Seaford Community Action Agency, DAB No. 1433 (1993)


  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