Bonuses and Incentive Compensation

Bonuses and incentive compensation plans take many forms. Usually they involve cash payments but might also include stock options, stock appreciation rights, etc, or a combination thereof. The allowability of these costs is covered in FAR 31.205-6 (j). Briefly, the cost principle allows the cost of bonuses and incentive compensation provided they meet the following two criteria;

• 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.

Contractors must be very careful that their bonus and incentive compensation plans meet these two criteria. Too often we've seen cases, especially among smaller contractors, where bonuses are paid out on considerations that cannot be defended based on this cost principle.