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DCAA: Unallowable and Allowable Costs

understanding unallowable and allowable costsEntering into a contract with a government entity presents a range of complex regulations that can be challenging to navigate and may lead to costly penalties. Such is the case when entering into a work agreement with the Department of Defense that leads to heightened scrutiny by the Defense Contract Audit Agency (DCAA). The DCAA oversees and enforces regulations that are divided and sub-divided into cost categories filled with restrictions and exceptions. One of the areas that draw the most concern from contractors is distinguishing between unallowable costs and allowable reimbursements.

DCAA Allowable Costs

Allowable costs are set forth by the Federal Acquisition Regulations (FAR). To qualify as allowable, a cost must meet the following criteria as outlined in FAR 31.201-2,3,4:

  1. Reasonable
  2. Allocable
  3. Meet Cost Accounting Standards (CAS) Board accounting standards
  4. Adhere to contract terms
  5. Stay within FAR subpart limitations

DCAA gives detailed descriptions of the guidelines, parameters, and supports of each item listed above. Therefore, a government contractor needs to view the details to gain a comprehensive understanding of how to properly interpret and apply the criteria when accounting for allowable reimbursements.

Allowable costs with specified restrictions include:

Compensation for Personal Services

FAR 31.205-6

Depreciation of Facilities and Equipment

FAR 31.205-11

Independent Research & Development or Bid & Proposal Costs

FAR 31.205-18

Travel Costs

FAR 31.205-46

Rental Costs

FAR 31.205-36

Selling Costs FAR 31.205-38
Trade, Business, Technical, and Professional Activity Costs FAR 31.205-43

Contractors must account for all costs with accurate, updated records and supporting documentation. Any missing data could constitute a dismissal of a claimed cost. Contractors need to understand what that means according to the FAR and not by their own understanding.

Reasonable is defined by the FAR as a cost that does not exceed what a prudent contractor would incur as they conduct day-to-day business. Translation: The contractor should not presume that any cost is reasonable. Instead, the owner or manager should scrutinize the cost under a heavy burden of proof. This is precisely the approach that the contracting officer will take when reviewing an itemized list.

The cost must be ordinary and necessary to conduct business. Assigning the cost as allowable must be a generally accepted sound practice that meets all Federal and State laws and regulations, allows the contractor to fulfill their business responsibilities to all stakeholders, and shows no significant deviation to the contractor’s established practice.

A cost is Allocable to a government contract if the contractor incurs it specifically for the contract, benefits the contract and all related work, and is necessary to business operations. The contractor must demonstrate that the cost is equitable to the business relationship.

DCAA Unallowable Costs

Any cost that does not meet all five criteria (reasonable, allocable, CAS, contract terms, FAR subpart limitations) is dismissed as an unallowable cost as outlined in FAR 31.205. This section of FAR is broken into categories, each containing an extensive list of unallowable costs, terms and conditions, and specified applications of each cost.

Contractors must establish separate accounts for each category and exclude federal government contracts when submitting reimbursements. Unallowable categories include (under specified terms and conditions):

Alcoholic Beverages

FAR 31.205-51

Bad Debts

FAR 31.205-3

Contributions or Donations

FAR 31.205-8

Interest and Other Financial Costs 

FAR 31.205-20

Entertainment Costs, Amusement, or Social Activities

FAR 31.205-14

Goodwill Stemming from Amortization, Write-offs, Company Acquisition

FAR 31.205-49

Executive Lobbying Costs

FAR 31.205-50

Loss on Other Contracts

FAR 31.205-23

Organization Costs

FAR 31.205-27

Contracting with Multiple Government Agencies

Companies may enter into a contract that involves multiple government agencies. Working with more than one agency can lead to either DCAA conflicts between agencies or variances in how the reimbursement allowances are interpreted and applied. For example, the Department of Energy (DoE) does not allow patent prosecution costs unless specifically authorized. Likewise, Health and Human Services (HHS) does not accept reimbursement claims for costs associated with research and development.

Interpreting and Applying FAR Through Contract Terms

To complicate the matter worse, there are few resources available to business contractors that explain DCAA regulations in a way that can be universally understood or applied. Even the wording within FAR is vague enough that contractors can often find themselves wading in regulatory penalties and fees or without plausible explanation as to why certain costs were written off as unallowable.

An example of this is FAR 31.001 that defines expressly unallowable cost as:

“...a particular item or type of cost which, under the express provisions of an applicable law, regulation, or contract, is specifically named and stated to be unallowable."

The problem with this wording is that it doesn’t account for costs that can be inferred as expressly unallowable even if FAR doesn’t express them in direct terms.

One way companies can properly interpret and apply DCAA unallowable costs is to view and clarify the contract terms between the company and the governing agency. The terms of the contract may outline in detail costs that are allowable. Contractors need to thoroughly examine both their prime and subcontracts so that they have a clear understanding of allowable and unallowable reimbursements included in the contract.

How Can Contractors Avoid Mistakes When Classifying Unallowable Costs?

There are proactive steps that contractors can take to mitigate the risk of improperly classifying allowable and unallowable costs such as:

  • Implement a FAR-compliant cost accounting system that fully meets the DCAA’s regulations. A comprehensive software system can ease the burden of manually recording and submitting allowable expenses. It also integrates this function with other accounting functions to streamline all accounting processes.
  • Develop formal written company-wide policies and procedures to clearly differentiate between allowable and unallowable categories. Managers need to update policies and continue ongoing training for all relevant personnel, particularly within the accounting department.
  • Review all month-end costs and categories to ensure proper classification per FAR 31-205.
  • Undergo a voluntary audit from time to time in order to test the company’s processes and procedures on all levels.
  • Review and revise policies as needed.
  • Utilize the FAR-compliant accounting system throughout every step of the process to optimize functionality and create procedural alignment within the organization through digitization.

Accounting Software for Government Contractors

If your company is looking for a viable digital solution to your accounting and DCAA-compliance needs, then you should consider SYMPAQ. We design cost accounting software for government contractors with a focus on providing an enhanced user experience, a clear and well-organized interface, along with abundant features.

To find out more about our products and service or to schedule a consultation, contact us today at
1-800-437-8151. You can also send a message on our contact page.

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