Thursday, May 30, 2013

Employee Morale - Guidance Given to Contract Auditors

Audit guidance relative to employee morale costs are contained in DCAA's Contract Audit Manual at Chapter 7, Section 2103. When reading through this guidance, three things stand out. First, DCAA wants its auditors to look for reasonableness of costs. Secondly, the Agency wants its auditors to determine whether employee morale costs are more accurately classified as entertainment costs. Entertainment costs are specifically unallowable while some judgment has to be applied to determine whether employee morale costs are allowable or not. Thirdly, DCAA wants to ensure that whenever a cost is challenged, it becomes the contractor's burden of proof to satisfy the allowability criteria.

Here then are some of the audit procedures that might be applied in determining whether employee morale costs are allowable.


In applying the provisions of FAR 31.201-3, Reasonableness, the auditor should consider whether the expenditure is reasonable in nature and amount both for the contractor as a whole and for the employee(s) benefited by the expenditure. The implication here is that overall costs might be reasonable but when averaged over the employee population, might be unreasonable.

Costs relating to welfare and morale activities, if significant, should be subjected to the test of reasonableness as to purpose and amount. When reasonableness as to purpose has been established, reasonableness of amount should ordinarily be applied to overall amounts and not to individual items of costs, provided the items are not made specifically unallowable by FAR Part 31. This guidance is based on the word "aggregate"  used in the cost principle.

Examining the Books and Records of Employee Associations

If a contractor has an arrangement permitting an employee association to retain the income from vending machines, such income should be considered in evaluating the total cost of the employee welfare and morale program as if the contractor...The auditor should examine the records of the employee association to ascertain that the income was reasonably expended for the purposes intended and that there is no undue accumulation of unspent funds. Any such accumulation should accrue to the Government by treating it as a deduction from otherwise allowable overhead.

Cafeteria Losses

Losses from operating cafeterias may be included as costs only if the contractor's objective is to operate such services on a break-even basis. One factor to consider is whether the prices charged are comparable to those available in commercial establishments. Losses sustained because these services are furnished without charge or at unreasonably low prices obviously would not be conducive to the accomplishment of the above objective and are not allowable. However, a loss may be allowable, provided the contractor can demonstrate that unusual circumstances exist such that even with efficient management, operating the service on a break-even basis would require charging inordinately high prices, or prices higher than those charged by commercial establishments. Examples of unusual circumstances are:
  • adequate commercial facilities are not available, or
  • reasonable prices are a necessary incentive to keep employees onsite to avoid the more significant costs of lost productive time due to longer lunch periods if the services were not provided.

When cafeteria losses are claimed by the contractor, it is the contractor's responsibility to demonstrate that unusual circumstances exist and to provide supporting documentation such as price comparisons with similar commercial establishments, or the distance of restaurants. The auditor should determine the validity of the contractor's justifications on a case-by-case basis. If the contractor fails to provide adequate documentation justifying the allowability of such losses, the auditor should question the costs.

Gifts, Recreation, and Entertainment

If the Government challenges the allowability of claimed recreation costs, it is the contractor’s responsibility to establish that the cost claimed meets the following criteria:
  • The cost is for employee participation in a sports team or employee organization.
  • The team or organization is company sponsored.
  • The team’s or organization’s activity is designed to improve company loyalty, team work, or physical fitness.

Relationship to the Entertainment Cost Principle

Entertainment costs are expressly unallowable, without exception. Therefore, even if the principal purpose for incurring an entertainment cost is other than for entertainment, the entertainment cost is unallowable. For example, while the cost of a contractor open house for employee families is generally allowable, the cost of entertainment provided as part of the open house is unallowable.

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