PCI Financial Forum Compensation Cost Allowability: Select Compensation Costs

Transcription

1 PCI Financial Forum Compensation Cost Allowability: Select Compensation Costs May 3, 2016 Steven M. Masiello Gale R. Monahan

2 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

3 Compensation Cost Generally Compensation costs FAR : all remuneration paid currently or accrued, in whatever form and whether paid immediately or deferred, for services rendered by employees to the contractor FAR (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

4 Compensation Cost Allowability General criteria for allowable compensation costs Must meet general cost allowability requirements in FAR Reasonable, allocable, GAAP/CAS, terms of relevant contracts, cost principles Also required to meet requirements in FAR 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 No presumption that compensation costs are allowable If requirements of FAR are met, requirements of FAR are also likely satisfied 4

5 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

6 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 , 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

7 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 (b)(2)) DCAM 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 , 12-1 BCA 34,920; Metron, Inc., ASBCA No , 12-2 BCA 35,066) But, DCAA continues to apply this test 7

8 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

9 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

10 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

11 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 , 15-1 BCA 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

12 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

13 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

14 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 , to the extent of its fair share 14

15 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

16 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

17 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

18 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 (j)(3) 18

19 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

20 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

21 Questions? Steven M. Masiello Partner Government Contracts Gale R. Monahan Managing Associate Government Contracts

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