Most companies have found that offering incentive bonuses or awards is a good way to obtain and retain good employees. There are short-term or spot bonuses or awards generally paid to the employee in cash within a short period of the employee earning the award and long-term bonuses or awards that are again normally paid to the employee in cash at the completion of an established performance period (i.e. fiscal year).[i]

The cost of these bonuses are recoverable through a company’s indirect rate structure which makes them subject to the review and allowability assessment of government auditors (i.e. DCAA).  To ensure that your bonuses or awards are considered allowable by DCAA there are a few things that need to be done.

FAR 31.205-6(f)(1) addresses the allowability of bonuses and incentive compensation as follows:

Incentive compensation for management employees, cash bonuses, suggestion awards, safety awards, and incentive compensation based on production, cost reduction, or efficient performance are allowable provided the awards are paid or accrued under an agreement entered into in good faith between the contractor and the employees before the services are rendered or pursuant to an established plan or policy followed by the contractor so consistently as to imply, in effect, an agreement to make such payment and the basis for the award is supported. 

First, you need to plan ahead to provide for a realistic bonus allowance to be included in your projected forward pricing rates approved for use in new proposals and billings.  This should, if you achieve your projected fiscal goals, provide the funds needed to pay to your employees the anticipated bonuses.  This bonus allowance should be established by management prior to the beginning of each year and employees should be informed of the company’s planned desire to pay a bonus based on the achievement of the established performance or financial goals.

Next, a formal written company policy needs to be put in place explaining which employees are eligible for the subject bonuses or awards.  Generally, the eligibility applies to all full-time and regular part-time employees although other categories may be included.  It is important that all employees within a category have an equal chance to receive a bonus or award based on their level of contribution to the attainment of established goals.  Individual bonuses or awards that are greater or less than the average award established for a category of employees, including those employees who were not awarded a bonus at all,  should be documented as to the reason for the variance to ensure the equitable awarding of bonuses and awards.

The policy should define when the bonuses or awards are to be provided to the employees and what level of bonus or award may be given to employees terminated during the performance period both voluntarily and involuntarily.  Partial bonuses or awards may be provided for terminated personnel on a pro-rata basis if desired.

The written policy should also indicate what is to happen if, for some reason, the bonus or awards plan is terminated in its entirety before completion of the performance period, and what if any, bonuses or awards would be provided must be defined.

To summarize! Establish the desired target bonus goal(s), ensure the necessary funding needed to pay out the bonuses upon achievement of the established goal(s), and define by policy the bonus distribution process to ensure an equitable distribution of the bonuses awarded.

[i] Long-term bonuses or awards can also be in the form of stock, stock options, stock appreciation rights, phantom stock plans, restricted stock, etc.  Only cash bonuses or awards are discussed here.