Allowable vs. Unallowable Compensation in Government Contracts

Compensation for management and executives can be allowable on government contracts if it meets certain requirements. Compensation includes all wages, bonuses, pensions, 401K, and other fringe benefits. All these costs can be rolled up into your overhead rate if it meets certain requirements. It must:

  • Be for work performed in the current year, it cannot include advances or retroactive adjustments to prior years
  • Pass a reasonableness test
  • Be consistent with company policies.

The reasonableness test takes into account similar companies within your industry, in your area, and with similar numbers of employees. The reasonableness test also ensures compliance with compensation policies.

One area that is highly scrutinized when it comes to compensation is bonuses. Here are a few examples of when bonuses are allowable and unallowable.

A business has a bonus plan in place that pays the CEO a competitive bonus if the company reaches a certain bottom line net income for the year. The policy identifies different thresholds for the executive to receive the full annual bonus or just part of it. At the end of the year, the company reached their highest level goal and the top executive received the entire bonus. In this case, the bonus meets all of the requirements to be allowable: it is based on current year results, it is reasonable compared to similar companies, and it is part of an existing bonus compensation plan that has been followed. This is expense is an allowable cost that can be assigned to your contract cost pools.

In contrast, a company does not have a written bonus plan in place. Rather it pays out bonuses as the owner sees fit. At the conclusion of a project, a top executive is awarded a bonus for performing the contract under budget. It is still a comparable bonus for the industry and location. This cost could be considered unallowable. Although it is for work performed in the current period and is comparable to other companies, it does not meet the requirement of consistency with current policies. There are no policies in this case. Also, the bonus is rewarded based on the performance on a contract that came under budget. Bonuses are not allowable if they are related to the results of a government contract. This could not be assigned to the government contract as an allowable cost. The company can certainly still pay the bonus for the performance on the contract, but would not be an allowable cost to assign to the contract.

Written by:
Ashley Peth
TGG Accounting

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