FAR Compliance: Is Your Bonus Plan Allowable?

An often-overlooked item when calculating FAR compliant overhead rates is the allowability of an organization’s bonus and incentive compensation programs. Compliance is relatively straight-forward, however, it may result in some changes to the current process(es).

FAR Alignment

Creating a compliant and effective incentive compensation plan for firms working on government contracts requires alignment with the FAR, particularly FAR 31.205-6 which governs compensation costs.

Note that distributions of profits to owners are unallowable under FAR 31.205-6. A distribution of profit plan should be clearly documented in a plan separate from bonus and incentive compensation plans to avoid any confusion.

FAR 31.205-6 states that bonuses and incentive compensation are allowable provided the awards are 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.

We often observe bonus plans that have consistently been followed for years and technically “may” comply with FAR 31.205-6. However, bonus plans should be evaluated and compared against the criteria defined above, as well as the best practices provided by AASHTO outlined below. Following the AASHTO best practices will significantly reduce the risk that bonus amounts will be rejected in one’s overhead rate submissions.

Best Practices

The AASHTO Uniform Audit & Accounting Guide (2024 Edition) states that best practices suggest bonus plans include the following components:

• Be in writing
• Eligibility criteria
• Period of bonus plan
• Performance criteria that are measurable and verifiable
• Incentive awards/spot bonuses must be related to performance, as measured by quantitative and qualitative factors
• Form of payment to be received
• Distribution timeline

Note that “verifiable” is highlighted; verifiable is easily overlooked. An annual spreadsheet of subjective bonus calculations with no measurement against goals, basis, or documentation is not sufficient. Verifiable can be achieved by utilizing an existing employee performance evaluation process IF a firm is maintaining documentation that measures employee performance against goals. The key to using an existing process is to make sure that evaluation and goal setting line up with one’s bonus and incentive plan.

For example, demonstrating company core values may be a factor in bonus calculations. If yes, performance evaluations should measure the employee’s performance against core values. Organizations can also use employee evaluations to make sure that bonuses are consistently calculated for employees at similar positions with similar performance ratings.

While not required, it is recommended that bonus plans be revisited and communicated to employees at least annually and ahead of the measurement period.

Designing a FAR-compliant incentive compensation plan is not just about satisfying audit requirements – it also ensures fair, performance-based rewards that align with the firm’s financial goals. By grounding the plan in FAR 31.205-6 and incorporating AASHTO guidance, firms can create transparent, auditable, and effective incentive structures that withstand regulatory scrutiny and motivate employees. Regular review, documentation, and adherence to policies are critical to maintaining compliance and maximizing allowability under government contracts.

Don’t hesitate to contact a member of the AEC team to discuss your incentive compensation plans and allowability under FAR. For more information about McKonly & Asbury’s Architecture, Engineering, and Construction (AEC) experience, visit the AEC Industry Page.

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