Allowable Cost

An allowable cost is a cost that the government will recognize and reimburse under a cost-type government contract, a cost that passes the four tests established by FAR 31.201-2: reasonableness, allocability, consistency with Generally Accepted Accounting Principles (GAAP) and applicable Cost Accounting Standards, and not being specifically unallowable under FAR Part 31 or the contract terms.

What is an Allowable Cost?

FAR Part 31 establishes the federal cost principles that define which costs a contractor may charge to a government contract. The four-part test for allowability requires that a cost be: (1) reasonable, what a prudent business person would incur under the same circumstances; (2) allocable, benefiting the contract to which it is charged; (3) in accord with GAAP and CAS where applicable; and (4) not specifically prohibited by FAR 31.205 or by agreement between the contractor and government.

FAR 31.205 contains more than 50 cost categories with specific allowability determinations: compensation for personal services (31.205-6), advertising (31.205-1), bad debts (31.205-3), entertainment (31.205-14), fines and penalties (31.205-15), interest (31.205-20), lobbying (31.205-22), and many others. Costs specifically addressed in 31.205 are allowable, unallowable, or allowable with conditions depending on the specific subsection.

Allowability determinations are not always binary. A cost can be partially allowable, for example, executive compensation is allowable up to the OFPP benchmark (currently in the $600,000-$700,000 range annually per executive on CAS-covered contracts) and unallowable above it. Business meals may be allowable when directly related to the active conduct of business but unallowable as entertainment. The specific facts surrounding how a cost is incurred and documented drive the allowability determination.

On cost-type contracts, the contractor tracks both allowable and unallowable costs throughout the year and excludes unallowable costs from its billings to the government. Unallowable costs are "identified and excluded" from the cost base used to calculate indirect rates, they cannot be allocated to government contracts even indirectly through the indirect cost pool.

Why Allowable Costs Matter for Government Contractors

Cost allowability is the foundation of every cost-type contract's financial management. Inadvertently including unallowable costs in billings, even due to accounting classification errors rather than intent to deceive, generates DCAA questioned costs, refund demands, and potentially False Claims Act exposure. Building allowability review into the accounting close process (flagging cost categories by FAR 31.205 reference) prevents unallowable costs from reaching government billings. Contractors new to cost-type contracting often underestimate the complexity of allowability determinations and the DCAA audit exposure they create.

Example

A defense contractor's controller reviews the company's monthly indirect costs for the G&A pool. She identifies three cost categories requiring allowability analysis: $12,000 in business meals (allowable if directly related to government contract work, documented with attendees and business purpose; unallowable if entertainment-only); $8,500 in charitable contributions (specifically unallowable under FAR 31.205-8); and $22,000 in professional dues (allowable under FAR 31.205-28 for memberships contributing to contractor capabilities). She excludes the charitable contributions from the G&A pool and flags the business meals for individual documentation review before including them.

Frequently Asked Questions

Are all costs not prohibited by FAR 31.205 automatically allowable?

No. A cost that is not specifically addressed by FAR 31.205 must still pass the four-part test: reasonableness, allocability, GAAP/CAS compliance, and no contractual prohibition. DCAA auditors frequently question costs that are not specifically listed in FAR 31.205 using the general reasonableness standard. A cost that no reasonable business would incur in the same circumstances is not allowable regardless of whether FAR 31.205 specifically addresses it.

How does allowability interact with allocability?

A cost can be allowable but not allocable to a specific contract. Allowability is about whether the type of cost is eligible for government reimbursement at all; allocability is about whether the specific cost benefits the contract being charged. A legitimate business expense (allowable) that has no relationship to a specific contract is not allocable to that contract. Direct costs must be specifically traceable to the contract; indirect costs must be allocated to the contract through a cost pool that rationally connects the cost to the contract.

What is the penalty for billing unallowable costs?

Knowingly billing unallowable costs is a False Claims Act violation. Even inadvertent billing of specifically unallowable costs (the categories identified in FAR 31.001 as "expressly unallowable") can result in a penalty of twice the amount of the questioned cost under FAR 42.709. The distinction between inadvertent billing and knowing billing matters for penalty purposes, but both result in mandatory refund of the unallowable amount plus interest. Contractors with cost-type contracts should perform annual unallowable cost reviews before submitting their incurred cost submissions to proactively identify and exclude any unallowable costs.

Can a cost be allowable for some contracts but unallowable for others?

Yes, in cases where the contract itself contains specific unallowability terms beyond FAR Part 31. Some contracts include special contract requirements (SCRs) that further restrict cost recovery, for example, prohibiting cost recovery for certain categories of subcontract costs or imposing specific documentation requirements that, if not met, render otherwise-allowable costs unallowable for that contract. Contractors should review both FAR Part 31 and their specific contract terms when evaluating cost allowability.