Allowable Costs: Rules and Strategies for Government Contractors

To successfully navigate the complex web of government regulations and ensure successful business outcomes, contractors must thoroughly understand relevant cost principles and comply with them. By doing so, they can increase the likelihood that an engagement is profitable by ensuring they only charge the government what they're legally allowed to.

However, due to the evolving nature of government regulations, achieving compliance can be challenging. Contractors must adhere to intricate rules, be prepared for audits at any time and understand potential penalties they may incur for willful or accidental non-compliance.

This can be a tall order that requires extensive knowledge, robust internal controls and ongoing vigilance.

This article examines the ins and outs of allowable costs, general policies and procedures contractors can use to track costs and best practices contractors should follow to ensure compliance. Plus, we take a deep dive into how contractors should think about travel costs to give you a better idea of what this looks like in the real world.

In this article:

• What is An Allowable Cost?
• General Policies and Procedures for Tracking Costs
• How Should Government Contractors Track Travel Expenses?
• Allowable Costs: 3 Best Practices for Government Contractors

In the world of government contracting, an allowable cost is an expense that is considered reasonable, allocable and compliant with the terms and conditions of a contract, as well as relevant regulations and cost principles.

Cost allowability is incredibly important for contractors because it determines whether they can charge the government for an expense they've incurred or not.

The government only agrees to reimburse allowable costs; if a contractor submits unallowable costs on an invoice, they won't be reimbursed in the best-case scenario. Depending on how severe the breach is, contractors can face penalties, audits, contract termination or even the loss of contracting privileges altogether.

Governed by FAR Part 31 — and FAR 31.201-2 specifically — allowable costs must be reasonable, allocable and compliant.

Related articles:

• What is the Federal Acquisition Regulation?
• Understanding FAR Clauses

Is the Cost Reasonable?

Of course, this is subjective and often the subject of debate between the contractor and the Defense Contract Audit Agency (DCAA) auditor or contracting officer. But generally speaking, reasonable costs are costs that a prudent person would incur doing a similar project for a competitive business.

Here, the burden of proof falls on the contractor's shoulders. As such, it's important to maintain documentation, implement strong policies and procedures that guide your team and ensure that your team is trained thoroughly and understands the standards of what your business expects.

Remember that some costs may be legitimate business expenses that don't qualify for reimbursement; taking your team out to a baseball game to celebrate success and boost morale can often be written off as a business expense, but the government would not reimburse such costs.

Is the Cost Allocable?

Allowable costs can be directly or indirectly attributed or allocated to the contract and must clearly provide benefits. In other words, reimbursable costs must be incurred specifically for the purpose of fulfilling a contract’s requirements. Additionally, the method used to allocate costs must be consistent with the contractor’s accounting practices and the terms of the contract.

Examples of allocable costs include direct labor, materials, subcontractor expenses and other expenses directly related to the contract’s performance (e.g., fuel for construction equipment and associated transportation costs). Some indirect costs — like overhead and administrative expenses — may also be allocable.

Is the Cost Compliant?

Costs must be compliant with the terms of the contract itself, Cost Accounting Standards and the limits spelled out in FAR 31.2. If your accounting doesn’t adhere to cost principles, costs resulting from inconsistent practices in excess of the amount that would have been allowed using practices consistent with the regulation are unallowable.

Ultimately, contractors need to ensure they are accounting for costs appropriately. They also need to maintain records, including supporting documentation (e.g., receipts and invoices), to demonstrate that the costs have been incurred, are allocable to the contract at hand and are in agreement with relevant cost principles.

Contracting officers have the final say in determining whether costs are allowable or not. In some circumstances, a cost might otherwise be allowable, but if you don’t maintain adequate documentation, the officer may decide to reject it. That being the case, it bears repeating: Contractors must maintain comprehensive documentation to support each allowable cost they submit for reimbursement.

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While every contractor is different, there are some general policies and procedures that should help you track costs accurately and efficiently, increasing the chances you avoid cost allowability issues.

• Maintain separate accounts for allowable and unallowable costs. By maintaining separate accounts, tracking expenses and reporting in compliance with cost allowability rules is easier. For example, while supply costs related to the contract are likely allowable, company party expenses won’t be reimbursed.
• Implement clear guidelines for incurring and documenting costs. You might have the best policies in the world, but if your team isn’t aware of them, what good is that? While your organization might decide to reimburse an employee who ordered a movie in their hotel room on a business trip related to the contract, the government is unlikely to repay such expenses.
• Put someone in charge of reviewing policies and ensuring compliance. This helps maintain accountability and oversight over cost-allowability protocols within the organization.
• Train employees on cost-allowability protocols and keep them updated. By doing so, you can ensure that your staff knows the relevant protocols they need to follow, making compliance that much easier to achieve.
• Review policies and procedures regularly to maintain compliance. Since regulations change from time to time, it’s important to regularly review your policies to identify and address any gaps or inconsistencies.

To give you a better idea of what this looks like in the real world, let’s take a look at some considerations to keep in mind while tracking travel expenses, which are covered under FAR 31.205-46:

• Keep receipts for any cost you incur that’s $75 or more. Maintain documentation that includes the date and place of the expense, the purpose and the people involved in the purchase.
• You have the option to get compliant transportation costs reimbursed based on actual costs incurred, by mileage rates or via some combination of the above. Whichever you choose, the method needs to stay consistent and the charges must be reasonable.
• Provided they’re reasonable, lodging, meals and incidental expenses may be reimbursed based on per-diem rates outlined in relevant regulations (e.g., Federal Travel Regulations for travel within the contiguous United States and Joint Travel Regulations for travel in Alaska, Hawaii or other U.S. territories). If you’re only traveling for half a day, it’s not reasonable to request a full per-diem reimbursement. If you think your expenses will be consistently higher than the prevailing per-diem rate, consider pursuing an advance agreement with the contracting officer.
• Contractors are required to get the lowest-priced airfare possible. Excess costs are only allowable if the alternative is flying during unreasonable hours, booking a flight that prolongs travel times significantly or are required to accommodate an employee’s medical conditions. Any discounts you may be able to get on airfare should be passed along to the government.
• If your organization has a private airplane or has leased a chartered aircraft, you are limited to allowable airfare reimbursement unless there’s a reason for flying that way. For example, commercial jets might not fly to certain locations. In these circumstances, have a conversation with the contracting officer to get an advance agreement.
• Contractors are expected to book flights from U.S. flag carriers whenever possible. If you travel abroad frequently, make sure you have solid processes and policies to ensure compliance.

Periodically, the DCAA — a steward of taxpayer dollars — will audit a contractor’s travel policies and procedures to see whether adequate controls of unallowable costs are in place.

Related articles:

• What is DCAA Compliance?
• Types of DCAA Audits

While cost allowability is ultimately determined by the contracting officer, following these best practices should increase the chances you comply with relevant rules and regulations — and that your next project is a financial success.

1. Adopt policies and procedures that comply with cost principle requirements and DCAA guidance: Contractors should establish robust policies and procedures aligned with cost principle requirements and guidance from the DCAA. Such policies help ensure adherence to regulatory standards, facilitating accurate cost allocation and reimbursement processes. By incorporating DCAA guidance into their operational framework, contractors can mitigate compliance risks, streamline audit processes and uphold integrity in government contracting endeavors.
2. Spot-check travel expenses submitted to reimbursement as an internal audit: Conducting spot checks on travel expenses submitted for reimbursement serves as an effective internal audit measure. Such checks help identify discrepancies or non-compliance with travel policies and regulations. By proactively reviewing expense reports, contractors can ensure accuracy, detect potential errors and maintain compliance with reimbursement guidelines and company policies.
3. Determine whether advance agreements make sense in certain circumstances: Depending on the nature of the contract, you may want to pursue advance agreements ahead of time. Such agreements can streamline cost allocation processes and provide clarity on allowable expenses. Under these agreements, the contracting officer lets you know whether certain expenses are allowable or not. As a result, you don’t have to incur costs wondering whether they’ll be reimbursed in the future.

>Successfully navigating the intricacies of government regulations is paramount for contractors striving for profitable engagements. In order to do so, understanding and adhering to relevant cost principles is crucial, as it ensures compliance and mitigates the risk of potential penalties.

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