A Government Contractors Guide to T&M Contracts
Key Details: In the world of government contracting, it is essential to understand the various offerings of contract types and the associated benefits and drawbacks. These contract vehicles specify the agreement between your business and the federal government and bring about varying levels of requirements and risk. In this guide, we explore the inner workings of Time & Materials (T&M) contracts as well as compliance topics to help your business remain competitive. For information regarding firm fixed price (FFP) and cost-type contracts, check out our two-part series here and here.
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What is T&M Contracts and How do they Work?
Under FAR 16.601, T&M contracts provides for the acquisition of supplies or services based on two key items:
- Direct labor hours at fixed hourly rates. This includes wages, overhead (OH) costs, general and administrative (G&A) expenses, and profit.
- Actual cost of materials.
Hourly rates refer to the rates prescribed in the contract for the payment of labor. Hourly rates differ by labor categories. Direct material expenses are the costs of materials that enter directly into the product to be delivered to the federal government. Direct materials also include materials used or consumed in direct connection with the furnishing of the product or service.
Government contractors performing work under T&M contracts are subject to a wide range of requirements such as adequate timekeeping and billing systems and proper tracking and allocation of direct and indirect costs by contract.
When Does the Government Utilize T&M Contracts?
T&M contracts are typically used in construction or product development where it is difficult to estimate the exact size of the project, or it is difficult to anticipate any changes that can occur during the performance of the contract. As such, the government typically uses T&M contracts when there are many uncertainties associated with contract performance and when the scope or duration of the job cannot be completely established before work begins.
Ceiling Price Risk Limitations
In addition to the limitations on the use of T&M contracts as described above, FAR 16.601 also provides that “the contract or order includes a ceiling price that the contractor exceeds at its own risk.” A T&M contract also provides no positive profit incentive for contractors in terms of controlling costs or labor efficiency.
Components of a T&M Contract
Key components of a T&M contract should include the following:
- Outline of the project / job’s objectives.
- Fixed price for hourly labor rate that includes wages, OH, G&A, and profit.
- Materials costs (that include associated expenses such as freight, taxes, and markup).
- An additional not-to-exceed clause where necessary that specifies a maximum price.
Pros and Cons of a T&M Contract
Price transparency and certainty– you know exactly what to charge the government on an hourly basis.
Potential for poor budget control. Rising inflation and labor costs make the contract less profitable since the price increases are generally 1 – 3% a year.
High level of administrative involvement – must have a robust timekeeping system.
Potential for price saving
Subject to incurred cost submissions in certain cases.
Compliance – Timekeeping
A critical component of T&M contracts is the accurate tracking of direct and indirect labor to support hours charged to various labor categories. Contractors should aim to have a timekeeping system that can properly allocate direct and indirect labor to projects. This means the timekeeping system must be able to track both employee hours and dollars by job and accounts. Government contractors should also aim to internally reconcile their timekeeping system to their payroll system, general ledger, and job cost system. Key aspects of an adequate accounting system include, but is not limited to the following:
- Employees must record their time daily and must not record time in advance or days after the fact.
- Employees must record time by day, project, and direct or indirect accounts. Employees must record all time, including vacation or sick time.
- Within the timekeeping system, project names or job codes must appear and be clear. These project or job codes should be available to employees that are authorized to perform work on that project or job.
- Supervisors must approve employee timesheets and any corrections to time entries made by the employee must also be approved.
- Documentation and retention of employee time sheets and all corrections must be maintained.
- Electronic timekeeping systems must be password protected and passwords should be changed periodically.
Additionally, government contractors are encouraged to maintain and regularly update their timekeeping policies and procedures. Key items in these policies should include:
- Purpose, scope, and key definitions.
- Procedures for training and informing employees of policies.
- Timesheet preparation.
- Timesheet approval process.
- Timesheet submission process.
- Adequate document retention regarding audit trails.
- Labor and charge codes.
- Employee authorization to charge labor to various project codes.
- Timesheet review process.
- Timesheet reconciliation process.
- Timesheet corrections policy.
Government contractors working on T&M contracts are encouraged to thoroughly review their timekeeping system to remain compliant and competitive in the future.
Compliance – Incurred Cost Submission
Government contractors performing on T&M contracts are sometimes required to file an incurred cost submission (ICS) in some cases. This is because under these contract types, billings throughout the year for costs incurred used either provisional or estimated indirect rates. The ICS true’s up the billings throughout the year to the actual indirect cost rate.
The ICS covers the following key areas:
- Presentation of pools and bases.
- Direct cost by contract.
- Cumulative costs incurred, cumulative billing, and over/under billing.
Contractors should note that the ICS must be submitted within 6 months of the fiscal year-end. Contractors performing on T&M contracts should also note that there are additional compliance requirements that need to be met. Contact Ryan & Wetmore today for further information.
Contractors are encouraged to perform the following action items to ensure a compliant system when performing on or bidding for T&M contracts.
- Establish an adequate timekeeping system.
- Understand labor category requirements after contract award.
- Review and confirm that the company has documentation that supports that each employee meets the labor category requirements for which they are to be billed under.
- The project manager should review time charges by category to confirm employees are billing to the correct category and job.
- Ensure document retention related to employee timekeeping and labor category requirements.
- Perform internal system audits to ensure employees are charging time to the correct categories.
- Ensure your timekeeping system has an audit trail that shows any edits to timesheets.
- Ensure timesheets are approved by managers or supervisors.
- Understand and implement risk mitigation practices to ensure adequate controls exist to prevent billing for hours that are not adequately supported.
- Review your accounting system to ensure adequate cost tracking and allocation to various cost pools and bases.
- Ensure invoices are reviewed for accuracy and review the tracking of cumulative costs incurred and billed.
For further information regarding compliance, contact Ryan & Wetmore today.
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About Peter Ryan
Partner, Co-founder, & CPA
Peter T. Ryan co-founded Ryan & Wetmore in 1988 with business partner Michael J. Wetmore. Peter provides clients with the best strategies for success. His expertise extends across various industries. Peter obtained a Master of Business Administration in Finance from the University of Baltimore and a Bachelor of Arts in Accounting from the Catholic University of America.
About Rosie Cheng
Rosie Cheng is a Finance Consultant at Ryan & Wetmore. She focuses on government contracting services and produces many of the firm’s government contracting newsletters. Rosie graduated from Georgetown University with a Master of Science in Management and from William and Mary with a Bachelor of Business Administration.