Pricing Matters – Unallowable Costs

The ears of PTAC clients seem to perk up when they hear the term unallowable costs.

In this article we will try to answer the following questions: What are unallowable costs? Why are they unallowable? What are the consequences of their being classified as unallowable?

Per FAR Subpart 31.2, for a cost to be allowable, it must meet the following requirements:

1. Reasonableness: The measure for reasonableness is the prudent person rule: The cost should not exceed that which a prudent person would incur in the conduct of competitive business.
2. Allocability: A cost is allocable or chargeable to a contract if (a) it is incurred specifically for the contract, (b) the benefits of the cost can be allocated in reasonable proportion to the benefits received, and (c) the cost is necessary for the overall operation of the business.
3. Generally Accepted Accounting Practices (GAAP) and Cost Accounting Standards (CAS), if applicable.
4. Terms of contract.
5. Cost limitations in FAR 31.2.

Costs that do not meet the preceding requirements are deemed unallowable.

Per FAR 31.201-6, unallowable costs cannot be included in any billing, claim, or proposal applicable to a Government contract.

What costs are unallowable? 

The following costs are generally unallowable:

• Bad debts (FAR 31.205-3)
• Contributions or donations (FAR 31.205-8)
• Entertainment (FAR 31.205-14)
• Fines, penalties, and mischarging costs (FAR 31.205-15)
• Interest and other financial costs (FAR 31.205-20)
• Lobbying and political activity costs (FAR 31.205-22)
• Losses on other contracts (FAR 31.205-23)
• Organization costs (FAR 31.205-27)
• Patent costs (but with exceptions) (FAR 31.205-30)
• Costs of alcoholic beverages (FAR 31.205-51)

Some costs are usually unallowable, but may have exceptions. For example, public relations and advertising costs (FAR 31.205-1) are generally unallowable. However, if they are specifically required by the contract, they would be allowable.

When trying to determine if a cost is allowable or unallowable, it is best to look to the particular circumstances of that cost.  Per GSA Form 1408, unallowable costs are to be excluded from costs charged to government contracts. In terms of the accounting system, unallowable costs should be separately identified. This can be accomplished by assigning a separate numerical sequence in the chart of accounts to the unallowable costs.

What are the consequences of including unallowable costs in billings, claims, and/or proposals under government contracts?

The unallowable costs under discussion are usually placed in indirect cost pools. This means that, if the unallowable costs are not separately identified, they might be included inadvertently in a company’s calculation of its indirect rates. The result may be inaccuracies in the company’s indirect rates.

Also, there are penalties associated with unallowable costs. Per FAR 42.709-1, the penalty is the amount of the unallowable cost plus interest.

As we can see, the proper treatment of unallowable costs is critical for a company’s billings, claims, and/or proposals under government contracts, as well as for the company’s accounting system. Lack of compliance with the relevant FAR principles and procedures may result in serious difficulties for a company that seeks to do government contract work.

Pricing Matters is a regular feature by Ronald Marta.  Watch for future posts on a wide range of pricing issues.

More about Procurement Technical Assistance Centers (PTACs)

Ninety-eight PTACs – with over 300 local offices – form a nationwide network of procurement professionals dedicated procurement professionals working to help local businesses compete successfully in the government marketplace. Funded under the Defense Logistics Agency’s Procurement Technical Assistance Program through cooperative agreements with state and local governments and non-profit organizations, PTACs are the bridge between buyer and supplier, bringing to bear their knowledge of both government contracting and the capabilities of contractors to maximize fast, reliable service to our government with better quality and at lower costs.