Navigating FAR 31.205: Selected Costs: Directly Associated Unallowable Costs

At a glance:

• The main takeaway: FAR defines certain costs as expressly unallowable, but it’s also crucial to understand the implications of costs that are directly associated with those expressly unallowable costs.
• The impact on your business: Understanding the nature and implications of directly associated costs can help you maintain compliance and manage your cost pools more efficiently.
• Next steps: Learn more about directly associated costs and reach out to Aprio for more information and assistance on managing these and other costs incurred while completing government contracts.

Schedule a consultation with Aprio’s Government Contracting specialists today.

• FAR 31.205 “Selected Cost” contains a list of 46 cost topics determining allowability.
• Some of those are identified as “Expressly Unallowable”
• A second category of unallowable costs are “Directly Associated Cost”

The full story:

Continuing our exploration of unallowable costs within the Federal Acquisition Regulation (FAR) 31.205, we delve into the concept of “Directly Associated Costs.” While FAR identifies certain costs as “Expressly Unallowable,” it’s crucial to understand the implications of costs that are directly associated with these unallowable expenses.

Let’s explore this often-overlooked aspect and its significance for government contractors.

What are Unallowable Costs?

As outlined in FAR 31.205, unallowable costs are expenses that cannot be billed to the government. These expenses, such as personal or entertainment costs, are typically excluded from the contractor’s indirect cost pool, which determines overhead rates for government contracts. Contractors must identify, segregate and exclude these costs from their contract billings to ensure compliance.

Typically, unallowable costs are disallowed during the government’s review of a contractor’s indirect costs. Disallowed costs are excluded from the contractor’s indirect cost pool, which helps determine the overhead rates applicable to government contracts.

What are Directly Associated Costs?

Directly associated costs, as defined in FAR 31.201-6, are costs that arise solely as a result of incurring another cost and would not have been incurred otherwise. Sometimes the DCAA will refer to this as the “but for rule,” as the associated costs would not have occurred but for the original unallowable cost.

In simpler terms, if an expense is directly caused by an unallowable cost it is considered directly associated and is also unallowable. This association must be demonstrable and, in some cases, may require a clear nexus between the unallowable cost and the incurred expense. For example:

Example1: If the cost of alcoholic beverages is unallowable, the tax on that cost would also be unallowable as a directly associated cost.

Example 2: If a contractor includes costs for an unallowable trade show sponsorship expense in its general and administrative (G&A) cost pool, all labor and fringe dollars associated with employees attending the trade show are related costs, would be classified as directly associated unallowable costs during a government audit.

Implications for Contractors

Identifying directly associated costs is crucial for compliance and has significant financial implications for contractors. Failure to segregate these costs accurately can lead to inaccuracies in contract pricing, distortion of indirect rates and increased audit risks. Here are some key considerations:

Contract Pricing: Failure to identify and segregate directly associated costs can lead to inaccuracies in contract pricing. Overstating allowable costs might result in a contractor overbilling the government, leading to potential penalties, contract disputes and reputational damage.

Indirect Rate Impact: Inclusion of directly associated costs in the indirect cost pool distorts the allocation of overhead costs, leading to higher indirect rates. This may negatively affect the contractor’s competitiveness in future bids and proposals.

Audit Risks: Government auditors are vigilant in reviewing costs billed to contracts. If a contractor fails to segregate directly associated costs correctly, it can raise suspicion during audits, triggering further investigations and potential sanctions.

Best Practices for Managing Directly Associated Costs

To ensure compliance and mitigate risks associated with directly associated costs, contractors should adopt the following best practices:

Comprehensive Accounting System: Implement an accounting system that accurately segregates allowable and unallowable costs. Use a separate account series within the chart of accounts for unallowable costs. Clearly label and document directly associated costs to facilitate easy identification during audits.

Training and Awareness: Train accounting personnel, project managers and employees involved in cost allocation about the nuances of directly associated costs. Awareness of unallowable cost types and their potential impacts will help prevent mistakes.

Internal Controls: Establish robust internal controls to review and verify the classification of costs before they are charged to contracts. Regular internal audits can help identify and rectify errors promptly.

Consultation and Legal Advice: Seek professional advice from experts in government contracting or legal counsel when uncertainties arise regarding the allowability of specific costs. This will ensure compliance and reduce potential risks.

Conclusion

Understanding directly associated costs is essential for government contractors to ensure compliance with federal regulations and mitigate financial and audit risks. By adopting best practices and maintaining meticulous accounting practices, contractors can navigate the complexities of directly associated costs and focus on delivering successful projects in the government contracting arena.

Schedule a consultation with Aprio’s Government Contracting specialists today for help managing costs and maintaining compliance.

Related Resources:

Avoid Overbillings: Understand the Role of GSA Schedule Ceiling Rates

Navigating FAR 31.205: Selected Costs: Allowable vs Unallowable

Using Support Items on GSA Schedule Orders