DCAA Compensation Reviews - Materiality Thresholds

This is the fourth and final part in our series of articles that examine the methodologies used by the Government to assess compensation reasonableness in the post JF Taylor/Metron era. There were two ASBCA (Armed Services Board of Contract Appeals) cases from 2012; JF Taylor (ASBCA Nos. 56105, 56322) and Metron (ASBCA Nos. 56624, 56751, 56752) that were (mostly) decided in favor of the appellants (i.e. the contractors). In deciding for the appellants, the ASBCA criticized the methodologies employed by DCAA in deriving its estimates of "reasonableness". You can refer to the following past articles for a recap of those decisions.

     Fatally Flawed Compensation Audit

     Fatally Flawed Compensation Audit - Part 2

     Executive Compensation - The Government Loses Again

In Part 1 of this series, we explained how DCAA continues to utilize the "fatally flawed" methodologies of the past to audit compensation costs. DCAA rationalizes that their methodologies were not repudiated - they just didn't have the right "expert" on the case to rebut the contractor's experts. In Part 2, we noted some cases where the contracting officers, rather than trying to defend the DCAA position on compensation, disregarded the audits and took matters into their own hands by performing their own analysis of compensation reasonableness. In Part 3, we discussed the difficulty in assessing the qualitative factors that enter into compensation levels and how DCAA often gives no consideration to such factors in deriving their "reasonableness" recommendations.

In Part 4, we want to address materiality. Materiality is a factor in setting the scope of any audit. Immaterial costs are less likely to be audited than significant items and may be omitted from audit coverage altogether. It makes business sense and audit sense to use scarce resources where the potential payback is most significant.

DCAA has set a threshold for executive compensation below which their compensation experts don't want to be bothered. DCAA keeps that threshold confidential but in 2011, the threshold was $165,000. DCAA wrote:

We use a materiality threshold that states that if the claimed cash compensation (base salary plus bonus) is less than $165,000 for the top paid executive, we determine the compensation to be reasonable based on a cursory review ... and do not need to perform a detailed review of this information.

Of course, that does not preclude other DCAA components from diving into reasonable determinations or contracting officers from doing the same. But, it seems unlikely that if the DCAA team in charge of compensation reviews is not interested in compensation below that threshold, no one else is going to get excited either.

Notwithstanding formal compensation reviews, auditors will typically scan positions and accompanying compensation levels to look for outliers. For example if a clerk/typist shows up at $160,000 per year, you can be assured that the auditor will ask questions and dig deeper.