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Labor categories are commonly used with Time & Material (T&M) contracts to bill an hourly rate based on a labor category which is essentially a skill level. For instance, a Senior Engineer would be billed at a higher hourly rate than a Junior Engineer due to a higher level of skill and experience. The labor categories and hourly bill rates are determined during contract negotiations and fixed in the contract terms unless modified at a later date (more on modifications later).
DCAA Compliance
From a DCAA compliance perspective, your accounting system will need to track both the revenue related to labor categories, and the costs associated with each labor category. This article will show you how to set up labor categories in QuickBooks for DCAA compliance.
Labor Category Revenue and Billing
Determining labor category revenue is straight forward. When an invoice is recorded in QuickBooks Online, a service item is used to record the number of hours of service delivered for a particular labor category and the associated bill rate. For instance, 100 hours of Senior Engineer time at an hourly rate of $150 is $15,000 in revenue. Service items are set up in QuickBooks Online in the Products and Services screen.
Service Item Categories
I like to keep service items organized by categories in QuickBooks Online because it makes it easier to manage them, especially if you have a lot of service items. QuickBooks Online Advanced allows you to create service item categories which in themselves can be nested, a nice feature and in itself a reason to upgrade from QuickBooks Online Plus if you have numerous service items. However, QuickBooks Online Plus offers the ability to nest service items as a sub-item to achieve the same result, even if it is not as easy to view on the screen.
Here are the service item categories that I recommend but you can create your own.
CLINs
Funding Periods
Labor Categories
Labor Items
Milestone/Phases
Other Direct Cost Items
Provisional Indirect Rates
Products
Service Agreements
Since this article is about labor categories, we will focus on that service item category.
Company-wide vs. Contract-specific Labor Categories
QuickBooks Online can handle both types of labor categories. Company-wide labor categories use the same hourly bill rate regardless of which project is being billed. One size fits all. This is often the case with standard service offerings.
Contract-specific labor categories have an hourly bill rate determined by the contract and can differ from one contract to another for the same labor category. For instance, contract A may have a bill rate of $150 per hour for a Senior Engineer but contact B may have a bill rate of $135 an hour for the same labor category, Senior Engineer. Contract-specific labor categories allow you to bill the correct hourly rate given the contract under which the work is performed.
Summary
Are you with me so far? Let's review. Service items can have service item categories to keep you organized. One of those service item categories is a labor category used to bill an hourly rate. Labor categories can be further broken down by company-wide labor categories when one size fits all, or contract-specific labor categories when bill rates differ by contract. Tracking revenue by labor category is one important aspect of labor categories in QuickBooks for DCAA compliance. The other is tracking labor category costs.
Labor Category Costs
Determining labor category costs are not as straight forward in QuickBooks Online and can become so complex that I often recommend that you engage a DCAA accounting expert. For DCAA compliance, determining labor category costs is a requirement. Labor category costs are also required to determine labor category profit (or loss), an important financial metric useful in managing a company's bottom line and bidding on labor category contracts. I believe that if you have T&M contracts, you must understand your labor category costs to optimize your company's profit.
W-2 Employees
To understand labor category costs, we need to first understand that labor costs in QuickBooks Online are recorded in general ledger accounts, otherwise known as your chart of accounts. In government contracting, the labor costs associated with W-2 employees that are paid through your payroll service are recorded in general ledger labor accounts.
Here are the usual types of W-2 labor accounts you will find in your chart of accounts:
Direct Labor
Paid Leave (PTO, Vacation, Holiday Pay, Sick Pay, Family Leave)
Overhead Labor
Facilities Labor
Service Center Labor
G&A Labor
B&P Labor
IR&D Labor
Unallowable Labor
Labor Distribution
Direct Labor will be used to record the W-2 labor payroll wages directly associated with the work being performed on a labor category. But also note that W-2 wages need to be allocated to other types of labor accounts which are not directly associated with labor category work and are known as indirect labor. The allocation process of W-2 labor costs to labor accounts, contracts and labor categories is known as labor distribution and is a DCAA requirement which requires a DCAA-compliant timesheet system.
An accurate labor distribution is a DCAA requirement and I highly recommend that you engage a DCAA accounting expert to get his right.
See a list of our DCAA accounting experts here.
The labor distribution process cannot be automated in a compliant manner with QuickBooks Online unless it is created and posted using GovBooks.
Learn more about how GovBooks handles the labor distribution here.
Subcontractors
In addition, government contractors often employ independent contractors (also known as 1099s) and subcontractors to perform work that is billed on a T&M basis. The cost of this outsourced type of subcontract labor is also a component of labor category costs.
Here are the usual types of outsourced subcontract labor accounts you will find in your chart of accounts:
Direct Subcontractors
Direct Consultants/1099s
Direct Subawards
In QuickBooks Online, subcontractors costs are recorded as a vendor invoice (bill) and can be paid in a variety of ways to include check, ACH, wire, or your payroll service. Regardless of the payment method, it is important to record subcontractor costs by contract, subcontract account and labor category for T&M contracts in order to stay in compliance.
Indirect Costs
In order to determine the net profit of a labor category, you will need to allocate indirect costs. Net profit is calculated by deducting direct costs (W-2 wages and subcontractor costs) and indirect costs from labor category revenue.
Here are the usual types of indirect costs that you will need to allocate:
Fringe Expenses
Overhead Expenses
Facilities Expenses
Service Center Expenses
Subcontractor Overhead
G&A Expenses
An accurate allocation of indirect costs is a DCAA requirement and I highly recommend that you engage a DCAA accounting expert to get his right.
See a list of our DCAA accounting experts here.
The indirect cost allocation process cannot be automated in a compliant manner with QuickBooks Online unless it is created using GovBooks.
Learn more about how GovBooks handles the indirect cost allocations here.
Labor Category Setup in QuickBooks Online and GovBooks
There are two methods to set up QuickBooks Online and GovBooks to track labor category costs, which determines how labor category costs are accumulated:
Service Item Method
Project Method
Service Item Method
The Service Item Method requires that you map the same service item that you use for billing purposes to an expense account on your chart of accounts in QuickBooks Online. The example below show how the labor category, "Engineer", is mapped to the labor account, "Direct Labor", by checking the box in the Purchasing section, "I purchase this service from a vendor". Don't worry that it says "vendor". The labor cost will be posted from GovBooks to an expense record using the service item and the labor costs will end up in the correct labor account.
This method requires the time data in QuickBooks Online to be coded to the service item. You can view this by running a "Time Activities by Employee Detail" report in QuickBooks Online. If the "Product/Service" field is blank or contains a different service item, you will need to correct this before GovBooks can create an accurate labor distribution. In most timekeeping systems you will be able to set up the service item and connect it to the project so that it is imported in QuickBooks Online along with the project. However, if your timekeeping system does not handle service items, you would need to enter this data manually (if this is the case, you should consider the next two methods which do not use service items for labor category costing).
When creating and posting the labor distribution in GovBooks, you would select "Yes" for "Use Service Item". This will generate the labor distribution based on service items recorded in the time data in QuickBooks Online. If you select "No", the labor distribution will be created based on labor accounts selected in GovBooks (see below).
Project Method
The Project Method does not use service items from QuickBooks Online time data to create the labor distribution in GovBooks. Instead, the Project Method relies on mapping between projects and labor accounts which takes place in GovBooks in the Labor Distribution/Projects screen.
You can learn more about creating a labor distribution using project in this article here.
The Project Method requires the creation of a unique project in QuickBooks Online for each labor category. In the example above, the project, "Engineer", is used in QuickBooks Online to capture the labor costs associated with the labor category, "Engineer". A separate project is required for each labor category with the Project Method as a way to segregate the labor costs within a single contract.
In Conclusion
From a DCAA compliance perspective, your accounting system will need to track both the revenue related to labor categories, and the costs associated with each labor category. If you would like more information on how to set up labor categories in QuickBooks for DCAA compliance, contact us for a GovBooks demo.