FAR Part 31 – Cost Principles & Procedures
January 31, 2020
The third segment of Determining Overhead Rates in Government Contracts explores some basics of FAR Part 31, the specific section of the government regulations that details cost principles and procedures. Defining costs as allowable, allocable and/or reasonable, and classifying costs as direct or indirect are focal points of the discussion.
Overview…what's FAR 31? Defines parameters for cost accounting systems requirements for government contractors, drives audit findings and recommendations related to cost accounting systems, other FAR sections alluding to acceptable cost accounting and estimating systems are tied to part 31. Part 31 defines your allowable, unallowable, allocable - it's a really important thing you need to learn if you’re going to be in government contracting. Like all government documents, it references out to other pieces of the FAR so it’s link to link to link. So it's fairly complicated. The government must be able to determine if direct or indirect expense items are allowable, allocable or reasonable. Allowable costs is, just what we said, determined by the FAR. They'll specifically say whether cost is allowable or unallowable. It may be determined by other regulations, whether it's the DFARS or contract specific.
So just because you see that something's allowable from a FAR standpoint, your contract may specifically disallow it. So you need to understand all the required regulatory or regulated documents though when you're working on a contract for the government. Allocable is - can a cost that's not specific to a contract be allocable to other contracts and other parts of the business? So you may have a company that does work as a defense contractor, does some local and state work, and also does commercial services to the private industry. You may have a cost that supports from an overhead perspective, say it's rent, that supports all of those business lines. You have to be able to take those specific costs and make sure that those are getting allocated to the specific projects or types of services or to the commercial entity in a fair manner. And so there are certain methods that we'll talk about later.
But the key is that you can't just as a contractor say, well if I charge this rent to overhead within my government work, I can pick that all up as a cost reimbursable. No. Someone will come in and say, well, that same rent is supporting other areas, they'll disallow it and say it's not reasonable and you could have some money due back or even get write offs and so forth doing things like that. So you have to think through that the purpose is the government wants to only pick up its fair share of a company's costs. And the next question is reasonable. Usually a basis for reasonable is what would a competitive company who was performing the same thing or incurring the same expense, what would they do?
So there's some judgment to that, but why that becomes an issue is oftentimes, smaller businesses, disadvantaged businesses will often get sole source awards. Basically they won it without having to compete for it. In those cases, the government wants to make sure, yes, we understand that this wasn't competed through but we want to make sure that we're still paying a reasonable price. So they'll make sure that even on a noncompetitive bid that the government's not getting overcharged for the services being delivered. FAR part 31 - direct and indirect costs definitions. We address those job cost allowability and allocation guidelines that cost should be allocable and reasonableness requirement. They speak about allowable and unallowable criteria of selected costs. And that was somewhat in that chart that we showed you in the prior slide and unallowable cost definition.
Anthony Faugno:The next few slides we can walk through very quickly because James just talked about a lot of it. So just to make up some time because there are some examples we want to get to in the time allotted. So, James, we'll just look through these next few slides real quick and I think you covered a lot of it. The next slide is just a contractor's responsibility to properly support proposed or billed costs. It's like Tony said in the example before - he had a client that didn't have the best accounting records and even had an issue where just the description wasn't completely accurate. You have to be careful and you have to make sure that you're well documented with what you're charging to the government because ultimately you’ll need to justify those costs at some point, whether it's through a contract close out or if whether an auditor comes in from one of the government agencies. You need to be able to well support all your claims on your costs.
JS: Real quickly, allowable. We talked about all this before. It has to be in accordance with GAAP, comply with the terms of the contract and needs to be reasonable and allocable. Allocable – we mentioned this – a cost that is assignable or chargeable to one or more cost objectives. If it's specifically for a contract it should be treated as a direct cost. If it's not, if it supports the general nature of the business and supports other aspects of the business, it should be allocated and that speaks for itself. And then reasonable…a cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business. Just what I mentioned before, what would your competitor do and how much would they charge is often a determination of reasonableness. So it's something that you have to think about as you’re charging for certain aspects and what you're incurring on the business side.
Anthony Faugno:This next slide, just real quick. This talks about what needs to be documented to support your costs. So it's important to have proper documentation in receipts and to produce because if you don't have that, they're going to just disallow it. It'll be considered a questioned cost. Just keep in mind, you have to have organized records and data. This is a list. I'm not going to go through every one of them, but you can read these. This is a list of costs that we sometimes typically see where documentation could be better, especially in the travel and entertainment area. Where you got a lot of employees spending money in those areas, you should have a system for getting expense reports with the proper backups.