FAR Cost Principles and Unallowable Costs: The Federal Contractor Framework for Allowable vs Non-Allowable Charges

Federal Acquisition Regulation (FAR) Part 31 establishes cost principles governing what costs can be charged to federal contracts. Specific costs are unallowable by regulation — alcohol, entertainment, political contributions, lobbying, most advertising, fines and penalties, bad debts, and others. Unallowable costs must be excluded from billings and indirect cost pools. DCAA audits scrutinize cost submissions for unallowable items. Contractors including unallowable costs face disallowances, penalties, and potential False Claims Act exposure.

Understanding FAR cost principles is essential for federal contractors. This post covers the framework and specific unallowable categories contractors most commonly encounter.

FAR Cost Principle Framework

FAR Part 31 structure:

FAR Part 31 provides comprehensive framework. General principles establish allowability tests (reasonable, allocable, consistent with CAS/GAAP, in accordance with FAR). Selected costs (31.205) specifies 50+ cost categories with specific rules. Specific contract type subparts. Contractors navigate via framework.

Allowability Tests

Four tests determine allowability:

Costs must pass all four tests. Reasonable amount (arm's-length transactions, market pricing). Allocable to contract (bears causal relationship). Consistent with accounting standards. Compliant with FAR and contract. Failure of any test makes cost unallowable even if category not specifically addressed.

Entertainment

Entertainment typically unallowable:

Entertainment broadly unallowable under 31.205-14. Tickets, venue costs, travel for entertainment, amusement, diversion — all excluded. Customer entertainment specifically unallowable. Employee events with entertainment component unallowable. Specific exceptions narrow (training, promotional). Separating business meals from entertainment requires care.

Alcohol

Alcohol entirely unallowable:

Alcohol unallowable without exception under 31.205-51. Meals including alcohol require separation — food portion may be allowable (business meal per 31.205-11), alcohol portion unallowable. Receipts split or alcohol excluded. Staff parties with alcohol entirely unallowable typically.

Political Contributions and Lobbying

Political costs unallowable:

Lobbying and political activity unallowable under 31.205-22. Political contributions and PAC donations unallowable. Influencing legislation at any level unallowable. Industry association dues include lobbying portion — that portion unallowable. Contractors must identify and exclude. Specific narrow exceptions exist.

Advertising

Advertising mostly unallowable:

Public relations and advertising largely unallowable per 31.205-1. Image advertising (company reputation) unallowable. Recruitment advertising allowable. Specific notices required by law allowable. Trade shows typically allowable. Contractors must distinguish. Many marketing activities contain mix.

Travel

Travel with specific limits:

Business travel generally allowable with specific limits. First-class travel unallowable absent specific justification. Business-class limited. Per diem or actual expense limits per FTR. Spousal travel unallowable. Documentation requirements substantial. Must support business purpose.

Fines and Penalties

Fines unallowable:

Fines and penalties unallowable. Government-imposed fines for regulatory violations. Traffic fines. OSHA penalties. Contract penalties. Related legal costs defending if result is fine. Contractors must identify and exclude.

Interest and Financial Costs

Interest typically unallowable:

Interest and financial costs generally unallowable per 31.205-20. Bond interest unallowable. Loan interest unallowable. Specific exceptions (LC fees, late payment interest in specific situations). Financing cost management affected — contractors can't charge government for their financing.

Executive Compensation

Executive compensation capped:

Executive compensation capped for federal contractors. Cap (around $650K+ adjusted annually) limits allowable for specific executive positions. Bonuses and total compensation above cap unallowable. Reasonableness test applies generally. Higher-paid construction executives face partial disallowance.

Accounting System Requirements

System must segregate:

Accounting system must segregate unallowable costs from billable. Separate accounts or cost objectives. Unallowable code applied at entry. Documentation of decisions. Training for AP to identify. Systematic exclusion from indirect pools and billings. DCAA tests during audits.

Penalties for Including Unallowable

Penalties substantial:

Including unallowable costs produces penalties. Basic disallowance recovers cost. 'Penalty' provisions can double assessment in some cases. False Claims Act exposure if intentional. Audit findings affect future work. Reputational damage. Serious cases debarment. Incentives strongly favor compliance.

Bottom Line

FAR Part 31 governs allowable costs on federal contracts. Four allowability tests — reasonable, allocable, consistent, FAR-compliant. Specific unallowable categories include entertainment, alcohol, political contributions and lobbying, most advertising, certain travel, fines, interest, and excess executive compensation. Accounting system must segregate unallowable costs from billings. DCAA audits test. Penalties for including unallowable include disallowance, doubling provisions, False Claims Act exposure, and debarment risk. For federal contractors, FAR cost principles are compliance essential. Understanding categories and implementing systematic segregation protects business. Quality financial management includes FAR compliance; poor management produces costly findings and risk.