Bonuses and incentive compensation fall under the Compensation cost principle (FAR 31.205-6) which means that to be allowable under Government contracts, the costs, when added to all other forms of compensation (including fringe benefits), must be "reasonable for the work performed". However, when it comes to bonuses and incentive compensation, there are a couple of other criteria that contractors must meet if they want to claim the costs on their Government contracts. These are;
- The awards must 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.
The most frequent challenge to bonus and incentive compensation costs come from auditor assertions that the costs were not paid pursuant to an agreement entered into before the services were performed. Careful planning and structuring of bonus plans should help avoid such challenges. Contractors need to avoid situations where they come to the end of the year, find they have some extra cash, and in a spate of goodwill, distribute bonuses to its employees.
A couple of things to keep in mind based on prior ASBCA (Armed Services Board of Contract Appeals). First, employees need not have had a right to receive the bonus, provided there was a reasonable expectation that the bonus would be paid. Secondly, some management discretion in making payments is permissible ("That is presumably what top management is for, and one of the requirements for the attainment of such a position is the ability to bear such responsibility and to make the decisions which grow out of it").