Decoding FAR Part 31…..What are ‘Unallowable’ Costs?
As a government contractor it is imperative that you segregate your unallowable costs from your allowable costs. Sounds simple, right? Maybe for those that have made it their goal to become scholars of the Federal Acquisition Regulations (a.k.a. FAR) in their spare time, but for most it can be guesswork at best. I’d like to point out some areas of FAR Part 31 that you should be aware of as you perform on government contracts.
Allowable vs Unallowable Cost
First, we need to know the difference between allowable and unallowable cost. To be allowable, a cost must comply with all of the following requirements:
- Standards promulgated by the CAS Board, if applicable, otherwise GAAP and appropriate practices
- Terms of the contract
- Any limitations stated in FAR 31.205
Reasonableness For a cost to be considered reasonable, it must not exceed what would normally be incurred in the course of competitive business. It should also not deviate from your company’s established business practices. Items that might be put to the test her are executive compensation, rental costs and some travel elements.
Allocability Now there’s a word I’m sure you use all the time, but let’s define it a bit for some who might not be familiar. The FAR states that “a cost is allocable if it is assignable or chargeable to one or more cost objectives on the basis of relative benefits received or other equitable relationship.” In laymen’s terms this can be summarized with these three criteria:
- A cost that is incurred specifically for a contract (i.e. direct cost)
- A cost that benefits both the contract and other work in reasonable proportion (i.e. overhead) or
- A cost that is necessary to the overall operation of the business but no direct relationship can be shown (i.e. G&A)
Now let’s take a look at FAR 31.205. This subpart, or section, is entitled ‘Selected Costs’ and contains definitions and limitations for 46 different cost elements, or categories. While there certainly may be other types of costs you’ll encounter in the course of everyday business, this section will call out costs that are allowable, unallowable and in some cases types of costs that have both allowable and unallowable elements in them.
I’d like to take you through a few of the cost categories from Subpart 31.205 and hopefully shed some light on some things that may not have been really clear to you when determining allowability of cost.
Public Relations & Advertising
One cost category that contains both allowable and unallowable pieces to it is 31.201-1 : Public Relations & Advertising. This is one that can be interpreted as black, white and even gray. Activities that promote sales of products or services normally sold to the U.S. Government are allowable, as are costs of communications with the public, press, stockholders and customers. The costs of promotional materials, brochures, magazines and the like that are designed to call favorable attention to the contractor are unallowable. Any memorabilia purchased for giveaway etc is also considered an unallowable cost, so while those nifty laser flashlights and iPhone covers with your company logo make you a hit at trade shows, you’re going to want to make sure those invoices are booked to an unallowable account.
Compensation for Personal Services
Subpart 31.205-6 covers Compensation for Personal Services and is a section that addresses nearly every type of compensation. This is a section that is usually use to craft a company’s compensation policy. An important reminder her is that bonus and/or incentive compensation are allowable costs, however they must be paid out per an existing agreement, plan or policy and must be supported using a consistent basis. For small businesses and LLCs, it is important to note that distributions of company profits to owners is an unallowable cost and should be recorded to a contra account in the Stockholder’s Equity section of the balance sheet.
Now there is an easy one. Always unallowable, right? I suppose you can say almost always. Interest paid on loans or as part of late payments are unallowable, as are all fees associated with opening or renewing lines of credit. However as Subpart 31.205-20 points out, interest assessed by State and Local taxing authorities is allowable – only if it occurs as a result of actions that were directed by the contracting officer. As I like to say, this will probably occur as often as a blue moon or when the planets align.
So remember, when you are looking to determine if a cost is allowable, ask yourself “is it reasonable?”, “is it allocable?” and when those are “yes”, don’t forget to pull out a copy of FAR 31.205 and make sure it passes those limitations as well.