Thursday, November 1, 2012

Compensation - Part 9 - Changes in the Prices of Corporate Securities

This section of the compensation cost principle is unlikely to apply to most small companies.

Sometimes, executive compensation (and less often, employee compensation) includes payments in the form of the contractor's corporate securities such as stock options and stock appreciation rights.

In general, securities must be valued at their fair market value on the measurement date (i.e. the first date the number of shares awarded is known). Any accruals for the cost of securities before issuance to the employees must also take into account the possibility that the employees' interest in the accruals might be forfeited.

There are a number of other restrictions that apply.

  • Any compensation which is calculated, or valued, based on changes in the price of corporate securities is unallowable.
  • Additionally, any compensation represented by dividend payments or which is calculated based on dividend payments is unallowable. Presumably, this restriction is because dividends are normally distributions of profit.
  • Finally, a contractor pay an employee cash in lieu of exercising the security. Specifically, the regulation states that if a contractor pays an employee in lieu of the employee receiving or exercising a right, option, or benefit which would have been unallowable under this paragraph, such payments are also unallowable.
These restrictions highlight the Government's long-standing position that compensation based on changes in securities prices is not compensation based on work actually erpformed and thus, is unallowable. Further, dividend payments are essentially a distribution of profits and likewise should not be reimbursed by the Government.

The application of this cost principle is not without controversy and if you are one of the few Government contractors who compensate employees with corporate securities, we recommend that you refer to the audit guidance in DCAA's Contract Audit Manual 7-2123.

Nect: Section (j) - Pension Costs

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