FAR Part 31 Unallowable Costs
How A/E Firms Should Identify and Segregate Expressly Unallowable Costs for FAR Part 31 Compliance
Identifying and segregating expressly unallowable costs is a mandatory requirement for any A/E firm working on government contracts, as FAR Part 31 strictly prohibits these expenses from being included in an overhead rate. To comply, firms must proactively remove costs such as entertainment, alcohol, and federal income taxes from their indirect cost pools before calculating their final billing rate. Failure to perform this segregation can result in severe financial penalties and the permanent loss of trust with State DOT auditors, making it essential for management to maintain a rigorous internal control system that flags these expenses at the point of entry.
Key Takeaways
What are some examples of expenses that are strictly unallowable under FAR Part 31 for engineering firms?
Expressly unallowable costs include items such as alcoholic beverages, entertainment, lobbying activities, and federal income taxes, all of which must be excluded from the overhead rate.
How can an A&E firm automatically prevent unallowable costs from being included in their overhead pool?
Firms should set up dedicated General Ledger accounts to specifically track unallowable expenses throughout the year, ensuring they are easily identified and removed during the audit process.
What happens if an architecture or engineering firm fails to properly segregate unallowable costs?
Failure to remove these expenses can lead to significant financial penalties, disallowed costs, and a loss of credibility with government agency auditors.
The High Cost of Unallowable Expenses
In the specialized world of government auditing, “expressly unallowable costs” are defined as specific expenses that are clearly excluded from reimbursement by regulation. Common examples found in FAR Part 31 include interest expense, lobbying costs, and certain types of advertising. While these are legitimate business expenses for a private company, the government refuses to subsidize them with taxpayer funds. When an A/E firm fails to scrub these from their overhead, they aren’t just making a bookkeeping error; they are risking their reputation. Agency auditors view the inclusion of unallowable costs as a red flag, often leading to a more intrusive and expanded audit process.
Automating the Segregation Process
Rather than relying on a manual review at the end of the year, successful firms implement a proactive approach within their financial software. By establishing specific General Ledger (GL) accounts dedicated solely to unallowable items, you can track these expenses automatically throughout the fiscal year. This setup ensures that when it comes time to generate your Schedule of Indirect Costs, these “poison” accounts are excluded with the click of a button. Utilizing a DCAA compliant accounting system allows for this level of granularity, ensuring that every transaction is categorized correctly from the moment an employee submits an expense report.
“In the eyes of a government auditor, the failure to segregate unallowable costs isn’t just a clerical error—it’s a high-stakes risk that can jeopardize your firm’s reputation and profitability.”
Management Responsibility and Internal Controls
It is a common misconception that the outside CPA firm is responsible for finding unallowable costs. In reality, the AASHTO Guide clarifies that management bears the sole responsibility for the integrity of the cost submission. This means leadership must implement robust internal control testing for A/E firms to verify that unallowable costs are not inadvertently billed to the government. Regular training for project managers and accounting staff is crucial, as they are the first line of defense in identifying costs that do not meet the criteria for reimbursement.
Accelerating the Audit Cycle
A clean segregation process does more than just avoid penalties; it significantly accelerates the audit timeline. When an auditor sees that a firm has clearly identified its unallowable costs and excluded them upfront, it builds immediate professional credibility. This transparency reduces the number of “disallowed expenses” discovered during the field review, which in turn leads to faster rate approval and smoother contract negotiations. By investing in specialized CPA overhead audit services, firms can ensure their segregation methods meet the highest standards of the AASHTO Uniform Audit and Accounting Guide.
Long-Term Profitability through Compliance
Ultimately, identifying unallowable costs is about protecting your profit. While it may seem counterintuitive to “lower” your overhead rate by removing expenses, doing so ensures that your remaining rate is defensible and sustainable. Firms that master the art of segregating unallowable costs in FAR audits avoid the heavy back-assessments and interest charges that come with audit findings. This allows the firm to focus on long-term growth and infrastructure projects, knowing that their financial foundation is built on accurate, compliant, and undisputed data.
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.