During a federal contract audit, executive compensation is often one of the first areas examined by DCAA and other government auditors. Their review typically begins with two questions: What market data supports the compensation level, and what documentation supports any bonuses or incentive payments? For many contractors, this is where things fall apart, not because the compensation is too high, but because the support is too thin. This article will show you how to use compensation surveys effectively and document incentive compensation so they are better positioned to stand up to audit scrutiny. 

Compensation surveys are your primary evidence 

When auditors evaluate reasonableness, they rely heavily on commercial compensation surveys. You should too. 

Remember strong benchmarking includes: 

• • Industry match (e.g., professional services, engineering, manufacturing) 

• • Company size match (revenue, headcount) 

• • Geographic relevance (South Mississippi vs. Washington D.C.) 

• • Job family alignment (comparing compensation against roles with similar responsibilities, scope, and functional leadership, such as CEO, COO, or CFO) 

The closer the match, the stronger your justification.   

What contractors often miss 

Even contractors that make a good-faith effort to comply with compensation requirements can overlook key documentation and survey selection practices. The following are some of the most common gaps auditors identify during compensation reviews: 

• • Using only one survey 

• • Using surveys that do not match their industry 

• • Not documenting why they selected certain surveys 

• • Not documenting the basis for the percentile used if other than the median or below 

• • Not maintaining copies of the applicable surveys they relied on 

Federal contractor auditors will likely ask you if you considered the compensation practices of comparable companies and then follow up about any of the applicable bullets listed above. If you can’t show the data you used, auditors will assume you did not use any. If you can’t explain the data you used, the auditors will perform a detailed evaluation with their own surveys. 

How to reconcile survey data with actual pay 

Your executive compensation will not always match the survey median and that is commonplace. What matters is whether you can explain why and how the total compensation was determined. 

Common, defensible reasons include: 

• • The executive performs multiple roles 

• • The company is in a high growth phase 

• • The executive brings unique experience or certifications 

• • The role includes significant business development responsibility 

• • The company operates in a competitive labor market 

A short well-written rationale goes a long way. Think of it as your “audit‑ready footnote.” Just be sure your footnote is supported by facts and verifiable evidence. 

Bonuses and incentives: The most common audit weak spot 

DCAA and other contractor auditors pay close attention to bonuses because they are often poorly documented and/or justified. 

For a bonus to be considered reasonable and allowable in accordance with FAR 31.205-6(f), auditors expect to see: 

• • A written bonus or incentive plan 

• • Clear, measurable performance criteria 

• • Evidence that the criteria were met 

• • Approval documentation 

What gets contractors in trouble 

• • “Discretionary” bonuses with no criteria 

• • Retroactive bonus decisions 

• • No documentation of performance metrics 

• • Blending bonuses into salary without explanation 

• • Pure profit sharing 

FAR requires you to document your criteria and basis for determining bonus payouts. If a bonus is tied to performance, the performance must be documented. If it is tied to company results, those results must be documented. Please note that basing incentives on company results (e.g., they have a year-long goal to lead the company to 10% in EBITDA) is not the same as profit sharing (e.g., there is an increase of 10% in EBITDA and then the company decides to pay out discretionary bonuses from excess profits). We recommend not giving retroactive bonuses – allowable compensation must be for the current year.   

The takeaway is to determine bonuses annually and maintain the documentation that clearly supports the decisions made and the proper approvals. 

Special considerations for owner‑executives 

Owner‑executives receive heightened scrutiny because they influence their own pay. 

To protect yourself: 

• • Keep job descriptions current 

• • Document how you allocate your time across roles 

• • Benchmark each role separately and prorate the salaries if you wear multiple hats 

• • Document the rationale for bonuses or salary increases 

• • Utilize an independent board to assist with compensation determinations of these executives (not required, but can help for other than the smallest of organizations) 

The more hats you wear, the more important your documentation becomes. 

The audit readiness advantage 

Benchmarking against compensation surveys and maintaining bonus documentation are not just compliance tools; They are your best defense in a potential future contract audit.  If you can clearly show the market data utilized, explain why you selected it, reconcile it with actual pay, and document how bonuses were determined and approved, you will be in a far stronger position than most federal contractors.