Cost Accounting Standard (CAS) 415 – Accounting for the Cost of Deferred Compensation

For cost accounting under Federal government contracts, including your contracts that are not CAS covered, deferred compensation must be measured based on the requirements of CAS 415. FAR 31.205-6(k) requires that the cost of all deferred compensation, other than pension costs, be measured, assigned, and allocated in accordance with CAS 415, Accounting for the Cost of Deferred Compensation.

What are the Basic Requirements of CAS 415?

Deferred compensation is assigned to the cost accounting period in which the contractor incurs an obligation to compensate the employee. However, if no obligation is incurred prior to payment, the deferred compensation is the amount paid and is assigned to the cost accounting period it is paid in – See risk below.

CAS 415 requires that the contractor measure its deferred compensation, other than for an Employee Stock Ownership Plan (ESOP), based on the present value of the future benefits to be paid by the contractor. For an ESOP, the deferred compensation cost is the amount contributed to the ESOP trust by the contractor.

In most cases, the contractor should account for deferred compensation separately for each award (i.e., based on the individual award to each employee). However, if the deferred compensation plan is consistent across groups of employees, and allows for reasonable accuracy, the contractor can measure and assign the cost by group.

What are the Technical Requirements of CAS 415?

CAS 415 is one of the cost accounting standards that require a detailed understanding of the Techniques for application to ensure the fundamental requirements are properly implemented.

Determining if the Contractor has an Obligation

To determine that the contractor has an obligation the following conditions must be met:

• There is a requirement to make the future payment(s) which the contractor cannot unilaterally avoid.
• The deferred compensation award is to be satisfied by a future payment of money, other assets, or shares of stock of the contractor.
• The amount of the future payment can be measured with reasonable accuracy.
• The recipient of the award is known.
• If the terms of the award require that certain events must occur before an employee is entitled to receive the benefits, there is a reasonable probability that such events will occur.
• For stock options, there must be a reasonable probability that the options ultimately will be exercised.

If these conditions are not met, the deferred compensation will be assigned to the cost accounting period when paid to the employee. We will discuss this concerning provision more below.

If the award requires the employee to perform future service to receive the benefits, the cost of the award will be assigned to the cost accounting periods of the future service.

When accounting for deferred compensation on an individual award basis, the contractor will credit any forfeitures in the cost accounting period in which they occur.

When accounting using groups, the contractor must consider potential forfeitures in calculating the amount to be assigned to the cost accounting period. The estimate of potential forfeitures is trued up in the period in which it is known. For example, if you estimate that 5% of the employees in the group will be terminated before receiving the payment, making them ineligible for the payment, and only 4% become ineligible then an additional expense related to the 1% difference will be assigned to the future cost accounting period. Had 6% become ineligible then a credit related to the 1% difference will be assigned to the future cost accounting period.

Cash Payments

When the deferred compensation will be paid in cash, the net present value of the future payments is used as the expense amount in the period in which the contractor is obligated to pay the employee. If the amount to be paid includes interest, the interest should be included in the calculation of the net present value. How the interest is determined will impact the calculation.

• When a fixed rate is agreed-to at the date of award, the interest will be calculated and included in the net present value computation.
• When a specified index (e.g., a published corporate bond rate) is used, the published index interest rate in effect at the end of the cost accounting period is used to calculate the amount of interest to be included in the net present value calculation. Any difference in the actual index interest rates and the rate used in the net present value calculation are adjustments assigned to the future cost accounting periods if material.
• When the interest cannot be determined at the date of award, the net present value of the principal amount is assigned to the current cost accounting period and the interest is assigned to the cost accounting period(s) in which the payment is made.

BEWARE – DCAA Contract Audit Manual (CAM) 8-415.1(g) states: “The allowability of such interest cost will be determined in accordance with applicable acquisition regulations.” Seeing as FAR 31.205-20 makes interest unallowable, I believe DCAA is saying “question the interest cost.” While I do not agree the interest should be questioned as it is not interest related to borrowing or financing, you need to be aware of the risk.

If the contractor’s plan requires that the deferred compensation be put into an interest-bearing escrow accounting (i.e., irrevocably funded), where the employee will receive the award amount plus the interest, the amount assigned to the current cost accounting period will be the amount placed into the account. No net present value calculation is needed as the future interest accounts for the time value of money.

Non-Cash Payments

If the award is paid in stock, the cost of the award is the stock’s value on the date the number of shares is known.

If the award is paid as a stock option, the cost of the award is the amount by which the value of the stock exceeds the option price multiplied by the number of shares on the date both the option price and the number of shares is known. If by chance the option price is equal to or greater than the value of the stock, no cost will be assigned for contract costing purposes. Stock option plans open to all employees to invest in the contractor are not considered compensation and the cost cannot be assigned to contracts.

Deferred Compensation – Related to an ESOP

For an ESOP, the cost is measured based on the amount paid by the contractor to the ESOP trust, including interest and dividends. In ASBCA, 00-1 BCA ¶30,864 Ball Corporation (Apr. 3, 2000) the board found that the administrative and interpretive history of CAS 415 indicated the entire amount of a contribution including interest should be treated as the allowable and allocable cost to contracts. If the contractor contributes stock, the amount is based on the value of the stock on the date it is contributed.

The amount of the contribution is assigned to a cost accounting period provided the underlying stock has been assigned to the individual employee accounts. Any portion of the amount not awarded to employees is assigned to a future cost accounting period in which it is allocated to individual employee accounts.

NOTE – This is a high-level summary of the CAS 415 requirements. I suggest you reach out to a subject matter expert when considering a deferred compensation plan or ESOP. These rough waters are nowhere to be without a guide.

What is the Risk When There is No Obligation?

CAS 415-40(c) provides that if no obligation is incurred prior to payment, the deferred compensation is the amount paid and is assigned to the cost accounting period it is paid in. It is important to remember that while a cost accounting standard can make a cost assignable to a specific cost accounting period, that does not make the cost allowable in all cases – yep, this may be one of those cases.

The risk is that a government auditor may find the payment of compensation related to a prior cost accounting period that the contractor had no obligation to pay unallowable “backpay.” FAR 31.205-6(h) provides that backpay is a retroactive adjustment of a prior year’s salaries or wages and is unallowable unless it is required by a union contract or court order. So, while CAS 415 provides that the cost be assigned to the period in which it is paid, without an obligation to make the payment there is a significant risk that cost will be questioned by the Government.

How Can Redstone GCI Help?

If you include or plan to include deferred compensation as part of your compensation plan, Redstone GCI can assist in several ways. They can draft changes to your existing compensation plan or develop a new one, which is essential for any adequate accounting system. You can refer to their articles, "Why a Comprehensive Compensation Plan is Key to Driving Organizational Success" and "What Policies and Procedures Should a Government Contractor Have?" for more insights. Additionally, Redstone GCI can draft policies and procedures to implement the requirements of CAS 415, develop or review your annual deferred compensation claimed amounts, and provide training on CAS requirements.

Redstone GCI assists contractors throughout the U.S. and internationally with understanding the Government’s requirements and implementing the necessary policies and procedures as well as training to support compliance with the cost accounting standards. We would be happy to be part of your team.