Annual Incurred Cost Submissions - Schedule L

FAR 52.216-7 requires all contractors with flexibly-priced (e.g. cost reimbursable) contracts to submit annual incurred cost submissions. The content of these submission are arrayed in a series of alphabetical schedules from 'A to 'O. Schedule L of the annual incurred cost submission is a reconciliation of labor payroll per the  IRS Form 941 to the labor cost distribution records.

The IRS 941 is submitted quarterly to the IRS and includes such totals as taxable wages, social security wages, and medicare wages paid during the quarter. By adding four quarters, you can determine the amounts paid during the year. Also, the sum of these four quarters should reconcile directly with the sum of employee W-2s that are handed out after the end of each calendar year.

The 941s are prepared on a cash basis. In other words, it reports on amounts actually paid to employees during the year. Contractor accounting records are prepared (or should be prepared) on an accrual basis. Therefore, labor per the accounting records will not agree with the 941s. For example, if your payroll date falls on the Wednesday after the end of the payroll period and the payroll period ended December 31st, you would need to accrue those payroll costs into the prior year. But, since the employee did not receive payment in the prior year, the amount will not be included in the 941 for the prior year. So, as part of the reconciliation, you will need to adjust the sum of the 941s for beginning and ending accruals.

Sometimes, contractors try to reconcile to the wrong line on the 941s. Line 1 is taxable income. But taxable income will exclude employee contributions to 401(k) plans so that is not a good line to reconcile to. Line 5a shows taxable social security wages. However, taxable social security wages is capped at $117,000 (for calendar year 2014) so that is not a good line to reconcile to. Line 5c shows taxable medicare wages which is not capped so it represents the best amount to begin the reconciliation. However, even this number is not "pure" because, for example, it does not include employee contributions to Sec. 125 Cafeteria Plans.

The Schedule L reconciliation is often one of the most difficult and time consuming schedules to prepare. It requires a team comprised of someone intimately familiar with accounting and someone intimately familiar with payroll. For companies that outsource their payroll, the reconciliation often requires the assistance of an account manager for the payroll service.

We've seen cases where contractors will come close to reconciling, give up in frustration, and submit their incurred cost submission with an un-reconciled difference. This is somewhat risky because some auditors, when preforming "adequacy" determinations, will reject them out of hand and return it to the contractor. We've also seen cases where auditors will accept an unreconciled difference. So, one never knows.