INQUIRY -  When developing a direct labor base and overtime premium has been incurred is it required to be included in the base even though it is an unallowable expense for recovery purposes?

RESPONSE - Even if the contract is not covered by the Cost Accounting Standards (CAS), the FAR cost principals, specifically FAR 31.201-6(c)(1), will compel any contractor subject to these principals to account for unallowable costs in accordance with 48 CFR 9904.405 - Accounting for Unallowable Costs (hereafter referred to as CAS 405). 

In essence, the government is saying that when FAR tells you that a specific Cost Accounting Standard, or some part of the CAS applies, then it applies, even though you may be exempt from CAS as a small business.  It is what it is!

One of the CAS 405 purpose statements [9904.405-20(a)(2)] provides - The Standard is predicated on the proposition that costs incurred in carrying on the activities of an enterprise - regardless of the allowabilityof such costs under Government contracts - are allocable to the cost objectives with which they are identified on the basis of their beneficial or causal relationships.

A fundamental requirement of the standard is that (unallowable costs) shall be identified and excluded from any billing, claim, or proposal applicable to a Government contract. [9904.405-40(a)] However, another fundamental requirement for purposes of computing indirect cost rates provides - In circumstances where these unallowable costs normally would be part of a regular indirect-cost allocation base or bases, they shall remain in such base or bases. [9904.405-40(e)]

For purposes of computing indirect-cost (overhead) rates for Government contracts we generally summarize -- per CAS 405-40(a) unallowable costs must be identified and excluded (removed) from the indirect-cost expense pool (numerator); but any unallowable costs allocable as a base cost must remain in the base (denominator) per CAS 405-40(e).