Step 5: Labor Distribution

meets the following DCAA Requirement:

  • A labor distribution system that charges direct and indirect labor to objectives.


I start by reviewing payroll systems and discuss the differences between Quickbooks Desktop payroll and an outside payroll services.  The differences between a payroll register and a labor distribution is reviewed.  If an outside payroll service is used, I show how to create of a “mock” payroll and the labor distribution report and discuss the need for the payroll journal entry.  If Quickbooks payroll is used, I discuss the need for a month-end journal entry for accrued wages and a sample is provided.  I demonstrate how to create the Labor Distribution Report.  Finally, I show you how to reconciled the labor distribution to your payroll register.

Payroll Systems

Labor distribution is the process by which labor costs are allocated to all time that is recorded on time sheets.  The distribution of labor costs must be allocated fairly among all cost objectives so that no customer or contract receives favorable treatment by receiving a cost subsidy.  DCAA will especially want to ensure that the labor costs are fairly distributed between commercial work and federal work, and between cost plus contracts and fixed price contracts.  The reason for DCAA's concern is that if the labor distribution system allocates labor costs in a manner that would unfairly reduce costs applied to commercial work or fixed price contracts, it would also unfairly increase costs on federal contracts and cost plus work.  The unfair share of labor costs then allocated to federal work and cost plus contracts would be incorrectly reimbursed by the federal contract, something the DCAA auditors are tasked to prevent.

Quickbooks handles the labor distribution when it runs a payroll.  When a payroll is posted in Quickbooks, it creates a paycheck, which contains payroll items.  Linked to the general ledger accounts for the various types of labor, the payroll items on the paycheck function to post the labor costs to the appropriate general ledger accounts.

If you are running payroll using Quickbooks Desktop Payroll, and using time sheets to create the payroll run, then you are also automatically creating the labor distribution.

If you run your payroll using an outside, third-party payroll provider such as ADP, you'll need to run a "mock" payroll in Quickbooks to create the labor distribution.

Mock Payroll

To run a mock payroll in Quickbooks, you'll need to first enter or import time sheets into Quickbooks.  Ensure that all time has been entered for the pay period; this may require 2 or 3 weekly time sheets, depending on your payroll cycle.

Next, you will process a mock payroll by selecting the "Pay Employees" feature in Quickbooks.  A mock payroll does not actually pay any employees, hence the term "mock".  The mock payroll simply records the labor costs at gross pay.  You will not need to duplicate the tax withholding or deductions in Quickbooks.  Your third-party, outside payroll service will track withholdings deductions in great detail so it is unnecessary to enter this data in Quickbooks at the paycheck level. Set the "Pay Period Ends" date to the last day in the pay period.  The "Bank Account" should be set to a "Payroll Clearing" bank account, to capture the credit when you run the mock payroll.  Later, after the mock payroll is complete, you'll transfer the credit balance to the "Accrued Wages and Salary" liability account using a journal entry. The "Check Date" should be set to the same date as the end of the pay period.  The "Check Options" should be set to "Handwrite & Assign check numbers" (the check number assigned is not important). Finally, check the column for the employees to be included in the mock payroll, and click on "Open Paycheck Detail".

When you click on "Open Paycheck Detail", you will be able to review the paycheck you are about to create.  You will want to ensure that the payroll item, customer:job and service item are correct. Also ensure that hours are populating on the paycheck from the time sheet.  No tax withholding or deductions should appear.  If all looks correct, you may click on "Continue".  This will take you to another screen, where you click on "Create Paychecks". The following screen will prompt you to print paychecks or pay stubs.  Simply click "Close" since you will not need to print either.

Labor Distribution Report

The mock payroll has created the labor distribution. Now we'll create the Labor Distribution Report.  This report is created from the paychecks in Quickbooks.  Start by customizing the Payroll Item Detail report. On the Display tab, the only columns you will want to select are the following; (1) left margin, (2) Date, (3) Num, (4) Name, (5) Source Name, (6) Account, (7) Qty, (8) Amount. Also on the Display tab, select "Employee" in the "Total by" field.  On the Filters tab, in the Current Filters Choices, select Payroll Item and then "Multiple Payroll Items", which will allow you to select all of the time sheet related payroll items.  Do not select any payroll items that are not related directly to time sheets. If you add new payroll items later, ensure that you also add the payroll items to this report.  Finally, rename the report to "Labor Distribution by Employee".

Payroll Journal Entry

If you run your payroll outside of Quickbooks with a third-party payroll provider, you'll need to enter your payroll transactions into Quickbooks with a journal entry.  The first step is to transfer the credit balance now in the payroll clearing account, generated from the mock payroll, to the Accrued Wages and Salary account.  Next, enter a journal entry that will debit the Accrued Wages and Salary Account with the amount of gross pay that appears on the payroll register from the third-party payroll.  You will also enter credits for any tax withholding and benefit deductions, and credit your cash account for the amount of the payroll disbursement.  This information should be entered at the summary level for the company and not detailed for each employee.

Payroll Reconciliation

After entering the payroll journal entry, your next step is to reconcile the Accrued Wages and Salary account.  The balance should be zero, unless you really do still owe pay to employees.  If it is not zero and you have paid all of your employees in full, then you have what is known as a payroll variance, which needs to be eliminated.  There are several causes of payroll variances.  One is that the pay rate in Quickbooks differs from the actual pay rate that was utilized to pay the employee.  If this is the case, then adjust the paycheck in Quickbooks to match. A second cause for a payroll variance is that the number of hours recorded on time sheets in Quickbooks does not match the actual number of hours paid to an hourly employee.  Again, solution is to adjust both the time sheet and the paycheck in Quickbooks.  A final cause for a payroll variance is rounding for salaried employees when labor costs are distributed among two or more cost objectives. Usually the rounding error is just pennies, and can be written off using a payroll journal entry.

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