Allowable costs are expenses that the government deems necessary, reasonable, and directly related to the contract. In contrast, unallowable costs are expenses that cannot be reimbursed or included in the cost base of a government contract.
It is very important that all government contractors have a firm understanding of the differences between allowable and unallowable costs in government contracting, as negative consequences can result from failing to comply with these regulations.
FAR 31.205
The Federal Acquisition Regulation (FAR), specifically FAR Part 31, sets forth the principles and standards for determining the allowability of costs. These regulations ensure that the government only pays for reasonable, allocable costs and is consistent with the contract's terms and conditions.
Common Examples of Unallowable Costs
It's essential to note that this list is not exhaustive, and other costs may also be considered unallowable depending on specific contract provisions or Federal Acquisition Regulation (FAR) clauses. See the full FAR 31.205.
Some common examples of unallowable costs include:
- Entertainment Costs: Expenses related to amusement, diversion, or social activities are considered unallowable as they do not directly benefit the contract's objectives.
- Lobbying and Political Activity Costs: The FAR prohibits using government funds for lobbying or political activities, including contributions to campaigns or candidates and membership dues to organizations engaged in lobbying.
- Advertising and Public Relations Costs: Advertising and public relations expenses are generally unallowable, except when they are specifically required by the contract or necessary to secure new business.
- Fines and Penalties: Any fines, penalties, or legal costs resulting from violations of laws, regulations, or contract provisions are unallowable.
- Alcoholic Beverages: The cost of alcoholic beverages is unallowable, as it is not deemed necessary for the performance of the contract.
- Bad Debts: Costs related to bad debts, such as uncollectible accounts receivable, are unallowable.
- Employee Morale and Welfare Costs: While reasonable costs for improving working conditions or employee health are allowable, excessive or lavish expenses for employee morale or welfare are unallowable.
Consequences of Misclassifying Costs
By understanding the rules surrounding unallowable costs, you can protect your organization from these risks and maintain a successful working relationship with the government. Misclassifying costs can lead to severe consequences, such as:
- Disallowed costs and reduced reimbursement
- Increased scrutiny and audits
- Penalties, including fines and interest
- Damage to your company's reputation
- Suspension or debarment from future government contracts
See 42.709 for penalties for unallowable costs
Best Practices for Identifying and Handling Unallowable Costs
- Develop internal controls: Establish clear policies and procedures to identify, segregate, and exclude unallowable costs from your government contract billings.
- Train your staff: Ensure that your accounting, finance, and project management teams understand the rules surrounding unallowable costs and how to handle them.
- Maintain detailed documentation: Keep clear and accurate records of all costs incurred, including justifications for any costs that may be questioned as unallowable.
- Seek expert advice: If you're unsure whether a cost is allowable or unallowable, consult an experienced government contracting professional or legal counsel.
How Peter Witts CPA Can Help
Understanding the nuances of allowable and unallowable costs can be challenging, but with expert guidance from Peter Witts, CPA, you can successfully navigate this complex landscape. You can confidently manage your government contracts and ensure compliance with all applicable cost regulations. At Peter Witts CPA, our team of experienced professionals can help you with the following:
- Understand the FAR and other relevant regulations
- Ensure compliance by developing and implementing cost accounting procedures
- Identify and segregate unallowable costs
- Provide support during government audits
- Offer guidance and training to your staff on cost principles and compliance
Need Government Contract Accounting help? With 20+ years of experience, our experts at Peter Witts CPA PC are here to answer any questions you have about allowable and unallowable costs in your contracts.
I’m Kristin, the PWCPA PC Customer Success Specialist. For more information about this topic, or any other, you can always reach me through our customer ticketing system.