Core Allowability Requirements
FAR 31.205-6 establishes several general conditions for compensation costs. Compensation must relate to work performed during the applicable year and generally cannot represent a retroactive adjustment of prior-year salaries or wages. Total compensation for an individual employee or employee class must be reasonable for the work performed.
The compensation arrangement should also be supported by the contractor's established compensation plan or a practice followed consistently enough to imply an agreement to make the payment. Major revisions or newly introduced compensation plans receive additional scrutiny when the cognizant administrative contracting officer has not had an opportunity to review their allowability.
For owners of closely held businesses, partners, sole proprietors, certain family members, and individuals with substantial financial interests, the rule includes additional requirements concerning reasonableness and distinguishing compensation from profit distributions.
Reasonableness and Compensation Benchmarking
Reasonableness is a central consideration when evaluating compensation under FAR 31.205-6. For compensation not established through applicable arm's-length labor-management agreements, the analysis considers the aggregate of allowable compensation elements and whether the total is reasonable for the work performed.
Relevant comparison factors can include the contractor's size, industry, geographic area, and comparable non-Government work. This makes Compensation Benchmarking useful as a supporting analytical process because it helps finance and contracts teams compare compensation practices against relevant market data while documenting the basis for reasonableness decisions.
For executive-level analysis, the CFO Compensation & Salary Benchmarking Report provides educational context on CFO pay by company size, industry, geography, and equity, helping readers understand the types of market variables commonly considered when examining executive compensation.
Similarly, the Director of Finance Salary Benchmark Report explains 2026 Director of Finance salary benchmarks, pay ranges, and compensation drivers across company size, industry, and location, providing useful context for understanding market-based compensation comparisons.
Compensation Components Covered by the Rule
Compensation for personal services can include substantially more than base salary. Depending on the applicable subsection and circumstances, the analysis can cover cash compensation, securities, bonuses, incentive compensation, deferred compensation, pension costs, postretirement benefits, and other employee benefits.
- Bonuses and incentive compensation: Allowability depends on requirements such as an established agreement or plan and support for the basis of the award.
- Backpay: Retroactive salary adjustments are generally unallowable, subject to specified exceptions such as certain settlements, orders, or qualifying labor agreements.
- Pension costs: Pension costs are subject to specific measurement, assignment, allocation, funding, and accounting requirements.
- Severance pay: Special provisions determine when severance costs may qualify as allowable contract costs.
- Deferred compensation: Specific requirements apply to recognition and allowability depending on the compensation arrangement.
Compensation Limits and Government Contract Costing
FAR 31.205-6 also contains statutory limitations on the allowability of certain employee compensation. The applicable limitation depends on factors including the contract award date and the type of executive-agency contract. For contracts awarded on or after June 24, 2014, the rule applies an employee compensation limitation to applicable executive agency contracts and subcontracts, with the allowable amount determined using the benchmark compensation amount established for the contractor fiscal year.
This means a contractor should distinguish between the amount actually paid to an employee and the amount that may be included as an allowable Government contract cost. The accounting system should preserve sufficient detail to support the compensation amount, employee classification, fiscal year, contract relationship, and applicable limitation.
Accounting Controls and Documentation
Strong accounting records support the analysis by maintaining compensation data in the general ledger, payroll records, job classifications, allocation records, approved compensation plans, and supporting documentation. These records help demonstrate how compensation was calculated, classified, allocated, and included in Government contract cost submissions.
The 2026 Chief Accounting Officer Salary Benchmark Report provides educational context on Chief Accounting Officer salary benchmarks, compensation ranges, and pay drivers across company size, location, and role complexity. Such market information can complement, but does not replace, the contractor's documented FAR allowability analysis.
Before compensation costs flow into indirect cost pools or contract charges, finance teams can establish review controls for new compensation plans, executive compensation, bonuses, incentive arrangements, and unusual adjustments. Compensation Approval is a related finance workflow concept that focuses on the authorization and review of compensation before it is processed or recorded.
Compensation Reporting and Disclosure
Compensation analysis also intersects with broader financial governance. Compensation Disclosure addresses how compensation information is presented and communicated in applicable business and financial contexts, while FAR 31.205-6 focuses specifically on the allowability of compensation costs for Government contract costing.
Keeping these purposes distinct helps contractors avoid treating external compensation reporting, internal payroll accounting, and Government contract cost allowability as interchangeable processes. Each serves a different control and reporting objective.
Summary
FAR 31.205-6 Compensation provides the framework for evaluating compensation for personal services under applicable Government contracts. The analysis centers on reasonableness, established compensation practices, supporting documentation, specific treatment of compensation components, and applicable statutory limitations. Contractors can strengthen Government contract accounting by connecting payroll and general-ledger records with compensation plans, market comparisons, contract classifications, approvals, and detailed cost-allocation controls.