Accounting for Purchased Labor

Government contractors must be very careful on how they account for the cost of purchased labor. Many contractors obtain engineers, technical writers, technicians, craftsmen and other personnel by subcontract (commonly called "purchased labor") to meet temporary or emergency requirements rather than hiring those skills outright. In most cases, this practice makes perfect business sense but if there is too much of it going on, government auditors may study the situation to determine whether any additional costs resulting from purchased labor is reasonable, necessary, and properly allocable to government contracts.

Once the reasonableness of purchased labor is established, it is necessary to properly account for it. The proper accounting treatment varies depending upon the circumstances under which the costs were incurred. For example, some contractors classify purchased labor as direct labor costs when the work is performed in the contractor’s facilities and under their supervision and otherwise meets the FAR definition of direct costs. These contractors cost such effort using the average labor rate incurred by their own employees for comparable work. Differences between the amounts derived and purchased labor prices are treated as overhead costs and are allocated accordingly. Other contractors classify purchased labor as subcontract costs.

Purchased labor most likely causes no fringe benefits and other employee-related costs to be incurred.  Such costs are generally paid by the entity providing personnel performing the effort.

FAR and CAS require that pooled costs shall be allocated to cost objectives in a reasonable proportion to the causal or beneficial relationship of the pooled costs to cost objectives. Purchased labor must share in an allocation of indirect expenses where there is a causal or beneficial relationship. In some cases, a separate allocation base for purchased labor may be necessary to allocate significant overhead costs to purchased labor such as supervision and occupancy costs, or to eliminate other costs not benefiting purchased labor such as fringe benefits costs.

Where the effort of purchased labor is performed in-house using the contractor's supervision and facilities, overhead exclusive of fringe benefits and other employee related costs, if material in amount, should be allocated to purchased labor. Conversely, where the effort of purchased labor is performed offsite under the supervision and control of an entity other than the contractor, none of the contractor's labor overhead costs may be allocable to purchased labor.

The determination on how best to allocate purchased labor costs on Government contracts must be supported by proper analysis and rationale. Government contractors must be prepared to demonstrate the propriety of the method they choose to use.