What’s in This Article:
When Is Compensation Allowable?
What Makes Compensation Reasonable?
Why Compensation Benchmarking Matters
What Should Contractors Document?
WHAT TO KNOW
Compensation is an important cost for government contractors, but paying an employee a certain amount does not automatically mean the entire cost is allowable under a government contract.
FAR 31.205-6, Compensation for Personal Services, establishes requirements contractors should consider when determining and documenting employee compensation.
WHEN IS COMPENSATION ALLOWABLE?
Under FAR 31.205-6, compensation generally must be reasonable for the work performed and consistent with the contractor’s established compensation plan or practices.
Compensation can include more than salary. Depending on the circumstances, wages, bonuses, incentive compensation, deferred compensation, and other forms of compensation may be subject to FAR requirements.
Contractors should also be aware that additional limitations can apply to certain compensation costs.
WHAT MAKES COMPENSATION REASONABLE?
Reasonableness is an important consideration when evaluating compensation.
Factors may include compensation paid by companies that are similar in size, industry, geographic area, and type of work performed.
For owners of closely held businesses, additional considerations apply. Compensation should reflect services actually performed and should not simply represent a distribution of profits.
WHY COMPENSATION BENCHMARKING MATTERS
Compensation benchmarking can help contractors support why an employee’s compensation is reasonable.
A useful analysis may consider:
- Position and responsibilities
- Industry and company size
- Geographic market
- Experience and qualifications
- Comparable compensation data
The goal isn’t simply to find a salary number. Contractors should be able to demonstrate that the information used is relevant to their particular circumstances.
WHAT SHOULD CONTRACTORS DOCUMENT
Good documentation can help support compensation costs if they are later questioned.
Contractors may want to maintain compensation policies, job descriptions, benchmarking data, compensation studies, bonus plans, approvals, and documentation supporting significant compensation decisions.
Having this information available before an audit or review is generally much easier than trying to recreate the support afterward.
CONCLUSION
Compensation decisions can affect indirect rates, contract costs, and cost allowability. Government contractors should periodically review compensation practices and maintain documentation supporting how compensation was established.
Need help with government contract accounting or compliance? Contact Cheryl Jefferson & Associates to discuss your GovCon accounting needs.
FREQUENTLY ASKED QUESTIONS
1. Is executive compensation allowable on government contracts?
Compensation may be allowable when it meets applicable FAR requirements, including requirements related to reasonableness and allocability. Contractors should also consider any applicable statutory limitations or contract-specific requirements.
2. How do government contractors determine whether compensation is reasonable?
Reasonableness generally requires evaluating compensation in relation to the work performed and relevant market conditions. Contractors should maintain documentation supporting how compensation levels were established.
3. Why is compensation benchmarking important for government contractors?
Benchmarking can help contractors support the reasonableness of compensation by comparing pay with relevant positions, responsibilities, industries, company sizes, and labor markets.
