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Unallowable Costs
The question comes to us each day in many forms: Is this cost allowable? Normally, the first reference point is FAR Part 31.205. The Federal Acquisition Regulation (FAR) spells out in alphabetical order which costs are unallowable. Case closed, right? Not necessarily. If we look back at FAR part 31.201-2, it states factors to consider that may render other costs unallowable as well, which include Reasonableness, Allocability, Terms of the Contracts, Generally Accepted Accounting Principles (GAAP) and Cost Accounting Standards (CAS).
Reasonableness covers all the items not covered in 31.205. The contracting officer using this principle is going to consider whether this was a) an ordinary and necessary expense in the contractor’s business, b) part of sound business practices, c) part of an arm’s-length transaction and d) adherent to the contractor’s established practices.
What is ordinary and necessary? Would it be necessary and ordinary for management to fly to Paris for the annual board meeting? Would it be necessary for the company to have a private plane, when a commercial flight is readily available? These examples show an unnecessary and not an ordinary business transaction. This is what DCAA will be looking for in examining costs pursuant to this principle.
Does it follow our established practices? DCAA will use your own procedures as part of its rule set. Do you have a policy that is much more limiting than the FAR itself, or better yet, do you have a policy that you are not even following? Now may be a good time to break out the policy manual.
Arm’s-length transactions are important because the government does not want to have in place a contractor that is earning profit twice on the same transaction. This concept takes many forms, but is most commonly seen in the contractor that rents from itself. Common control is the term that the government uses to test for an arm’s-length transaction. This term does not always mean that you have over 50% ownership. Court cases such as Brown v. NASA have held that less ownership can still constitute control. These transactions normally have to be handled at cost to address the element of common control.
Look at FAR part 31.201-4 for Allocability. Go to your contracts and make sure that there are not further limitations to your stated costs. Look at CAS, see if it is applicable, and see if you have areas of concern. Next time we will discuss when CAS coverage comes into play. Call me if this seems to be an area of concern but you just are not sure where you need to be looking. I look forward to seeing you soon.
Unfortunately, it is impossible to give comprehensive tax and accounting advice over the internet, no matter how well researched or written. Before relying on any information provided here, contact a tax or accounting professional to discuss your particular situation.