Many costs of doing business are valid in the commercial environment, but for Government contracts, they are expressly unallowable. If you advertise for your business, spend money on alcohol during your marketing efforts, or pay interest on debts, you will not be able to seek reimbursement under Government contracts to pay for those costs.

Most companies properly separate those unallowable costs, but many do not.  Auditors are eager to find that out. Let’s delve into what is behind unallowable costs and why it is so important to keep your books clear of these items for Government contracts.

What are Unallowable Costs?
To properly recognize unallowable costs, you need to start with your understanding of the contents of FAR 31.205.  In that section of the FAR, the text distinguishes between allowable and unallowable types of costs. Examples of unallowable costs are public relations and advertising, contingencies, contributions, some employee morale, entertainment, interest & financial costs, lobbying, some taxes, excess goodwill, alcoholic beverages,  losses on other contracts as well as many other costs.  Some allowable cost examples are compensation, engineering, and manufacturing, selling, depreciation, bid and proposal, insurance, material, termination costs among others.  Be sure to read and understand all of FAR Part 31 to completely get the list as well as the explanations.  Read the DCAA Contract Audit Manual Contract Cost Principles and Procedures (DCAAM 7640.1).

Accounting for Unallowable and Allowable Costs
It seems so simple to do that. However, many Government contractors overlook this important step. Set up a separate bank of accounts in your general ledger for unallowable costs.  It is up to you to set up your unallowable categories to match your business practices.  If you never incur advertising costs then it is unnecessary to set up an account for that cost.  What is extremely important is for you to establish clear-cut policies regarding unallowable costs, what they are, how you will deal with them when they are incurred, and what your policy is in reimbursing for them (or not)!  Make sure your Government contracting company accounts for unallowable costs as they are incurred.  What gets an auditor snooping in the wrong direction is when you move costs from allowable to unallowable.  That practice lets the auditor know you do not have clear-cut policies to deal with internally reviewing all of your costs, regardless if they are allowable or unallowable.

Unallowable vs. Unbillable Costs
Unbillable Government contract costs are different from unallowable costs. An unbillable cost is specific to a Government contract but the client is unwilling (contractually) to reimburse you for the cost.  The unbillable costs must be treated and recorded as unbillable contract costs.  Unbillable costs get fully burdened just like billable costs.  Unbillable costs are NOT indirect costs and should never be coded into the indirect costs pools as allowable costs.  Contractually, unbillable costs are not covered costs – remember to read your contract. However, when you are classifying unbillable vs. unallowable costs, ask yourself who receives the benefit.  If the costs are attributable to one contract and not reimbursable, it is an unbillable cost.

Simple Accounting
Accounting for unallowable costs requires no special accounting system or application.  Being able to distinguish unallowable costs in your books of record requires a simple bank of unallowable accounts for various types of costs that your company regularly incurs, institutionalizing the training of project and accounting personnel to understand the regulations regarding unallowable costs, and the discipline to record the costs accurately.  Doing so will keep your company from claiming such costs in your Government contracts and your indirect rates. An effort worth the time and diligence.

Read more on Unallowable (Non-Reimbursable) Cost Definitions

Marsha Lindquist
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