FAR Part 31 Cost Principles
A/E Firm and Construction Firm Guide to FAR Part 31 Compliance and AASHTO Overhead Rate Audits
FAR Part 31 cost principles are the mandatory federal regulations used to determine which expenses an Architecture or Engineering (A/E) or for any Construction firm can legally bill to the government. These principles serve as the foundation for determining contract reimbursement by establishing strict criteria for cost reasonableness, allocability, and overall compliance. For A/E firms and Construction firms seeking State DOT or federal contracts, adhering to these rules is not optional; it is the primary requirement for achieving a defensible overhead rate and ensuring that all indirect costs are properly accounted for during an audit.
Key Takeaways
How does an engineering or construction firm determine if a business expense is allowable for government reimbursement?
A cost is considered allowable under federal regulations if it is reasonable, allocable to the project, and complies with the specific cost principles outlined in FAR Part 31.
Why is it necessary for A&E and contructionfirms to separate unallowable costs from their overhead pool?
Firms must segregate unallowable expenses like entertainment and lobbying to ensure they are not inadvertently billed to the government, which protects the firm from audit penalties and disallowances.
What is the benefit of using an accrual-based accounting system for federal contract audits?
Maintaining records on an accrual basis in accordance with GAAP ensures that revenues and expenses are matched to the correct period, providing the necessary financial transparency for a successful FAR audit.
The Foundation of Government Reimbursement
In the world of government contracting, FAR Part 31 acts as the ultimate rulebook. It provides a standardized framework that allows federal agencies and State DOTs to evaluate a firm’s financial claims with consistency. By following these guidelines, your firm ensures that the government only pays for costs that are necessary and appropriate for the work performed. Without this foundation, firms risk facing significant disallowances, which can drain project profitability and damage long-term agency relationships.
Criteria for Reasonableness and Allocability
To be considered allowable under federal guidelines, every expense must pass a multi-part test. First, a cost must be reasonable; it shouldn’t exceed what a “prudent person” would spend in a competitive business environment. Second, the cost must be allocable, meaning it specifically benefits the contract or the overall operation of the firm in a logical proportion. Finally, the expense must comply with the specific terms of the contract and be documented according to GAAP accounting standards. Mastery of these criteria allows management to defend every dollar in their overhead pool.
“A certified, defensible overhead rate isn’t just a compliance requirement—it’s the most powerful lever an A/E firm or construction firm has to ensure full reimbursement on government contracts.”
Applying Principles to the Entire Cost Structure
One common misconception is that FAR principles only apply to specific government projects. In reality, A/E firms and construction firms must apply these principles to their entire cost structure to calculate a valid overhead rate. This means your accounting system must be capable of segregating unallowable costs across the entire company, regardless of whether a specific expense was incurred for a private or public client. When the government audits your indirect cost rate, they look at the total “pool” of expenses to ensure that no “expressly unallowable” items—such as alcohol, entertainment, or lobbying—are being subsidized by taxpayer funds.
Distinguishing Between Direct and Indirect Costs
A successful audit hinges on the clear distinction between direct costs, indirect costs, and unallowable items. Direct costs are those identified specifically with a single project, such as project-specific engineering labor. Indirect costs, or overhead, are expenses that benefit multiple projects, like office rent or accounting services. Finally, unallowable items are those the government refuses to pay for under any circumstances. Implementing a DCAA compliant accounting system is often the best way to automate this sorting process and ensure that your final billing reflects only the allowable portions of your business expenses.
Strategic Benefits for Project Profitability
Beyond simple compliance, a deep understanding of cost principles provides a significant competitive advantage. Firms that master these rules can more accurately forecast project profitability during the bidding phase because they know exactly which costs are recoverable. Furthermore, preparing an AASHTO internal control questionnaire helps firms identify operational gaps early. By minimizing disallowances and maximizing justifiable indirect cost recovery, A/E firms and Construction firms can protect their margins and negotiate government contracts from a position of financial strength and transparency.
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.