Guide to FAR Part 31 Costs
Mastering Allowable vs. Unallowable Costs to Maximize Overhead Recovery and Ensure FAR Part 31 Audit Compliance for Architecture, Engineering, and Construction Firms
FAR Part 31 defines the specific cost principles used to determine which expenses the government will reimburse, and for Architecture and Engineering (A/E) and Construction firms, it hinges on the three-part test of reasonableness, allocability, and compliance with specific contract terms. To be allowable, a cost must be what a “prudent person” would pay in a competitive environment, provide a direct or indirect benefit to the government’s project, and strictly adhere to the list of “selected costs” outlined in FAR 31.2. Improperly claiming unallowable costs—such as interest or entertainment—can lead to painful audit disallowances and legal penalties, making it critical for firm management to proactively scrub their overhead pools before submission.
Key Takeaways
What are the main criteria used to determine if a cost is allowable for government reimbursement under FAR Part 31?
To be considered allowable, a cost must be reasonable for a prudent person, allocable to provide a project benefit, and compliant with the specific cost principles outlined in the federal regulations.
Which common business expenses are typically classified as unallowable and must be removed from an overhead pool?
Expenses such as interest on business loans, alcohol, entertainment, and promotional advertising are strictly non-reimbursable and must be segregated from a firm’s indirect cost calculations.
Who is responsible for identifying and removing unallowable costs before submitting a final indirect cost rate?
Firm management holds the sole responsibility for implementing internal controls to scrub overhead pools and ensure that only allowable costs are included in government contract proposals.
Understanding the FAR Part 31 Framework
For Construction and A/E firms, FAR Part 31 is the rulebook that separates business expenses into those the taxpayer should fund and those the firm must cover out of its own profit. The primary objective is to ensure that the government only pays its fair share of costs that are “causal and beneficial” to the contract. While your firm might incur many legitimate costs to stay competitive, not all of them are reimbursable. This regulation provides the standard guidelines for FAR Part 31 audit compliance for designers, ensuring a level playing field across the industry.
Common Allowable Indirect Costs
Most of the daily expenses required to keep an engineering office running are considered allowable indirect costs. This typically includes fringe benefits—such as health insurance, employer 401(k) contributions, and paid time off—as long as they are applied consistently across the entire staff. Facility expenses like rent, utilities, and maintenance for your primary office are also generally allowable. Furthermore, professional fees for accounting, legal advice (non-litigation), and certain training programs that enhance the skills needed for contract performance are eligible for inclusion in your overhead pool.
“In the A/E world, FAR Part 31 compliance isn’t just about following rules; it’s about ensuring every legitimate business dollar is recovered while shielding your firm from the steep penalties of improper cost classification.”
Strictly Segregating Unallowable Costs
The “dreaded” unallowable costs are those that FAR specifically names as non-reimbursable. For Construction and A/E firms, the most frequent offenders are alcohol, interest on business loans, and entertainment expenses. It is not enough to simply not charge these directly to a project; they must be strictly segregated from your overhead pool entirely. If an auditor finds even a small amount of “promotional advertising” or “bad debt” buried in your general and administrative (G&A) expenses, it can trigger a deeper dive into your entire accounting system.
Management’s Responsibility for Cost Scrubbing
A common misconception is that the auditor’s job is to find and fix your mistakes. In reality, FAR 31.201-6 places the sole responsibility on management to identify and remove unallowable costs before submitting a proposal or a final indirect cost rate. Firm leadership must implement internal controls—such as specific general ledger accounts (9000-series) for unallowable items—to ensure that these costs never touch a government invoice. Certifying a rate that contains unallowable costs is a serious matter that can lead to allegations of “false claims” if the oversight is deemed negligent.
The Cost of Improper Classification
Misclassifying costs doesn’t just result in a slightly lower check from the government; it can lead to significant financial penalties. When allowable vs unallowable government contract costs are mixed, the government may assess fines equal to the amount of the unallowable cost plus interest. More importantly, it lowers your firm’s profitability. If your overhead rate is artificially deflated because you failed to capture all allowable costs, or if it is rejected entirely during an audit, you lose out on the ability to recover your true business expenses.
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.