(Editor’s Note. These rules provide considerable opportunity to time the recognition of certain costs to desired cost accounting periods.) Deferred compensation refers to compensation in a future cost accounting period for services in one or more prior periods. It does not include year-end accruals for salary, wages or bonuses paid within a reasonable period of time.
To be allowable, deferred compensation must be based on current or future services and be measured and be measured and accounted for in conformity with Cost Accounting Standards 415 (whether or not the contractor is CAS covered). CAS 405 requires costs be (1) measured by the present value of future benefits to be paid using the discount rate established by the Secretary of Treasury at time the cost is assigned and (2) assigned to the cost accounting period the contractor incurs the obligation. Six other conditions must be met for deferred compensation to be allowable in the current period:
The requirement to make future payments cannot be unilaterally avoided by the contractor.
The compensation award must be satisfied by future payment of cash, stock or other assets
The amount of future payment must be determinable with reasonable accuracy
The recipient of the award must be known
If receipt of the award is based on occurrence of future events, there must be a reasonable probability that such events will occur
For stock options, there must be a reasonable probability the options will ultimately be exercised.
If any of these conditions are not met, then the cost must be assigned to the cost accounting period the payment is actually made.
Differential Pay
The cost of domestic and foreign differential pay, including expenses associated with housing, cost-of-living adjustment, transportation and bonuses. The cost of tax "gross ups" to an employee for additional federal, state, local and foreign income taxes is now allowable but only for foreign duty assignments.
Fringe Benefits
Fringe benefits are defined as allowances in addition to regular wages and salaries. Fringe benefits for executives commonly include free parking, use of company-owned cars, life and disability insurance and ownership in social, dining or country clubs as well a normal fringe benefits provided to all employees (e.g. health insurance, vacation/sick leave, etc.). To be allowable, the costs must be reasonable and required by law, employer-employee agreement or established policy.
Fringe benefits, whether or not included as taxable income to the employee, are also considered in determining the overall compensation paid to the employee. As we saw last issue, the statutory "cap" imposed by the Department of Defense in fiscal years 1995 and 1996 includes fringe benefits.
Certain fringe benefits are unallowable. These include (1) employee rebates and purchase discounts (2) personal use of company-furnished automobiles, including home-to-work transportation and (3) costs of memberships in social, dining and country clubs.
Pension and Other Post Retirement Benefits
Pension Plans. Cost of deferred pension plans, whether funded or unfunded, must be measured, allocated and accounted for in accordance with CAS 412 and 413 whereas deferred contribution plans are subject to CAS 412 only. Under other types, pension payments must be reasonable, paid pursuant to a good faith agreement entered into before the work or services were performed and consistent with an established pension plan. Cost of living adjustments are allowable if part of a policy or practice. Except for unfunded pension plans, the pension costs must be funded by the time set for filing the contractor’s federal income tax (including any extension for filing). If not funded and absent a waiver under the Employee Retirement Income Security Act of 1974, any pension costs assignable to the current year are unallowable and may not be charged to any future year. Moreover, increased costs caused by delays in quarterly contributions are also unallowable. On the other hand, premature funding of pension plans must be charged to the period they would be assignable. One-time only supplemental benefits are allowable only if they represent a separate pension plan and the benefits are payable for life at the option of the employee.
Early Retirement Benefits. These costs must be accounted for and allocated in the same manner as pension costs – payments must be made in accordance with the contractor’s early retirement incentive plan and applied only to active employees. In addition, the total allowable amount of such incentive payments may not exceed those employees’ annual salary for the fiscal year prior to retirement.
Post Retirement Benefits. Like other costs, PRB must be reasonable and incurred pursuant to law, employee-employer agreement or an established plan. PRB costs must be accounted for on a cash, terminal funding or accrual basis. Like pension costs, they must be funded by the federal income tax return filing date and increased costs caused by delays to quarterly payments are unallowable. The allowability of PRB attributable to past service is limited to the amount that would be assigned under the delayed recognition provisions of Financial Accounting Standards Statement 106 (too detailed to recount here).
Severance Pay
Severance pay is considered payment in addition to salary and wages to workers whose employment is being involuntarily terminated. The costs must be reasonable and either required by law, employee-employer agreement, established policy that effectively constitutes an implied agreement or part of the circumstances for employment. The payment is unallowable if the employee is employed by a replacement contractor or employed by an affiliate of the contractor. "Normal" severance pay must be allocated to all work performed in the contractor’s plant. Though accruals for "abnormal" or "mass" severance is not permitted, the Government is obligated to pay "its fair share" of the payment. Recent Board decisions have held that the contractor is not entitled to recover severance costs under fixed-price contracts if not included in its proposed overhead rate.
Though earlier regulations prevented both severance and early retirement pay, later changes to the cost principle allows the cost of both as long as the early retirement pay limitations of one years’ salary is honored.
There have also been changes to employee release agreements where employees are given more severance pay than they would otherwise receive in exchange for releasing the contractor from potential liability for wrongful termination. DCAA initially took the position such costs were unallowable because they represented payment for work not performed. DOD firmly rejected DCAA’s position,, forcing DCAA to issue guidance prohibiting auditors from questioning such payments because they are unallowable backpay for work not performed and direct auditors to examine such payments on a case-by-case basis for reasonableness.
Payments Related to Mergers and Acquisitions
Two types of employee payments related to M&As are unallowable. First, "golden parachutes" where payments are made to employees under agreement where they receive special compensation in excess of normal severance pay if their employment is terminated as a result of a change in management control or ownership. Second, "golden handcuffs" are unallowable as part of payment made to keep employees when management control or ownership changes.
In addition, DOD Appropriations Acts since 1996 have prohibited bonus costs in excess of normal salary when such payments are part of the restructuring costs associated with a business combination. This limitation does not apply, however, to severance payments or early retirement payments.
{TAG_FORM_TITLE}
To discuss your needs, contact Bill Lennett, Principal, at 1-925-362-0712 or email him at
This e-mail address is being protected from spam bots, you need JavaScript enabled to view it
.
