If you have ever wondered how DCAA decides whether your executive compensation is “reasonable,” you’re not alone.

For many government contractors, this aspect of an audit can feel like a black box: complex, intimidating, and filled with unfamiliar terminology.

In this article, we share what actually happens when DCAA reviews executive compensation, and what you should do to be prepared for it.

DCAA uses a standardized, data driven methodology

DCAA does not just “guess” whether compensation is reasonable. They follow a structured process based on FAR 31.205-6 that includes:

• • Reviewing your compensation policies
  • Analyzing job duties and responsibilities
  • Benchmarking pay against multiple commercial compensation surveys
  • Evaluating internal controls around how pay decisions are made

DCAA reviews your documentation, evaluates the facts, and compares compensation levels against market benchmarks. The auditors expect you to have a policy or a consistent practice for compensation that is reasonable for the work performed. The elements of compensation that will be reviewed by DCAA include salaries, fringe benefits, bonuses, and pensions. Auditors look for compensation decisions that are supported by a formal policy or a consistently applied practice that aligns with the work performed.

Compensation surveys are the backbone of the audit

DCAA typically uses a few reputable compensation surveys to benchmark your executives’ pay. As documented in FAR 31.205-6(b)(2), they consider factors such as:

• • Industry alignment
  • Company size
  • Geographic region
  • Engaged in similar non-government work

Historically, in my experience, they have calculated an average and applied a 10% “range of reasonableness” factor.

If your compensation falls outside that range, auditors will expect strong justification and they will look closely at your documentation.

Internal controls matter more than most businesses realize

DCAA looks at more than just what you pay; They also look at how you decide what to pay and how well you document those decisions.

They want to see:

• • A consistent and established compensation plan with clear approval authority and well-documented rationale for all pay decisions (FAR 31.205-6(a))
  • Evidence that bonuses or incentives are tied to measurable performance (FAR 31.205-6(f))

One of the biggest red flags for an auditor is when you have weak or informal processes.

Owner‑executives get extra scrutiny

Compensation paid to founders, owners, or someone contractually committed to acquiring a financial interest in the company, is typically subject to significant examination.

Auditors will analyze areas such as whether:

• • The role is clearly defined
  • The pay aligns with market data
  • Bonuses are tied to documented performance metrics
  • The compensation increased faster than company growth
  • The compensation is a distribution of profit (unallowable per FAR 31.205-6(a)(6)(ii)(B))

This is because owner‑executives generally have the ability to set their own pay, which increases audit risk.

What triggers a more intensive review

As previously mentioned, DCAA uses survey data to establish a market-based benchmark and evaluate the reasonableness of compensation.

DCAA may expand their review if they see:

• • Compensation significantly above survey benchmarks
  • Large bonuses without documented performance criteria
  • Rapid pay increases not tied to business growth
  • Missing or outdated job descriptions
  • Blended allowable and unallowable compensation

These issues do not automatically mean your compensation is unreasonable, but they do mean you will need strong documentation to support it.

Bottom line

Once you understand the framework, DCAA's review of executive compensation becomes far more predictable. The process is structured, data-driven, and heavily dependent on documentation that demonstrates both the reasonableness of compensation and the consistency of the decision-making process.

Organizations that maintain current job descriptions, benchmark pay regularly, and document compensation decisions consistently are better positioned to support compensation costs during an audit.

For more information on executive compensation, please review our article, How DCAA evaluations executive compensation: What contractors should expect. (Opens a new window)  

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