Compensation Cost Allowability: Select Compensation Costs...Jun 01, 2016 · • DOD and DCMA...

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PCI Financial Forum

Compensation Cost Allowability:Select Compensation Costs

May 3, 2016Steven M. Masiello

Gale R. Monahan


Agenda

• Compensation Cost Allowability

• Overview

• Trends and Issues

• Specific Compensation Cost Allowability Provisions

• Executive Compensation

• Severance Pay

• Bonus and Incentive Compensation

• Pension Costs

• Deferred Compensation

• Postretirement Benefits other than Pensions

• Fringe Benefits

• Best Practices

2


Compensation Cost Generally

• Compensation costs

• FAR 31.001: all remuneration paid currently or accrued, in whatever

form and whether paid immediately or deferred, for services rendered

by employees to the contractor

• FAR 31.205-6(d): includes compensation paid, or to be paid in the

future, to employees in the form of

• Cash

• Corporate securities

• Other assets, products, or services

• While generally allowable, the FAR contains detailed guidance and

limitations on the allowability of specific forms of compensation

3


Compensation Cost Allowability

• General criteria for allowable compensation costs

• Must meet general cost allowability requirements in FAR 31.201-3

• Reasonable, allocable, GAAP/CAS, terms of relevant contracts, cost principles

• Also required to meet requirements in FAR 31.205-6

• Compensation must be for work performed in the current year

• Compensation for individual employees must be reasonable for the work performed

• Must be based upon/conform to contractor’s established compensation plan or practice

• Must comply with other provisions of FAR 31.205-6

• No presumption that compensation costs are allowable

• If requirements of FAR 31.205-6 are met, requirements of FAR 31.201-3 are

also likely satisfied

4


Compensation Cost Reasonableness

• Compensation cost reasonableness is the element of allowability where

contractors experience the most frequent challenges

• “A cost is reasonable if, in its nature and amount, it does not exceed that which

would be incurred by a prudent person in the conduct of competitive business”

• Reasonableness considerations

• Is the cost ordinary and necessary for the conduct of the contractor’s business?

• Is the transaction consistent with: generally accepted sound business practices,

arm’s-length bargaining, and federal and state laws and regulations?

• What are the contractor’s responsibilities to the government, other customers, etc.?

• Has the contractor significantly deviated from established practices?

• Compensation cost reasonableness factors include, but are not limited to,

conformity to practices of other firms of

• Same size

• Same industry

• Same geographic area

• Engaged in similar non-government work under comparable circumstances

5


Trends and Issues in Cost Reasonableness

• Historically, the government has focused on contractor processes/

procedures

• Methods of contractor performance and business decisions (and resulting

costs) typically not second guessed

• Contractor discretion

• Old rule (e.g., Boeing Aerospace Operations, Inc., ASBCA Nos. 46274, 46275, 94-2

BCA ¶ 26,802)

• “Costs may not be disallowed on the basis of unreasonableness if the contractor has acted within

the scope of its discretion in a nonarbitrary manner”

• Government may not substitute its judgment for that of the contractor

• New rule (e.g., Kellogg Brown & Root Servs., Inc. v. United States, 728 F.3d 1348 (Fed.

Cir. 2013); Kellogg Brown & Root Servs., Inc. v. United States, 742 F.3d 967, (Fed. Cir.

2013), cert. denied, 135 S. Ct. 167 (Oct. 6, 2014)

• Courts are permitted to evaluate not only a contractor’s processes, but also employee decisions

made implementing those processes

• Strict application of cost allowability requirements

6


Trends and Issues in Compensation Costs

• Increased scrutiny of contractor compensation costs

• Compensation is reasonable if the aggregate of each element amounts

to a reasonable total amount (FAR 31.205-6(b)(2))

• DCAM 6-413.7 acknowledges that offsets are permitted

• A compensation element may be unreasonable, but total compensation may

still be reasonable

• Unreasonable compensation elements are still high risk

• DCAA’s reliance on 10% “range of reasonableness” test

• Rejected in by case law (J. F. Taylor, Inc., ASBCA No. 56015, 12-1 BCA

¶ 34,920; Metron, Inc., ASBCA No. 56624, 12-2 BCA ¶ 35,066)

• But, DCAA continues to apply this test

7


Executive Compensation

• Multiple ceilings may apply to a contractor depending on date of contract award

and awarding agency

• Executive Agencies other than DOD, NASA, and Coast Guard

• For contracts entered into before June 24, 2014, executive compensation caps apply to

top 5 senior executives

• 2014 = $1,144,888; 2013 = $980,976; 2012 = $952,308

• For contracts entered into after June 24, 2014, cap for all employees is $487,000

(adjustment annually based on BLS Employment Cost Index)

• DOD, NASA and Coast Guard

• For contracts entered into before Dec. 31, 2011, executive compensation caps apply to

top 5 senior executives

• 2014 = $1,144,888; 2013 = $980,976; 2012 = $952,308

• For contracts entered into after Dec. 31, 2011 and before June 24, 2014, compensation

caps apply to all employees

• For contracts entered into after June 24, 2014, cap for all employees is $487,000

(adjustment annually based on BLS Employment Cost Index)

8


Executive Compensation (Cont.)

• DOD and DCMA previously issued guidance in support of using blended rates

and encouraging advance agreements

• DCAA recently issued MRD 16-PSP-005(R) implementing DOD and DCMA

guidance on the use of blended rates

• DCAA will provide a non-audit service on the proposed advance agreement to ensure

that it complies with the DOD guidance

• DCAA will audit forward pricing proposals, interim billing rates, and incurred costs

submissions to ensure that compensation costs do not exceed the allowable amount

• DCAA will evaluate:

• Basis for measuring the volume of contract effort

• Accuracy of calculations

• Method for accumulation of compensation costs

• DCAA will analyze a forward pricing rate proposal even if an advance agreement does

not exist

• DCAA will return any incurred cost proposals submitted after June 1, 2016 that use

blended rates if an advance agreement is not in place

9


Severance Pay

• Allowable if it is required by:

• Law;

• Employer-employee agreement;

• Established policy that constitutes, in effect, an implied agreement on the contractor’s

part; or

• Circumstances of the particular employment

• Severance is not allowable if terminated employee is employed by:

• Replacement contractor where credit for prior service is preserved under substantially

equal conditions of employment; or

• Same contractor, but at another facility, subsidiary, affiliate or parent company

• Compensation incidental to a business acquisition may not be allowable

• Special compensation in excess of the contractor’s normal severance pay practice is

unallowable

• Payments to employees under plans introduced pursuant to a change in management or

ownership, which are contingent upon an employee remaining with the contractor for a

specified period of time, are unallowable

10


Bonus and Incentive Compensation

• Bonus and incentive compensation costs are allowable if:

• The awards are paid or accrued under an agreement entered into in good faith with the

employee and before services are rendered; or

• Pursuant to an established and consistently followed plan or policy; and

• The basis for the award is supported

• If costs are deferred:

• The costs still must comply with the above requirements; and

• The costs must comply with the requirements of CAS 415

• But, such costs are unallowable if the awards are made in periods after the work was

performed

• Raytheon Co., ASBCA No. 57576, 15-1 BCA ¶ 36043

• Bonus and incentive compensation costs are not expressly unallowable costs, but may

be unallowable in certain circumstances (e.g., if they are granted to a person who

engages in expressly unallowable activities)

11


Pension Costs

• Two Types of Pension Plans

• Defined-benefit

• Defined-contribution

• Basic pension cost allowability requirements

• Measured, assigned, and allocated in accordance with CAS 412 and CAS 413,

even if a contractor is not performing CAS covered contracts

• Funded by the deadline set for filing federal income tax returns

• Payments must be made in accordance with a good faith agreement negotiated

before employees perform work

12


Defined-Benefit Pension Plans

• Except for nonqualified plans, pension costs assigned to fiscal years but not

funded are not allowable in subsequent years

• Amounts funded in excess of the pension costs assigned to a cost accounting

period are unallowable in that period

• Any excess amount shall be accounted for as a prepayment credit and may be allowable

in a future period to which it is assigned

• Increased costs are unallowable if:

• They are caused by a delay in funding beyond 30 days after each quarter of the year to

which they are assignable; or

• They result from the withdrawal of assets from a pension fund and a transfer to another

employee benefit plan fund, or a transfer of assets to another account within the same

fund, unless such transfer is authorized by an advance agreement

13


Defined-Benefit Pension Plans

• Pension adjustments and asset reversions

• For segment closings, pension plan terminations, or curtailment of benefits, adjustments

shall be measured, assigned, and allocated in accordance with CAS 412

• Where assets revert to a contractor, or such assets are constructively received, the

contractor shall, at the government’s option, make a refund or give a credit to the

government for its equitable share

• Costs of indemnifying the Pension Benefit Guaranty Corporation (PBGC)

under ERISA arising from terminating an employee deferred

compensation plan may be allowable on a case-by-case basis

• Insurance must be required by the PBGC under ERISA

• The indemnification payment is not recoverable under the insurance

• Government must consider the extent to which the indemnification payment is allocable

to government work

• If a beneficial or other equitable relationship exists, the government will participate,

despite the requirements of 31.205-19, to the extent of its fair share

14


Defined-Contribution Pension Plans

• Allowable costs are limited to the net contribution required to be made in a

period, after taking dividends and other credits into account, where applicable

• Any portion of pension costs computed for a cost accounting period that is

deferred pursuant to a waiver granted under the provisions of ERISA will be

allowable in those future accounting periods when the funding does occur

• The allowability of these deferred contributions is limited to the amounts that

would have been allowed had the funding been made in the year the costs would

have been assigned except for the waiver

• Any amount paid or funded to the trust before the time it becomes assignable

and allowable shall be applied to future years, in order of time, as if actually paid

and deductible in such years

• These rules also apply to profit sharing plans, savings plans, and other such

plans that fall within the definition of a pension plan

15


Early Retirement Incentives

• Costs are allowable, subject to the requirements of defined-benefit

contribution pension plan costs, if

• They are measured, assigned, and allocated in accordance with the

contractor’s accounting practices for pension costs

• The incentives are in accordance with the terms and conditions of an early

retirement incentive plan

• The plan only applies to active employees

• Cost of extending the plan to retired or terminated employees is unallowable

• The present value of the total incentives given to any employee in excess of the

amount of the employee’s annual salary for the previous fiscal year is

unallowable

16


Deferred Compensation

• Compensation awarded to an employee in a future cost accounting

period for services rendered before the date of receipt of the

compensation

• Costs are allowable, subject to the these limitations:

• They are measured, assigned, and allocated in accordance with CAS 415

• The costs of deferred compensation awards are unallowable if the awards are

made in periods subsequent to the period when the work being remunerated

was performed

17


Postretirement Benefits other than Pensions

• All benefits, other than cash and life insurance benefits paid by pension plans,

provided to employees, their beneficiaries, and covered dependents during the

period following an employee’s retirement

• Examples: postretirement health care, life insurance provided outside a pension plan,

tuition assistance, day care, legal services, housing subsidies

• Costs are allowable if they are:

• Required by law, employer-employee agreement or an established policy

• Calculated in accordance GAAP

• Funded by the time set for filing the Federal income tax return or any extension thereof

• Increased PRB costs caused by delay in funding beyond 30 days after each

quarter of the year to which they are assignable are unallowable

• Government shall receive an equitable share of any amount of previously funded

PRB costs which revert or inure to the contractor pursuant to FAR 31.205-6(j)(3)

18


Fringe Benefits

• Allowances and services provided to employees as compensation in

addition to regular salary

• Costs of vacations, sick leave, holidays, military leave, employee insurance,

and supplemental unemployment benefit plans

• Allowable if:

• Reasonable; and

• Required by:

• Law

• Employer-employee agreement, or

• An established policy

• Cost of company furnished automobiles that relates to personal use by

employees is unallowable regardless of whether cost is reported as

taxable income

19


Cost Reasonableness Best Practices

• Document fully the basis for your compensation costs

• DCAA/DCMA often take the position that if an action is not documented, it did not happen

• Salary surveys are strong evidence of compensation cost reasonableness

• Establish and consistently apply policies and procedures

• A key element of demonstrating compensation cost reasonableness is establishing,

maintaining, and consistently applying policies/procedures (e.g., bonus plan)

• Employ a Record Retention Policy

• Ensures documentation will be available to support compensation cost reasonableness

(e.g., annual employee reviews, salary surveys)

• Anticipate government challenges

• All policies and procedures should be designed with the expectation that DCAA will

question the reasonableness of your costs

20


Questions?

Steven M. Masiello

Partner

Government Contracts

303.634.4355

[email protected]

Gale R. Monahan

Managing Associate

Government Contracts

303.634.4311

[email protected]

21

Dentons US LLP

1400 Wewatta Street

Suite 700

Denver, CO 80202-5548

United States

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