The government as a matter of law and regulation will not reimburse contractors for certain types of costs it may incur.  These costs are generally referred to as Unallowable Costs.  Also, the government will not knowingly negotiate a fixed price contract based on cost or pricing data including any unallowable costs. Unallowable costs are prohibited from any billing, proposal or claim.   Also, penalties can be assessed for passing such costs onto the government.  Costs can be made unallowable by regulation (Federal Acquisition Regulation (FAR) Subpart 31.2), by statute or by contracting officer decision.

The governing regulation for unallowable costs, general accounting practices and other financial rules is FAR 31.2, Cost Principles for Commercial Organizations.  This regulation is invoked any time cost analysis by the government is required.  There are other similar regulations applicable to not-for-profit organizations, colleges and universities and State/Local governments.  These regulations (especially FAR 31.2) are rather lengthy and in certain cases complex.  I have 25 years direct and focused unallowable cost experience and a good resource for guidance on this subject.

The majority of government contractors are subject to these regulations.   Failure to comply with FAR 31.2 results in significant burden and financial exposure.  Compliance is a given and must be addressed in cost accounting systems, policies/procedures and cost accounting practices.

As important as this subject is, there are few resources available to small business contractors that explain the requirements in universally understandable terms.  Also, quick access to common questions is not always simple.  Please contact me for questions regarding FAR 31.2 or for a deeper understanding regarding unallowable costs.  I have written a handbook titled, FAR 31.2, Unallowable Costs Explained.  I provide this handbook to my clients free of charge it is not available for sale.

I classify unallowable costs in two distinct categories.  One is Expressly Unallowable Costs.  These are costs that are unallowable under any and all circumstances, no exceptions.  This is a manageable list.   This list includes the following items.

1. Interest Expense (FAR 31.205-20) is unallowable however represented including bond discounts, costs of financing and refinancing capital including associated costs.  Some associated costs include related legal and professional fees incurred in connection with propectuses, the costs of preparing stock rights are generally unallowable with special rules.  However, interest assessed by certain state and local taxing authorities are allowable under certain conditions.  Suggest the author be contacted on these special rules.

2. Donations/Contributions (FAR 31.205-8)

3. Entertainment (FAR 31.205-14) - The costs of entertainment and recreation however represented are unallowable including associated costs.  It also includes costs associated with social activities including social, dining, country clubs and similar organizations are unallowable.

5. Contingencies (FAR 31.205-7)

6. Bad Debts (FAR 31.205-3)

7. Fines and Penalties (FAR 31.205-15) - The costs of fines and penalties for violating federal, state or local laws is unallowable including associated costs.  Specifically, the costs associated with the mischarging of costs to government contracts is unallowable.

8. Goodwill (FAR 31.205-49) - The write-up of assets, resultant depreciation and goodwill from business combinations is unallowable.

9. Losses on Contracts (FAR 31.205-33) - The excess of cost over income on any contract is unallowable.  This includes the contractor's share of any cost contribution on cost sharing agreements.

10. Organizational (FAR31.205-27) - Organization costs and re-organization costs are unallowable however represented including professional and legal fees.   However, the costs of executive bonuses, employee savings plans and employee stock ownership plans are not considered organization or re-organization costs and are not made unallowable by this principle.  Such costs are addressed by FAR 31.205-6.

11. Alcohol - Alcohol is expressly unallowable under all circumstances.

12. Promotion - this cost is unallowable if the primary purpose is to promote a company's image or products or service.

13. Personal Use - Personal use of anything as compared to business purpose is unallowable.

14. Profit Distribution - Any cost presumed to be a distribution of profits is unallowable in all cases.

15. First Class Air Fare -  First class air fare is unallowable in most cases.  There are a few exceptions, but are available in rare circumstances.  Please contact me about these exceptions as needed.

16. Legal Costs - Certain legal costs are unallowable.  In order for legal costs to be allowable the costs must be documented by scope of work, rate description and work product.  In any case please contact me regarding the circumstances that these costs are allowable or not.  Claims against the government and Defense of certain fraud proceedings are unallowable.

17. Travel Costs - Hotel, meals and incidentals generally are unallowable if they exceed on a daily basis the Federal Travel Per Diem Rates published by the General Services Administration.   There are many rules and exceptions in applying this rule.  Please contact me about these exceptions.

The second one is Circumstantial Unallowable Costs.  These costs are either allowable or unallowable depending on the special and unique circumstances that embody numerous exceptions and special rules.   The majority of cost items addressed by FAR 31.2 fall into this category.   The rules and exceptions are to voluminous to include here.  Please contact me if you have any questions about what is allowable.