meals, the same documentation requirements apply as described above, with the additional requirement that the purpose of the meal must be properly justified.  In contrast, the purpose of a travel meal is supported based on the business purpose of the travel.  If overnight travel is required

the meals associated with that travel are considered necessary.  For non-travel meals, it is important to adequately justify the purpose of the meal.  For example, the consultant provides training on a technical or human resources topic over the lunch hour, and provides lunch in return for employees attending during their lunch hour, thereby increasing efficiency by not taking away from work time.

Another example of an allowable indirect non-travel meal is when a consultant is implementing a new phone system.  Documentation is available to support the implementation requirement for all staff to be in attendance. The phone system was to be installed during normal business hours and training was to be provided during the normal meal period.  The consultant provided lunch for the staff while they attended the in-house training for the new phone system. Documentation of an itemized receipt was provided to support that the meal cost was within the per diem allowable for the locale and employees completed a sign in sheet to support their attendance.  A detailed training agenda was also made available.

Indirect non-travel meals must be reasonable in amount, and Caltrans considers the FTR limits as the reasonable amount.  Any amount above the FTR limits must be justified by the consultant.  The burden of proof rests upon the consultant to support the reasonableness of costs for non-travel meals.  It is strongly recommended that consultants develop a policy regarding non-travel meals, and discuss the policy with Caltrans A&I staff.  Indirect meals costs claimed as allowable must be reasonable for the circumstances and business purpose of the meal.  

Unallowable Indirect Meals Costs

Indirect meals costs which are considered unallowable include, but are not limited to:

Consultants should establish a policy regarding the costs of alcoholic beverages.  If the consultant chooses to reimburse such costs to employees, appropriate steps must be taken to ensure that 1) alcohol costs are properly identified as unallowable and excluded from the indirect cost rate calculation, and 2) such costs are not invoiced as direct costs to Caltrans or any other local government agency contract.  Employees should be trained on the importance of properly identifying and documenting the costs of alcoholic beverages included in meals.  Consultants should establish separate general ledger accounts for unallowable meals and/or alcohol costs for use in properly segregating such costs, and should perform monitoring to ensure that employees are following the company’s policies.


External Audits – Architectural and Engineering (A&E) Contracts 03/12/2018 (revised edition)

Architectural and engineering (A&E) firms working on public works projects in California are required to pay prevailing wages to certain categories of employees working on specific types of work.  The requirements for payment of prevailing wages, and the required prevailing wage amounts to be paid, are established by the California Department of Industrial Relations (DIR). Payment of prevailing wages often results in A&E firms paying additional amounts to covered employees in the form of additional wages, additional benefits, or both.  These additional payments in excess of the employee’s standard wages and benefits are commonly referred to as “prevailing wage deltas;  Because prevailing wages are established as two components – a base wage component and a fringe benefits component – the prevailing wage deltas are also established separately, as “prevailing wage delta base” and “prevailing wage delta fringe”.  The treatment of prevailing wage deltas may have a significant effect on the calculation of an A&E firm’s indirect cost rate, as well as amounts used in preparing cost proposals and invoices.  The purpose of this guidance document is to describe the requirements for treatment of prevailing wage deltas for accounting, contract negotiation, and invoicing, for A&E firms contracting with Caltrans or local government agencies.


The following definitions apply to the calculation of prevailing wage deltas:

Prevailing wage delta base – the difference between the employee’s standard hourly wage and the base wage identified in the Prevailing Wage determination (established by DIR) specified for the covered service the employee is performing.  

Prevailing wage delta fringe – the difference between the fringe benefits normally provided to the employee (as calculated by the A&E firm), calculated on an hourly basis, and the prevailing wage fringe amount required to be paid for the employee’s role established by the DIR, also calculated on an hourly basis. 

An example of prevailing wage delta base and delta fringe would be as follows:

An A&E firm has an employee working on a project requiring payment of prevailing wage; relevant information is as follows:

Actual base hourly wage           $40.00          
Base hourly wage per prevailing wage determination           $50.00          
Actual fringe benefits, calculated on an hourly basis           $8.00          
Fringe benefits per prevailing wage determination           $12.00          
Prevailing wage delta fringe           $4.00          

Importance of Consistency

 This document discusses the possible accounting treatments A&E firms may use in accounting for prevailing wage deltas, establishing their indirect cost (overhead) rate, and contracting with Caltrans and local government agencies.  It is critically important for each firm to establish a method of accounting and apply it consistently to ALL prevailing wage delta costs, regardless of the client, contract, or reimbursement method.  Firms may not change their method of accounting based on whether the costs are billable or non-billable, or based on the method that provides the best result for a specific contract.  The decision of the accounting method for prevailing wage deltas must be applied to the entire A&E firm, every time that such costs are incurred.  Firms must be able to prove that their accounting treatment for prevailing wage deltas is consistent, in order to be reimbursed for prevailing wage delta costs on Caltrans and local government agency and local government agency contracts.  Firms may provide evidence of their accounting treatment for prevailing wage through an overhead audit or through other documentation.

Possible Accounting Methods

 Generally, there are three methods that firms may use to account for prevailing wage delta costs:

  1. Account for the delta as direct labor cost
  2. Account for the delta as other direct cost
  3. Account for the delta as overhead cost

 It is important to note that because A&E firms sometimes pay their affected employees the prevailing wage deltas in different ways for delta base versus delta fringe, it is possible that a firm might use one accounting method for delta base and another method for delta fringe.  This approach is allowable, provided the firm uses the same methods consistently for all contracts.  For the following examples, we will assume for illustration purposes that the firm uses the same method for treatment of both the delta base and delta fringe; however, it is noted that firms at times use different methods for treatment of the deltas.  

 Effect on Indirect Cost Rate (Overhead) Calculation

 The accounting method chosen by an A&E firm for treatment of prevailing wage deltas has a significant effect on the indirect cost rate calculation.  The proper calculation of A&E firm indirect cost rates is established by Federal Acquisition Regulation 48 CFR 31 (FAR Part 31) and the AASHTO Uniform Audit and Accounting Guide (AASHTO Audit Guide).  The indirect cost rate calculation can be summarized as follows:

Indirect cost rate = Total FAR allowable indirect costs / Total direct labor costs

As an example, assume an A&E firm has the following costs:

Total direct labor costs =      $1,000,000
Total indirect costs =             $1,600,000
FAR unallowable costs =          $100,000
Total FAR allowable costs =  $1,500,000

Indirect cost rate = 1,500,000 / 1,000,000 = 150.00%

Accounting Method 1 – Treat Prevailing Wage Deltas as Direct Labor Cost

 The first method which A&E firms may use to account for prevailing wage deltas is to treat them as direct labor costs.  Using the previous example, we will assume that the firm has an additional $20,000 of prevailing wage delta costs, which they account for as direct labor costs.  The result would be as follows:

Previous Example

Add Prevailing Wage Deltas


Total direct labor costs


$    20,000


Total indirect costs




FAR unallowable costs

$   100,000


$   100,000

Total FAR allowable indirect costs




Indirect cost rate





Accounting Method 2 – Treat Prevailing Wage Deltas as Other Direct Cost

 The second method which A&E firms may use to account for prevailing wage deltas is to treat them as other direct costs.  Using the same example, we will assume that the firm accounts for the additional $20,000 of prevailing wage delta costs as other direct costs.  The result would be as follows:

Previous Example

Add Prevailing Wage Deltas


Total direct labor costs




Total indirect costs




FAR unallowable costs

$   100,000


$   100,000

Total FAR allowable indirect costs




Indirect cost rate




Prevailing wage other direct costs




Accounting Method 3 – Treat Prevailing Wage Deltas as Indirect / Overhead Cost

 The third method which A&E firms may use to account for prevailing wage deltas is to treat them as overhead / indirect costs.  Using the same example, we will assume that the firm accounts for the additional $20,000 of prevailing wage delta costs as indirect costs.  The result would be as follows:

Previous Example

Add Prevailing Wage Deltas


Total direct labor costs




Total indirect costs


$     20,000


FAR unallowable costs

$   100,000


$   100,000

Total FAR allowable indirect costs


$     20,000


Indirect cost rate




As the examples illustrate, there can be a significant effect on an A&E firm’s FAR allowable overhead rate depending on the accounting method chosen for the treatment of prevailing wage deltas.  Again, any of these methods is acceptable, but the costs MUST be accounted for consistently for ALL contracts.  Reimbursement of the costs must not determine the accounting treatment; instead, firms must account for the prevailing wage delta costs in the same manner in all cases, regardless of reimbursement.

Documentation Requirements

 A&E firms must document their accounting treatment for prevailing wage deltas.  Firms should prepare a written policy outlining the following information:

In addition, if the A&E firm has a CPA firm perform an audit of its indirect cost rate, the audit report should include a footnote describing the A&E firm’s treatment of prevailing wage deltas for both base and fringe.  The CPA firm is expected to perform testing to verify the information disclosed in that footnote, including testing to support that the A&E firm accounts for prevailing wage deltas consistently.  A&E firms with CPA-audited overhead rates will be allowed to provide other supporting documentation while transitioning to inclusion of this information in the indirect cost rate audit. A&E firms which do not have CPA-audited overhead rates will be required to submit their Prevailing Wage Policy prior to contract execution. A&I reserves the right to perform additional procedures at any time, as deemed necessary, to verify the firm’s accounting treatment is consistent and properly supported.   

Effect on Contract Negotiation and Invoicing

 The three methods described above to account for prevailing wage deltas result in different indirect cost rates, and should be reimbursed differently.  It is Caltrans’ intent that A&E firms which can provide evidence that they account for prevailing wage deltas properly and consistently, using one of the three approved methods, shall be reimbursed for the prevailing wage delta costs consistent with the firm’s accounting treatment.  A summary of the three methods and related reimbursement is as follows:

Prevailing Wage Delta Cost Accounting Treatment

Prevailing Wage Delta Multiplier Value

Classified as Direct Labor

(1+OH)*(1+Fee) Full Multiplier 

Classified as Other Direct Cost

1.00 Multiplier

Classified as Overhead / Indirect Cost

0.00 Multiplier

As noted earlier, it is important for A&E firms to account for prevailing wage deltas consistently, regardless of the method or amount of reimbursement, and to provide documentation of their accounting method, in order to be eligible for reimbursement of these costs.  Caltrans will review the firm’s Prevailing Wage Policy’s accounting treatment to ensure it is consistent and properly supported.  Once accepted, reimbursement of prevailing wage delta costs will be allowed based on the table above, consistent with the firm’s accepted accounting treatment.  The burden of proof is on the A&E firm to provide evidence that the prevailing wage delta costs are accounted for properly and consistently.  If an A&E firm cannot support that their accounting treatment for prevailing wage deltas is proper and consistent, the contracting agency will not reimburse the prevailing wage deltas.  

Reimbursement for Firms Using Safe Harbor Indirect Cost Rate

 A&E firms using the Safe Harbor Indirect Cost Rate on a contract will be reimbursed for prevailing wage deltas as an Other Direct Cost.

Implementation Period 

Caltrans implemented this policy on March 1, 2017, and all A&E firms must comply to be eligible for prevailing wage delta payment reimbursements. A&E firms should begin working now to document their policies and procedures in this area. Firms who have a CPA audit of their indirect cost rate should notify their CPA firm of the expectations for footnote disclosures and testing of prevailing wage delta accounting treatment immediately, so those items can be addressed in upcoming audits.


External Audits – Architectural and Engineering (A&E) Contracts - 11/06/2015

This Document will address Uncompensated Overtime, which is an issue that affects many
Architectural and Engineering (A&E) consultants.  The California Department of Transportation (Caltrans) pays for labor and overhead costs based on what was accepted at the time a contract is executed.  The true effect of this is that the indirect cost rate(s) and the fully loaded labor rates may be overstated on our specified rate (fixed rate) contracts. The fully loaded labor rates cannot be adjusted due to the nature of our fixed-rate contract, combined with the fact that the consultant is unable to submit weekly invoices with labor costs adjusted to the effective labor rates for that week.  We continue to work with consultants to help them account for costs correctly and make appropriate adjustments in accordance with Part 31 of the Federal Acquisition Regulations (FAR).  To ensure compliance, we discuss uncompensated overtime with CPA firms that perform audits of the consultant’s indirect cost schedules. 

Definition of Uncompensated Overtime

Per FAR 52.237-10,uncompensated overtime means the hours worked without additional
compensation in excess of an average of 40 hours per week by direct charge employees who are exempt [salaried] from the Fair Labor Standards Act.  Compensated personal absences such as holidays, vacations, and sick leave must be included in the normal work week for purposes of computing uncompensated overtime hours. 
Consultants contracting with Caltrans under A&E agreements must have procedures covering the consistent recording and accounting for hours worked, whether paid or unpaid, to ensure the correct distribution of labor costs. This is necessary because labor rates and labor overhead costs can be affected by total hours worked, not just paid hours worked.

Accounting for Uncompensated Overtime

The AASHTO Uniform Audit & Accounting Guide for Transportation Consultants, 2012 Edition (AASHTO Audit Guide) gives an example of the 

Salary Variance Method (Standard Rate or Effective Rate) for calculating uncompensated overtime based on 2080 hours per year. Under the Salary Variance (Standard Rate Method), the consultant calculates a standard hourly labor rate based on the employee’s salary divided by 2,080 hours (for fulltime employees) and records every hour worked at that standard cost rate.  The cost recorded in excess of the salary paid represents uncompensated overtime, and is recorded in a salary variance account which is credited to indirect labor cost in the indirect cost rate calculation.    For example, an employee with a salary of $80,000 per year works 10% uncompensated overtime hours and a portion of his/her time is spent working on projects. The company would record costs of $88,000 to a combination of direct and indirect labor, and would record a salary variance of ($8,000) to indirect labor.  

Under the Effective Rate (Effective Rate Method), consultants record labor costs at an effective hourly labor rate that is calculated by dividing the employee’s salary for the week, pay period, or month by the actual hours worked in the period. For example, an employee who is paid a salary of $52,000 per year ($1,000 per week) would have a standard hourly rate of $25 ($1,000 / 40 hours). If the employee worked 50 hours in a given week, their effective hourly rate for that week would be $20 ($1,000 / 50 hours). The firm would record all hours for the employee for that week at $20 per hour, with the result that the total labor cost recorded would be equal to the labor cost paid. No salary variance is recorded under the Effective Rate Method

The Effective Rate Method does not apply to Caltrans A&E Cost Reimbursable Agreements. Instead, the Standard Rate Method must be used for determining labor costs associated with agreements between the consultant and Caltrans.  This requires A&E firms to prepare cost proposals and invoices based on the standard hourly rate for each employee (salary/ 2080 hours for full-time staff).  As noted above, an employee with a salary of $52,000 should be included in cost proposals and invoices on Caltrans contracts at a standard hourly rate of $25.  For firms using the Effective Rate Method, the result is that the standard hourly rate billed may exceed the effective rate used to account for the labor costs, when there is uncompensated overtime.  In the example above, the effective rate was $20, which was less than the standard rate by $5 per hour.  Since Caltrans contracting method does not allow for billing of labor costs at effective hourly rates, another method must be used to adjust for the potential overbilling that may result from the excess of standard labor rates billed over the effective hourly labor rates used for internal costing.
If your firm accounts for labor at effective rates using the Effective Rate Method, the labor costs will need to be converted to an annual basis using 2,080 hours, and an adjustment will need to be made to the indirect cost schedule to convert to standard rates as described below in Adjustments for Uncompensated Overtime. These adjustments will ensure that each labor account, as well as the uncompensated overtime, is recorded at standard labor rates.  Some labor systems have the capability to run a report to show the effective labor rate to standard labor rate conversion.  If your system does not have this capability, the attached worksheet (EXAMPLE A: Salary Variance Method - Effective Rate Worksheet) can be used for this purpose.  The adjustment increases direct labor (and possibly indirect labor) for the uncompensated overtime, and calculates the offsetting salary variance to be credited to indirect labor. 

If your firm accounts for labor at standard rates, adjustments for uncompensated overtime should be made using the Standard Rate Method as described in the AASHTO Audit Guide. Normally this

should be done on a monthly basis. If you have a policy under which all employees are paid for all hours worked, there is no uncompensated overtime and therefore, no adjustments necessary.  

If the Consultant Does Not Record Employee Hours Worked Over 2,080 per Year

If your firm is not currently recording hours worked over 2,080 per year for each employee, the attached worksheet can be used to compute the estimated value of uncompensated overtime (EXAMPLE B: Salary Variance Method - Effective Rate Worksheet Estimate).  We will allow a one year estimate, but we expect consultants to implement procedures in subsequent fiscal years to account for all hours worked, and to record uncompensated overtime appropriately.          

Key Points for Uncompensated Overtime Adjustments

  Consultants will be notified of the above requirements as necessary and information related to uncompensated overtime will be available online at: and

WORKSHEET: Procedures for Handling Uncompensated Overtime and Posting of Payroll

  The following is an example of the calculation of the payroll variance/uncompensated overtime for the general ledger payroll journal entry ($48,776/year; $4,064.67/month; $23.45/hour):

Employee A’s Timesheets for July
Projects Timesheet Hours Raw Hourly Costs Monthly Salary
Direct - Project ABC
Direct - Project XYZ
Indirect Labor - Administration
Indirect Labor - Holiday
82 hours
80 hours
10 hours
8 hours
Total 180 hours $4,221.00 $4,064.67
Payroll Journal Entry for General Ledger
Checking Account Withdrawal/Monthly Salary
Direct Labor
Indirect Labor - Administration
Indirect Labor - Holiday
Payroll Variance/Uncompensated Overtime

82 hours + 80 hours
10 hours
8 hours

Salaried employees are required to work the minimum number of hours each semi-monthly pay period.  All hours worked must be posted on timesheets whether billable or not.  Exempt employees do not receive overtime pay for extra hours worked.

All hours contained on timesheets are posted to the project cost management system at the employee’s standard rate (annual salary divided by 2,080 annual hours).  At the end of each month, a payroll journal entry is computed by taking ALL direct labor hours posted on timesheets and multiplying that by the standard rate – that is the Direct Labor posting for the general ledger.  For example, $3,789.90 [= (82 hours + 80 hours) * $23.45] is posted to the general ledger for direct labor. Then the indirect labor hours posted on timesheets (administration, proposals, business development, vacation, sick leave and holiday) are multiplied by standard rate– that is the Indirect Labor posting for the general ledger.  For example, $422.10 [= (10 hours + 8 hours) * $23.45] is posted to the general ledger for the indirect labor.

For Indirect Cost Rate calculation purposes, Direct Labor is not adjusted down and remains unaffected by the negative figure contained in the Payroll Variance/Uncompensated Overtime account.

EXAMPLE A: Effective Rate Worksheet


Hrly Rate
Salary (based on 2,080)

(per eets), _

Direct Hrs



Indirect Hrs

Vaca Hrs


Sick Hrs


Holiday Hrs


Hrs >

Uncomp OT

John Doe

    $1 10,000      $52.88














Jane Day

    $105,500      $50.72











2,23 1.68


















ICR Adjustments:

Payroll Variance/Uncompensated Overtime ($22,063)

The firm was recording all hours worked on timesheets. However, this firm had recorded their labor at the "effective rate", not based on the standard 2,080 hours per year. Effective rates are computed weekly, based on actual time charges. If the Consultant records labor at effective hourly rates, then an adjustment must be made at year end to convert to the standard hourly rate. The total number of direct hours (for instance) is multiplied by the difference between standard and effective hourly rates.
The difference between the labor totals at the effective rate, and the labor totals shown on the worksheet based on 2,080 hours is our adjustment.

Uncompensated overtime adjustments apply to direct and indirect only. The Paid Time Off (PTO) categories are used only to arrive at total hours worked. The main purpose of the uncompensated overtime worksheet is to correct direct and indirect labor as needed, we typically don't make an adjustment for PTO.

EXAMPLE B: Salary Variance Method - Effective Rate Worksheet for Estimate

Exempt Employee Salary Standard Hourly Rate (based on 2,080) Total Hours Worked (per t/sheets) Direct Hours % Direct VAC Hours Sick Hours Holiday Hours Estimated Hours > 2,080 Uncompensated OT
John Doe 110,000 $52.88 2,080 1,610 85% 145 29 58 80 $4,230.40

Overhead Adjustments:

C. Credit to Indirect – Payroll Variance/Uncompensated Overtime ($4,230) A + B

Uncompensated overtime requires the following adjustments:

The A&E consultant must estimate the amount of direct (and indirect labor hours, if appropriate) that were worked by each employee with uncompensated overtime. Since labor hours vary between consultants, the estimate must be specific to that A&E consultant and management should provide support for the basis used to estimate the direct (and indirect, if appropriate) labor hours. An estimate/percentage of Direct Labor was used in this instance. In the optimal situation, the hours would be tracked individually on timesheets. See Worksheet: Procedures for Handling Uncompensated Overtime and Posting of Payroll, and Section 5.4.F.2 of the AASHTO Audit Guide for more information.