Friday, January 27, 2012

"Fatally Flawed" Compensation Audit - Part 2

Yesterday, we reported on a recent ASBCA decision that calls into question the methodology used by the Government to assess the reasonableness of contractor compensation levels. The Government of course could appeal that decision. But in the meantime, we have a new methodology, accepted by the ASBCA, for determining "reasonable" compensation levels. The Board's methodology generally results in higher benchmark compensation level when compared to the Government's methodology, We recommend you use it. The methodology is somewhat technical and beyond the scope of this blog but if you are in a situation where your compensation levels are being reviewed and/or questioned, we recommend you seek out expert help in that field.

Compensation for each employee or job class of employees must be reasonable for the work performed. Compensation is reasonable if the aggregate of each measurable and allowable element sums to a reasonable total. In determining the reasonableness of total compensation, contractors must consider factors determined by the contracting officer (who has the ultimate responsibility for deciding whether compensation is reasonable) to be relevant. According to FAR 31.206.b.(2), this would usually entail a comparison with compensation practices of other firms of the same size, in the same industry, in the same geographic area, and engaged in similar non-Government work under comparable circumstances. Making such comparisons, indeed finding the raw data with which to make such comparisons is very difficult. Such work has often been called an "art" rather than science or analysis.

There are a few, benchmarking surveys on the market. Their cost however is often prohibitive for small contractors. Even though the Government relies on them to perform benchmarking studies, these surveys have limitations because its often difficult to find enough companies of the same size, industry, geographical area, doing commercial work under comparable circumstances to make meaningful comparisons. Also keep in mind that there is no FAR requirement for contractors to purchase these surveys, even though the Government often tries to push them into doing so.


  1. The IRS litigates this issue when it perceives compensation is excessive. In the DCAA/DCMA excessive compensation assertion, the Board ruled primarily on the persuasiveness of the contractor's expert. To your knowledge, has anyone attempted to bring the IRS and Contract Auditors to a uniform test/position on the topic? See

  2. Thanks for the comment and the reference. There are significantly different standards regarding the reasonableness of compensation for government contracting purposes and income tax purposes. For contracting, the Government seeks to reimburse a reasonable wage/salary. For income tax purposes, the IRS seeks to find if a taxpayer is doing something unreasonable for the sole purpose of avoiding income taxes.