Department of Health and Human Services
DEPARTMENTAL APPEALS BOARD
Appellate Division
SUBJECT: Seaford Community Action DATE: August 17, 1993
Agency Docket
No. A-93-108 Decision No. 1433
DECISION
The Seaford Community Action Agency (Seaford) appealed a determination
by
the Administration for Children and Families (ACF) disallowing
$7,844.00 in
expenditures charged to the Head Start Program for the
budget period January
1, 1991 through December 31, 1991. ACF disallowed
one-time supplemental
salary payments made to Seaford's Head Start
employees which ACF found were
unallowable under the applicable cost
principles. See Office of
Management and Budget (OMB) Circular A-122,
Attachment (Att.) B, .6. 1/
For the reasons explained below, we reverse the disallowance of
$5,716.87,
uphold the disallowance of $297.62, and remand the
disallowance of
$1,829.51. We find that, with the exception of six
supplemental salary
payments, Seaford's lump-sum payments to its
employees were allowable
incentive compensation. We uphold the
disallowance of the payment made
to one employee whose performance
rating was lower than that required by
Seaford's own policy on incentive
awards. In addition, we remand the
disallowance of the payments made to
five employees with ratings labeled
"Average" to give Seaford an
opportunity to prove that these employees had
numerical ratings which
were above
average..
BACKGROUND
The disallowance was based on the results of a comprehensive
management
review of Seaford's Head Start program for the 1991 budget
period.
Based on this review, ACF determined that the salary supplement
payments
to Seaford's employees were made without regard to incentive
for
performance, but were distributed on the basis of employee seniority
and
position within the organization. ACF Response, Ex. 1. ACF
found that
these payments did not conform to Seaford's written merit bonus
policy.
ACF concluded therefore that the payments did not meet the
requirements
of OMB Circular A-122:
Incentive compensation to employees based on costreduction,
or
efficient performance, suggestionawards, safety awards,
etc.,
are allowable to the extent that the overall compensation
is
determined
to be reasonable and such costs
are paid or accruedpursuant to an
agreement entered into in good
faith between the organization and the
employees before the
services were rendered or pursuant to
anestablished plan
followed by the organization so consistently as to
imply, in
effect, an agreement tomake such payment.
OMB Circular, Att. B, .6(h) (emphasis added).
The record shows that Seaford paid salary supplements to 29 employees
in
1991. Seaford Brief (Br.), Att. 2. Payments to 24 employees
were
allocated in whole or in part to Head Start. ACF Response,
Exhibit
(Ex.) 2 at 9. Seaford's worksheet shows that, with the
exception of one
employee whose overall rating was "Fair," salary supplements
were paid
to employees with ratings labeled as "Average," "Good," and
"Excellent."
2/ Seaford Br., Att. 2. For 1991, the amount of each
salary supplement
was determined using a formula which took into account an
employee's
performance rating, salary rate, and length of employment.
Seaford Br.
at 3. The salary supplements ranged from $100 plus 2% of
the employee's
salary to $400 plus 2% of the employee's salary depending upon
the
employee's years of service. Seaford Br., Att. 2. Seaford
explained
that it had a long-standing practice of paying salary supplements
at the
end of each budget period so long as funds were available.
Seaford
Reply, Aff.; Att. 1, 2, 3, 4, and 5. Seaford sometimes paid
merit
bonuses as well, although none were paid in 1991.
In response to the ACF management review which questioned these
salary
supplement payments, Seaford had asserted that its salary
supplements
were allowable expenditures under the incentive compensation
provision
in OMB Circular A-122. Seaford stated --
According to [Seaford's] 1991 personnel policies, incentives
for
salary increases include salary supplements for
average/above
performance and merit bonuses for
outstanding/excellent
performance or major contribution to [the]
agency.
ACF Response, Ex. 2 at 5. (emphasis in original). Seaford also
asserted
both that its "written personnel policies establish an agreement"
to
award such incentive payments and that for 1991 it had applied
its
salary supplement formula "consistently to federal and non
federal
employees within the organization." Id. at 6. Seaford
stated that
these "Christmas bonuses" rewarded its staff at year end when
they were
most needed. Seaford argued that it employed sound business
practices
and that the amount of incentive compensation was reasonable since
its
total "COLA [cost of living adjustments] and incentives did not
exceed
7%" which was below the increase in the cost of living index.
Id.
The Personnel Policies manual in effect during the budget period at
issue
expressly included a "Merit Promotion Plan/Incentive Program."
Seaford Br.,
Att. 1 at 93-94. This program covered promotion policies
as well as
incentive awards in the form of "salary supplements" and
"merit
bonuses." The stated purpose of the program was, among other
things,
"to offer incentives for above average performance." Id. at 93.
The
plan stated that the awards were based on a performance rating scale
using a
5-point scale in which "1" was "Low," "3" was "Average" and "5"
was
"Outstanding." Id. 3/
Seaford's 1991 Merit Promotion Plan/Incentive Program stated that - -
Salary supplements shall be provided when additionalfunding
is
available for salary increases and shallbe distributed
according
to wage scale.
Id.
Like the salary supplements, the merit bonuses were distributed
as
one-time, lump-sum payments and were awarded only when
additional
funding was available. The 1991 plan described these
payments as
follows:
Based on availability of funds, additional meritbonuses may
be
distributed as a onetime supplementfor excellent or
outstanding
performances or majorcontribution to [the] agency.
Id. at 94.
ANALYSIS
On appeal Seaford argued that the salary supplements were
incentive
compensation awards based on satisfactory performance evaluations
and
were awarded pursuant to both an express agreement in its
Personnel
Policies, as well as a long-standing practice of making
incentive
awards. Seaford also argued in the alternative that the
payments were
allowable as salary increases because they were a part of
total
compensation and because they complied with both the
allowability
requirement and the reasonableness requirement of the OMB
Circular A-122
section on "Compensation for personal services."
As explained below, except for the supplements paid to the employee
with
the "Fair" rating and the employees with "Average" ratings, we
reverse
the disallowance on the basis of Seaford's first argument.
However, we
reject the second argument since we find that the salary
supplements at
issue cannot be treated as salary increases under Seaford's
written
salary policies.
1. Except for one inconsistent payment and a few questionable
payments,
Seaford's salary supplements were allowable incentive
compensation.
It is important to note here that bonus payments are not per
se
unallowable. In accordance with the applicable cost
principles,
expenditures for incentive compensation are allowable if
reasonable in
amount, based on "efficient performance," and made pursuant to
a good
faith agreement with the employees entered into before the services
are
rendered or pursuant to an established plan. OMB Circular A-122,
Att.
B, . 6(h). Seaford agreed in its Personnel Policies to give
employees
incentive payments, and according to this plan, only employees
with
"above average" performance ratings were eligible for the
incentive
awards. Seaford Br., Att. 1 at 93. Thus, we see no
reason to read
Seaford's Personnel Policies, as ACF apparently did in its
disallowance
determination, to limit allowable incentive compensation only to
merit
bonuses paid to employees with overall ratings of "Excellent"
or
"Outstanding."
ACF argued that Seaford's payments were not "incentive payments"
since
they were awarded on the basis of seniority and position within
the
organization, rather than as an incentive for satisfactory
performance.
ACF contended that these payments could not be considered
incentive
payments since all employees received "bonuses," regardless of
whether
their performance was above average. Contrary to ACF's
assertions,
however, to the extent these payments were conditioned on
employees
performing at an above average level, performance was a factor in
paying
salary supplements. While the salary supplement amount was
calculated
in part based on length of service and rate of pay, nothing in the
cost
principles requires that performance be the only factor in
calculating
an incentive payment amount.
While ACF asserted that these supplements were paid at the end of the
year
when the staff needed additional funds most, this did not, as ACF
contended,
undermine Seaford's position that the payments could be
considered
incentive-based and made only when additional funds were
available. ACF
confused a point made by Seaford to support its salary
supplements as a sound
business practice as somehow determinative of the
character of the payment
itself.
ACF also argued that Seaford failed to follow the cost principles of
OMB
Circular A-122 which require that incentive payments be reasonable
and
paid in accordance with an agreement or an established plan
consistently
followed by the organization. 4/ According to ACF, during
the 1991
calendar year Seaford did not have either an express or implied
policy
of rewarding its employees for their performance. ACF contended
that
the section pertaining to salary supplements in Seaford's
Personnel
Policies made no mention of an incentive requirement.
Moreover, ACF
asserted that Seaford conceded it did not have an express
policy when it
alleged that the payments were made pursuant to an implied
agreement.
Furthermore, ACF argued that Seaford's practice of granting
salary
supplements to employees rated as merely "Average" (and in one
instance
"Fair") on the performance scale, despite the incentive program's
stated
purpose of offering incentives for above average performance,
proved
that Seaford did not have a long-standing incentive policy.
These arguments are unpersuasive since Seaford did, in fact, have both
a
written personnel policy providing for salary supplements and
a
long-standing practice of awarding such payments to eligible
employees.
Seaford demonstrated by way of payroll registers, minutes of
Policy
Council meetings, evaluation sheets, and lists of awardees that it
has
had an organization-wide salary supplement program in effect for
at
least the last 10 years. Seaford Reply, Att. 1, 2, 3, 4, 5.
Seaford
relied both on its written incentive policy and a long-standing
practice
of awarding salary supplements. Seaford Reply, Aff. We
see no reason
to second-guess Seaford's decision to pay salary supplements to
the
extent the payments were made to employees rated "above average."
As
for the awards made to employees with ratings labeled "Average,"
these
payments are allowable only if the employees' numerical ratings on
the
performance scale fell somewhere between "Average" and the next
rating
level, and therefore could reasonably be found to be "above
average"
within the meaning of the written policy. 5/ This, however,
has no
bearing on whether Seaford had a long-standing practice of
awarding
incentive payments. Even if Seaford violated its written
policy by
making a few salary supplements to employees who were not
"above
average," as the written policy required, Seaford clearly proved that
it
had an established incentive plan in effect and, therefore, the
majority
of the incentive payments are allowable. 6/
In addition, Seaford demonstrated that the "overall compensation [to
its
employees] was determined to be reasonable," as required by
the
applicable cost principles. OMB Circular A-122, .6(h).
Reasonableness
is defined in A-122 as compensation which is "comparable to
that paid
for similar work in the labor markets in which the organization
competes
for the kind of employees involved." OMB Circular A-122, .
6(c).
Seaford contended, and ACF did not disagree, that "when
fiscally
possible [staff salaries] were within 70% of the local school
district's
salaries." Seaford Br. at 4. Thus, Seaford's overall
compensation to
its employees clearly fell within the range of reasonable
salary rates.
Furthermore, ACF did not determine that the overall
compensation was
unreasonable or that the calculation method alone rendered
the payments
improper. ACF also alleged that the payments which
Seaford made here
were indistinguishable from the one-time, lump-sum payments
disallowed
in Licking County Economic Action Development Study, DAB No.
1159
(1990), and Rural Day Care Association of Northeastern North
Carolina,
DAB No. 1384 (1993). In Licking County the grantee argued
that its
payments were not bonus payments but "salary adjustments
or
enhancements." Licking County at 2. The Board looked beyond
this
characterization of the payments, however, and determined that they
were
unallowable bonuses since they did not conform to the applicable
cost
principles. 7/ According to ACF, just like the payments in
Licking
County, the payments at issue here were not simply salary
adjustments,
but unallowable payments which were not incentive-based nor paid
in
accordance with the federal guidelines for incentive compensation.
ACF
also argued that the payments in this appeal were "virtually
identical"
to the Christmas bonuses at issue in Rural Day Care. ACF
Response at 5.
These bonuses were also paid without regard to award or
incentive for
improved performance and were not issued pursuant to an
established
policy. Thus, ACF contended that we should follow previous
Board
decisions and disallow Seaford's salary supplement and merit
bonus
payments.
We reject this argument, however. This appeal is
factually
distinguishable from Licking County and Rural Day Care.
Unlike the
payments made in those cases, Seaford's salary supplements were
not
impromptu payments based solely on the availability of unexpended
Head
Start funds. Seaford had a written policy, in the "Merit
Promotion
Plan/Incentive Program" section of the Personnel Policies,
which
expressly provided for the distribution of incentive payments, as
well
as a long-standing practice of making these awards. Since
incentive
payments were awarded to all employees, including personnel
working
under programs besides Head Start, the cost of the salary
supplements
was allocated among available funding sources. Thus,
although both
Seaford and the grantee in Rural Day Care referred to their
incentive
payments as "Christmas bonuses," this is not dispositive of
the
allowability of the payments. Seaford's incentive payments were
not
Christmas "gifts," to the extent they qualified as performance
awards.
Finally, ACF argued that Seaford's practice of distributing the
lump-sum
"bonus" payments created a conflict of interest between
Seaford's
obligations to its Head Start participants and its desire to reward
its
employees financially. Apparently, ACF's concern was that Seaford
would
shortchange program needs in order to have funds remaining at the end
of
the year for employee salary supplements and merit bonuses.
ACF did not made any finding, however, that Seaford scrimped on Head
Start
expenses during the 1991 budget period in order to have funds
remaining at
the end of the year for employee incentive payments. 8/
ACF's disallowance
letter stated that these payments "were made from the
general operating fund
that would have otherwise been reported as
carry-over balance." ACF
Response, Ex. 1. This statement implies that
these funds were not
required to meet other program needs. Also, there
is no requirement
that Seaford operate its program in order that
carryover funds are
available.
Moreover, the Executive Head Start Director described how she
assessed
each October whether, after budgeting for program needs, funds
were
available for either salary supplements or merit bonuses.
Seaford
Reply, Aff. It is important to keep in mind that the grantee,
as an
employer, is the best judge of which compensation policies and
incentive
plans are appropriate for its workforce. ACF's position does
not take
into account the autonomy accorded a grantee to determine
appropriate
expenditures in the operation of its program and management of
its
employees.
Thus, we find that the majority of Seaford's 1991 salary supplements
were
allowable expenditures which may be charged to the Head Start
program.
Seaford had a written incentive compensation policy which
complied with the
cost principles under OMB Circular A-122, as well as a
long-standing practice
of paying salary supplements.
2. The incentive payments made to the Seaford employees who did
not
perform "above average" are not allowable.
Seaford argued that it had a consistent practice of awarding
salary
supplements to employees with "Average" ratings and therefore
these
payments were allowable under the applicable cost principles.
The
record, however, does not support this contention. While the
evidence
which Seaford submitted supports a finding that Seaford had
a
long-standing practice of paying salary supplements, it is
insufficient
to prove that Seaford had interpreted its policy so as to
consistently
pay salary supplements to "average" as well as "above
average"
employees. Seaford's Personnel Policies do not explicitly
assert that
Seaford may award incentive payments to employees with average
ratings,
nor does the affidavit which Seaford submitted provide that it has
had a
long-standing policy of rewarding average performance. See
Seaford Br.,
Att. 1; Seaford Reply, Aff. Although Seaford argued that
it simply
needed to "clarify written procedures" to conform to its
practice,
Seaford presented no evidence that the written policy was intended
as a
change from the long-standing practice rather than as a reflection
of
that practice. ACF Response, Ex. 2 at 7.
As noted at page six above, however, Seaford could reasonably
interpret
its written policy to apply to employees whose numerical ratings
were
between the average score and the next highest level. Since
Seaford did
not provide the numerical ratings given in the employee
performance
evaluations, we are unable to determine which "average" employees
had
ratings greater than 3.0 on the 5-point scale. 9/ Thus, since
the
written Personnel Policies provided for incentive payments only
to
"above average" employees, and Seaford did not demonstrate a
broader
interpretation, consistently applied, we cannot allow these payments
at
this time.
Accordingly, we remand $1,829.51 of the disallowance, which
represents
these payments, to give Seaford an opportunity to prove to ACF
that the
employees who received salary supplements, but were rated as
"Average,"
in fact had numerical performance ratings which were higher than
3.0.
3. The incentive payment made to the Seaford employee with a "Fair"
rating
on the performance scale is not allowable.
While we reverse the portion of the disallowance for salary supplements
to
employees who the record shows were rated above average, and remand
the
portion of the disallowance concerning the performance awards for
employees
labeled "Average," we uphold the disallowance amount
representing the award
given to the employee rated "Fair" on the
performance scale. Seaford
alleged that this individual received an
incentive award because the
employee's 2.7 rating was "rounded up" to a
3.0 or "Average" rating.
Seaford Reply, Aff. at 4. According to
Seaford, the employee's
performance warranted a salary supplement
payment. We find, however,
that this award was not a reasonable
application of Seaford's incentive
policy. The stated objective of the
incentive policy was to reward
employees whose performance was "above
average," not to compensate employees
whose work was merely "Fair" or
below average. Since this salary
supplement award was not based on a
performance level provided for by
Seaford's own policy, it may not be
recognized. Thus, we uphold the
disallowance of $297.62, which
represents the incentive payment given to the
employee with a "Fair"
performance rating.
4. The salary supplements cannot reasonably be treated as salary
increases
under Seaford's written salary policies.
We reject Seaford's alternative argument that the salary supplements
at
issue were allowable as salary increases. The awards which
Seaford
distributed to its employees were one-time, lump-sum payments and
not
permanent increases in salary. While Seaford's Personnel Policies
cause
some confusion by referring to the salary supplements as
"salary
increases," the policy does draw a distinction between true increases
in
salary and one-time incentive payments by providing separate
sections
for each. 10/ Seaford Br., Att. 1 at 93. Salary
increases are
addressed in the "Salary Administration" section and the
incentive
payments are described in the "Merit Promotion Plan/Incentive
Program."
See Seaford Br., Att. 1. Moreover, Seaford's affidavit
explained that
the salary supplements, or "Christmas bonuses," were paid out
as
one-time, lump-sum payments whenever there were additional
funds
remaining at the end of the year. Seaford Reply at 1-2.
CONCLUSION
Based on the foregoing analysis, we find that the majority of
Seaford's
one-time lump-sum payments to its employees were incentive awards
which
satisfied the cost principle standards for allowable
incentive
compensation, and with respect to these payments we reverse
the
disallowance of $5,716.87. We remand the disallowance of
$1,829.51,
representing the awards to "Average" employees, and give Seaford
30 days
(or such longer period as ACF may permit) to submit documentation to
ACF
which demonstrates that these payments were made to employees
with
performance ratings greater than 3.0 (or above average) on the
5-point
scale. 11/ In addition, we uphold the disallowance of $297.62
which was
the payment made to the one employee whose performance rating was
lower
than that required by Seaford's incentive award policy.
___________________________
Judith
A. Ballard
___________________________
M.
Terry Johnson
___________________________
Cecilia
Sparks Ford
Presiding Board Member
1. OMB Circular A-122 sets out the cost principles for
non-profit
organizations such as Seaford. The circular is made
applicable to
Department of Health and Human Services (DHHS) grants by 45
C.F.R. .
74.174(a) (1987). In turn, this regulation is specifically
made
applicable to the grant at issue by DHHS/Human Development
Services
(HDS) Terms and Conditions, which was attached to the Notice of
Grant
Award, and by Head Start regulations at 45 C.F.R. . 1301.10.
2. The Executive Head Start Director's affidavit explained
that
salary supplements were based on fund availability and merit.
She
stated that the employee who received an overall rating of "Fair"
had
scored 2.7 on a 5-point scale and that she had determined that
this
individual qualified for a supplement as "Average" by rounding up
the
2.7 rating to 3.0 (Average). Seaford Reply, Affidavit of
Betty
Richardson at 6. (Aff.).
3. Different rating scales were used over the years;
however, during
the budget period at issue, employees were rated according to
either a
4-point or a 5-point scale, depending upon the evaluator and
the
employee's position. Under the 4-point scale a "4" was "Excellent,"
a
"3" was "Good," a "2" was "Fair," and a "1" was Poor. Seaford
Reply,
Att. 8 at 10.
4. ACF asserted that OMB Circular A-122, Att. B, .6(h)
required a
written agreement between the grantee and its employees.
This, however,
is not the case. A-122 merely requires that there be an
"agreement
entered into in good faith between the organization and the
employees
before the services were rendered or . . . an established plan
followed
by the organization so consistently as to imply, in effect, an
agreement
to make such payment."
5. As discussed below, these payments have been remanded to
ACF for
further findings.
6. In view of Seaford's written policy, it is fair to
presume that
the possibilities of salary supplements would provide an
incentive for
above average performance. We recognize, however, that
such supplements
could potentially lose their character as incentive payments
if a
grantee had a pattern over a number of years of violating
written
policies and paying all employees salary supplements, regardless
of
performance. There is no evidence which establishes such a
pattern
here.
7. The auditors had found that the payments were
arbitrarily
determined without regard to award or incentive for
improved
performance; the grantee did not contest this finding, asserting
instead
that the payments were based on job position and seniority.
8. In support of its position, ACF noted that in November
and
December of 1990 Seaford made incentive payments to its employees
even
though earlier that same year it had requested additional funds in
order
to meet the needs of the program. According to ACF, this
demonstrated
that Seaford did not always determine its program needs before
paying
employee bonuses for that year. There is no evidence, however,
that
Seaford requested additional funds in order to continue its Head
Start
services for the 1991 budget year, and, therefore, this argument
is
irrelevant to the present appeal.
9. Unlike the ratings on the 5-point scale, all of the
payments made
to employees rated on a 4-point scale were allowable.
This was because
a "Good" on this scale was a 3.0 and therefore constituted
an "above
average" score since 3.0 is higher than the average score of
2.5. See
footnote 3 above.
10. The only exception to this is the fact that the
provision for
step increases in salary is included in the incentive plan
section of
the policy. As mentioned earlier, Seaford acknowledged that
its
Personnel Policies manual is poorly worded.
11. To the extent Seaford submits no documentation or
the
documentation does not substantiate the numerical ratings above 3.0
for
these awards, they are unallowable. ACF should issue a
revised
determination of the amount of any remaining disallowance for
this
category of awards. If there are any questions regarding only
the
revised calculations, Seaford may return to the Board within 30 days
of
receiving ACF's revised