Enhancing Overhead Rates through Compensation Policies

Transcription

1 Enhancing Overhead Rates through Compensation Policies Compensation is the largest single expense design firms incur. Get the most from what you pay. Allowable OH is the Most Important Part of the FAR Compensation Formula Consultant Fees = Level of Effort (Hours) Direct Labor Rates ($/Hour) FAR Overhead (% of D.L.) Expenses x Mark up Profit (% of Costs) The Largest OH Expenditures Bad Debts Interest Training Legal/Accounting Telecom Licenses/Permits Computers Office Supplies General/Liability Insurance Business Development Office Space Indirect Labor Payroll Burden % of Direct Labor 3 1

2 Common Mistakes by CPA Firms 1. Cash basis for taxes limited to $5 or $10 million in revenues? 2. Lumping together direct and indirect labor or other costs 3. Expense accounts by what is spent rather than why (e.g., combining all advertising into a single account) 4. Advising firm to buy their building as an investment (thus confusing both government contracting cost and ownership transition) 5. WIP at cost, or not recognized at all 6. Issuing financial statements on cash (tax) basis 7. Offsetting internal billing of in house project costs (e.g., mileage, printing, etc.) to expense accounts rather than setting up contra accounts 8. Lumping bonuses into payroll expense rather than showing as discretionary 9. Including wives and kids on the payroll to reduce taxes 10. Low owner salary with high distributions 4 What does the FAR Say? (a)(1) Compensation for personal services must be for work performed by the employee in the current year and must not represent a retroactive adjustment of prior years salaries or wages (a)(2) The total compensation for individual employees or job classes of employees must be reasonable for the work performed (a) Not be a distribution of profits (which is not an allowable contract cost). What is the Profit? Income (P&L) Statement for ABC Consultants Revenues Service Revenue Reimbursable Revenue Total Revenue Direct Expenses Direct Labor Reimbursables Costs Other Direct Costs Total Direct Expenses $ $ Gross Profit 66 Overhead Fringes Depreciation Other Overhead Total Overhead Operating Income (EBBT) 16 Other Expenditures Discretionary Bonuses 401K Contributions Taxes Total Net Profit $1 6 2

3 It Gets Even More Interesting Because.. Compensation can be. Direct Indirect Allowable Unallowable Labor is a Contract Cost Regardless if Direct or Indirect Consultant Fees = Level of Effort (Hours) Direct Labor Rates ($/Hour) FAR Overhead (% of D.L.) Expenses x Mark up Profit (% of Costs) Labor Charging Mistakes Low salaries/high distributions Capping labor rates for certain employees (unallowable) Not having appropriate labor charging policies for marketing time Not educating staff on what constitutes entertainment Not encouraging employees to put notes on indirect time 3

4 The FAR Requires Reasonable Compensation for Each Labor Category Junior Professional Staff Admin & Tech Support Staff Managers & Executives Based Mostly on New Graduate Salaries Based Mostly on Local Market Wage Levels Based Mostly on Firm Size (Nationally) The Government Focuses Mostly on Executive Compensation Overview of Executive Compensation Compensation analysis only required for top five executives with firm wide responsibility plus 10% owners, and family members of these five. Evaluated on total compensation, which comprises: Salary Bonus Company payments to qualified retirement plan Other company paid, and allowable, benefits included in w 2s Executive comp is subject to strict allowability criteria BCA no longer automatically available 4

5 Determining Reasonable Compensation Step 1 - Examine elements of compensation for allowability. Step 2 - Determine job description of each position. Step 3 - Obtain three nationally published surveys. Step 6 - Determine average of surveys. Step 5 -Update survey to common date. Step 4 - Obtain median/mean from each survey. Step 7 - Increase average by 10% for range of reasonableness. Compensation Got Easier National Compensation Matrix Determining Reasonable Compensation Step 1 - Examine elements of compensation for allowability. Step 2 - Determine job description of each position. Step 3 - Obtain three nationally published surveys. Step 6 - Determine average of surveys. Step 5 - Update survey to common date. Step 4 - Obtain median/mean from each survey. Step 7 -Increase average by 10% for range of reasonableness. 5

6 NCM Key Matrix Points Match executive job description and duties to position description in Matrix Only one each Chairman, CEO and Executive Vice President are allowed Multiple Senior Vice Presidents and Vice Presidents are allowed Small firms must pay close attention to duties as opposed to title Related parties must be evaluated Consultants Can Justify 75 th Percentile Compensation if They Are Above Average in: Growth Client Satisfaction Performance 6

7 Achieving Above Average Compensation 1. Firm must document above average Performance Growth Customer satisfaction 2. Above Average entitles above average executives, based on performance criteria, the 75th percentile total compensation. 3. Court cases Techplan and Information Systems. BONUSES Not a Tax Planning Tool Staff Managers Retained Earnings Owners (ROI) Leaders Example Calculation A. Cash available at year end = $800,000 B. Current shareholder equity = $1,000,000 C. Target equity = $35,000/staff D. Current staff size = 50 FTE E. Target ROI = 10% share appreciation + 15% cash distributions F. Current equity/staff = B/D =$25,000 G. Retained earnings = D x (C F) = $500,000 H. Target equity distributions = 15% = 0.15 x B = $150,000 I. Performance bonus pool = A G H = $150, A Word about Owners Shareholders should have some reward. Reward does not need to be cash. Shareholders should participate in performance bonus plan. Portion of profits, or share appreciation attributable to owners should be documented in compensation plan and be identified as unallowable. 7

8 Bonuses.. What the FAR Says (f) (i) 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 (ii) Basis for the award is supported. Allowable Bonus Plans Develop, document, and communicate to all effected employees a bonus plan applicable to a broad class of employees. Plan should document covered employees, factors used, schedule for payments. Include objective performance criteria for firm and individual executives. Firm and individual executives must meet objectives in order for bonus to be allowable. Allowable total compensation can be at the 75% level. T. Wayne Owens & Associates, PC 8

9 [Built for A/E/C] We are a CPA firm that provides a full range of accounting and financial management solutions, including audits, FAR audits and tax services tailored for the design industry. Our services are specifically geared toward boosting the effectiveness, well being and profitability of your A/E/C firm. Our relationship with you is the driver; consider us a partner on your success team, providing experienced guidance and advice for your situation and spotting opportunities to position your company for the future. Todd Jones Consulting, LLC Todd Jones Consulting, LLC Provides consulting and Federal Acquisition Regulation (FAR) training throughout the United States. We can show you how to maximize your overhead rate while being within the FAR guidelines, which will result in all government agencies accepting the calculation. Although based in North Carolina, we have the experience with the policies and procedures from most every State and can assist you with maximizing your profits while exceeding the expectations and requirements of various governmental agencies. 9

10 Questions Todd Jones Todd Jones Consulting, LLC C: Sign up for the semi regular newsletter on A/E firm management and government contracting at Questions T. Wayne Owens, CPA T. Wayne Owens & Associates, PC O: C: Sign up for the semi regular newsletter on A/E firm management and government contracting at 10