Government Contracting: Don’t Let Unallowable Costs, Cost You

July 6 2017 | by Scott Hursh, CPA, CCIFP, CDA

Working with government contracts introduces a series of complex regulations which can be a nightmare to navigate and result in costly penalties. In the government contracting world, not all costs are created equal. They are sliced and diced into different categories that each have their own restrictions, including allowable and unallowable costs. Costs are aggressively audited by the Defense Contract Audit Agency (DCAA) as well as state DOTs and other agencies so it is imperative that contractors have a clear understanding of how each is applied to government contract accounting. The most important of these are unallowable costs.

What Exactly are Unallowable Costs?

The short answer? They are a little bit of a mess.

Here’s the longer and more complicated answer. Unallowable costs, which include the subset of expressly unallowable costs, don’t follow a straight path. In fact, not all unallowable costs are expressly unallowable, and not all expressly unallowable costs are subject to penalties. An expressly unallowable cost references a specific item or type of cost which, under the express provisions of an applicable law, regulation, or contract, is named and stated to be unallowable.

Per the Federal Acquisition Regulations (FAR) Cost Principles there are several business expenses which must be shown in a contractor’s accounting system but are specifically excluded from government reimbursement. To be compliant, a contractor must identify and exclude these costs from any billings, claims, and proposals related to a government contract.

Generally, expressly unallowable costs fall into one of the following categories:

  • Advertising
  • Airfare travel costs, above and beyond the lowest available option
  • Alcohol
  • Automobile costs for personal use
  • Debt Services
  • Donations and contributions
  • Entertainment
  • Goods & services for personal use
  • Lobbying
  • Personal housing and living expenses
  • Public relations

It’s Complicated

The Armed Service Board of Contract Appeals (ASBCA), a neutral, independent forum whose primary function is to hear and decide post-award contract disputes between government contractors and various Federal agencies, recently decided to expand the circumstances under which costs may be deemed expressly unallowable. Previously the ASBCA only found expressly unallowable costs when the cost was unallowable in all circumstances under FAR §31.205. However, in this most recent decision, ASBCA applied penalties for expressly unallowable costs if the cost was unallowable under FAR §31.205 in the contractor’s specific circumstances. Thus, leaving significant room for case by case interpretation.

This redefining of expressly unallowable costs is worrisome for contractors and will likely result in an increase in FAR penalties. It’s also a good indication that the DCAA may be specifically focusing on this area during audits.

Current penalties for expressly unallowable costs are broken down as follows:

An expressly unallowable indirect cost is subject to a penalty that is equal to:

  • The amount of the disallowed costs allocated to contracts for which an indirect cost proposal has been submitted; plus
  • Interest on the paid portion of the disallowance

OR

If the indirect cost was previously determined to be unallowable prior to the proposal submission, the penalty assessed is:

  • The amount equal to 2x the amount of the disallowed cost; plus
  • Interest on the paid portion of the disallowance

Next Steps

Determining allowable costs for contract pricing or reimbursement purposes can be described as complex at best. There are several proactive steps that contractors can and should take to address unallowable costs. Contractors need to establish policies and procedures for identifying and accounting for unallowable costs. As you can see, there are many variables related to cost, and compliance is vital.

  • Develop and maintain stringent internal controls to identify and exclude unallowable costs
  • Educate employees on identifying and recording unallowable costs
  • Utilize your accounting system to segregate unallowable costs

If you determine that professional assistance could benefit your company, let’s talk. SN’s cost advisory services include a team of professionals ready to:

  • Assist with contract cost principles interpretation
  • Recommend policies, practices, and procedures to identify and track unallowable costs
  • Review proposals and billings for compliance
  • Help prepare pre-proposal agreements on allowable costs
  • Provide support with cost allowability disputes

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