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Argy Articles
Employee Incentive Plans in Government Contractors
Charlie BonoccelliMost government contractors create incentive compensation plans, including bonuses in order to attract and retain good employees. In many cases, such plans are a key to success. This article focuses on performance incentives and bonuses. Such payments to employees may be for a variety of reasons, including working in hazardous environments to improving overall perfor¬mance. However, only plans in accordance with the Federal Acquisition Regulation (FAR) Part 31.205-6, will have the costs of its plans will be considered allowable cost.
While two companies can spend the same amount on two types of incentive plans, the requirements of Federal Acquisi¬tion Regulation (FAR) Part 31 may result in the costs on one type of plan completely allowable while the other company’s plan is disallowed in part or in total. The latter company has to pay a considerable amount of its incentive plans out of its profits. But by following the federal FAR rules much of the cost of the incentive program could be allowable.
For a federal government contrac¬tor creating incentive and bonus plans is complicated by the Federal Acquisition Regulations (FAR) Part 31 that sets a myriad of regulations that restrict or make unallow¬able certain types of employee compensation. This article will address the main types of incentive plans used by businesses and the restrictions government contractors face. Because of these restrictions, government contractors need to carefully plan what types of incentive plans will be implemented or face the possibility of creating a plan that the government may not allow as an indirect cost.
General Considerations
FAR 31.206-6(a) places certain require¬ments on all compensation programs. A government contractor, therefore, should be informed that before it installs a bonus or incentive plan, it should assess whether such a plan will result in reasonable compensation for the work performed. It also cannot pay such programs arbitrarily or inconsistently if the plan is not written. The federal govern¬ment does not presume that a new or significantly revised bonus or incentive plan is allowable, if the plan has not been reviewed by the Administrative Contracting Officer (ACO) before, or within a reasonable time after, the plan has been established. So sharing information on the plans should be provided to the ACO in a timely fashion and an advance agreement should be entered into if possible.
Such plans may be for the current or deferred. There are three recognized methods for payment of incentive programs, cash, corporate securities and other assets, products or services. The value for current year bonuses paid within a reasonable period after the fiscal year ends is the actual cash payment or Fair Market Value (FMV) of the stock or other asset. All such plans, when deferred, are valued at other than the value of the actual payment.
Unallowable Incentive Plans
The government contractor has to be especially careful whenever it uses company securities to pay for compensation plans. It requires close attention when design¬ing an incentive plan that uses the value of corporate securities as a basis for payments to individuals to be aware of the federal government accounting requirements. These are plans such as stock options, stock appreciation rights, phantom stock plans and any other plan where the compensation to the employee only occurs when there is an increase in the stock price, or where no actual exchange of corporate security takes place. The cost of such plans is unallow¬able for federal government contracting purposes.
Valuation of the Plans
The federal government requires that when securities are used to pay for an incen¬tive or bonus plan that the cost is limited to the fair market value (FMV) on the date the number of shares is first known. This requirement is used for both stock options and bonuses. For stock options, the only cost that may be recognized is the difference between the strike price and the FMV of the stock on the first date the number of shares to be awarded is know. For a stock bonus, the cost recognized is the FMV on the first date the number of shares is known. In both cases, the result of the government contract¬ing valuation may result in a large difference between the recorded value and the FMV at that date.
Even in deferred compensation the FMV of the stock is at that earliest date the number of shares is known is used to value the stock under the Cost Accounting Standards 9904-415. This may also result in differences between booked and federal government cost. This is especially true where stock options are recorded using acceptable GAAP estimating methods. The differences have become more pronounced over the years, as the static na¬ture of CAS does not adjust to the dynamics of a changing GAAP.
For cash payments, incentive and bonuses are less complicated. Such payments if paid within a reasonable time after the end of the fiscal year are recorded at the actual cost. However, where bonus and incentive plans require future performance and are paid in subsequent years, another set of rules takes over. 48 CFR 9904-415, Accounting for the Cost of Deferred Compensation, is the requirement that all federal government contractors follow. It requires that the cost of the deferred compensation plan be measure using the present value of future benefits. This again is not like the GAAP presentation of the cost that is normally measured based on the actual payments.
For deferred payments the amount of compensation recognized by the federal gov¬ernment depends on the type of payment and the vesting schedule. After the compensation is recognized there normally are employees that will forfeit benefits. Such forfeitures must be offset against the cost of the plan in the year the forfeiture occurs.
Types of Incentives and Bonuses
Incentives and bonuses may be paid for a variety of reasons. Domestically, most in¬centives are for common occurrences, such as:
- Project completion
- Performance
- Year-end bonuses
- Hazardous Duty
- Hardship Duty
- Foreign service
- Assignment completion
- Rest and Relaxation (R&R)
- Danger Pay
Conclusion
As a federal government contractor you should:
- Be aware of the types of incentive and bonus plans that the federal government will not pay for.
- Design plans around data can be docu¬mented.
- Put the plan in writing.
- Check for the reasonableness of the compensation.
- Realize that measurements of the cost by CAS and GAAP may be different.