5 Common Unallowable Costs Threatening Your Overhead Rate
Identifying Frequently Missed Unallowable Costs to Protect Your Overhead Rate and Ensure FAR Part 31 Audit Compliance
Beyond obvious items like alcohol, the most frequently missed unallowable costs for Construction and A/E firms during a FAR Part 31 audit include executive compensation exceeding statutory benchmarks, brand-focused advertising, interest on business debt, bad debt write-offs, and legal fees associated with claims against the government. While these expenses are standard deductions in the commercial world, they are strictly excluded from federal reimbursement because they do not directly support the performance of a government contract. Identifying these “hidden” unallowables early is the key to maintaining a defensible overhead rate and avoiding significant audit findings.
A/E Firm FAR Compliance Cheat Sheet
The following table summarizes the most common expenses and how they must be treated under FAR Part 31. If you are ever in doubt, code the item as Unallowable to protect the firm from audit penalties.
| Expense Category | Business Example | FAR Status | Account Type |
|---|---|---|---|
| Executive Pay | Salary & Bonuses | Partial | Allowable up to BCA Cap |
| Marketing | Firm Brochure / PR | Unallowable | Image Enhancement |
| Business Dev | Specific Proposal Work | Allowable | Bid & Proposal |
| Debt | Line of Credit Interest | Unallowable | Financing Cost |
| Client Meals | Working Project Lunch | Allowable | Direct / Indirect (Reasonable) |
| Social Meals | Happy Hour / Parties | Unallowable | Entertainment |
| Legal Fees | Contract Review | Allowable | Professional Fees |
| Legal Fees | Bid Protest / Claims | Unallowable | Litigation |
| Travel | Coach Airfar | Allowable | Direct / Indirect (Per Diem) |
| Travel | First Class / Alcohol | Unallowable | Personal / Excess |
Critical Reminder: The “Certification” Rule
Every time you submit a timesheet or an expense report, you are legally certifying that the costs are accurate and compliant with federal regulations.
- Be Specific: Never use vague descriptions like “Consulting” or “Travel.” Use “Site Visit – Project X” or “Contract Review – Legal.”
- Be Prompt: Record all time and expenses daily to ensure the audit trail is contemporaneous.
- Be Reasonable: If the cost feels excessive for a taxpayer to fund, it likely belongs in an unallowable account.
The Executive Compensation Ceiling
For many principals in the design world, salary and bonuses are a reflection of firm ownership and success. However, auditors view this through the lens of unallowable executive compensation caps. Each year, the government establishes a Benchmark Compensation Amount (BCA) that limits how much of an individual’s pay can be charged to a contract, either directly or through indirect pools. In 2026, navigating these limits requires rigorous documentation. If a principal’s total compensation package—including base salary, bonuses, and employer contributions to deferred compensation—exceeds the current cap, the excess must be moved to an unallowable account. Failing to do so is one of the most common ways firms accidentally “pad” their overhead rates, leading to painful disallowances.
The Fine Line in Advertising and Public Relations
Architecture and Engineering firms, as well as Construction firms, often invest heavily in their brand to win high-profile projects. The challenge lies in distinguishing allowable vs unallowable advertising expenses. Under FAR 31.205-1, the government generally only pays for advertising related to recruiting personnel, acquiring scarce materials, or disposing of scrap. Most other marketing efforts, such as trade show booth rentals, firm brochures, and general public relations meant to “enhance the image” of the firm, are unallowable. When firms host an open house or sponsor a local community event, those costs must be segregated. Even the labor hours spent by staff on purely promotional activities must be carefully tracked and excluded from the overhead pool to ensure FAR Part 31 audit compliance for Construction and A/E firms.
“For A/E firms, the difference between a profitable year and a failed audit often comes down to how well you distinguish between ‘growing the brand’ and ‘performing the contract’ in your overhead pool.”
Legal Costs and Professional Services
Legal fees are a frequent “gotcha” during audits because their allowability depends entirely on the outcome and nature of the legal matter. Costs incurred in defense of a claim or appeal against the federal government are typically unallowable. Similarly, legal fees associated with organization or reorganization—such as changing a firm’s legal structure or pursuing a merger—cannot be charged back to the government. A/E firms must keep detailed, itemized billing records from their legal counsel to prove that the work performed was for allowable activities, such as contract review or general corporate governance, rather than for disputes or prohibited organizational changes.
Financial “Leaks”: Interest and Bad Debt
Perhaps the most frustrating unallowables for firm owners are interest and bad debt. In the private sector, interest on a line of credit is a cost of doing business; under FAR, interest on any debt—regardless of the purpose—is unallowable. Furthermore, if a client fails to pay their bill, that “bad debt” loss cannot be recovered through your Architecture and Engineering indirect cost rates. These items must be clearly flagged in your chart of accounts to prevent them from “leaking” into your overhead multiplier.
To help your accounting team stay compliant, keep an eye on these frequently overlooked categories:
- Charitable Contributions: Even if the cause is noble, these are never allowable.
- Entertainment: This includes sporting event tickets, holiday parties, and social club memberships.
- Fines and Penalties: Any cost resulting from a violation of law or regulation.
- Personal Use of Company Vehicles: This must be calculated and stripped from the overhead pool.
- Federal Income Taxes: While state and local taxes are often allowable, federal taxes are not.
By proactively managing these categories, your firm can build a “bulletproof” overhead rate that stands up to the most rigorous scrutiny. This not only protects your current revenue but also makes your firm more competitive when bidding on future government contracts.
Disclaimer: This article provides general information and should not be considered professional financial or tax advice. Please consult with a qualified CPA or financial advisor for guidance specific to your individual business needs.
Questions?
Missy leads Brady Ware’s AASHTO and FAR Overhead Rate Audit team. With nearly two decades of CPA experience and a background in consumer finance, she provides tax, audit, review, and compilation services, as well as business consulting.