A Few Things Every Contractor Needs to Know About Cost Allowability

Recently, we conducted research related to some incurred cost audit findings for a client and came across an Armed Services Board of Contract Appeals (ASBCA) case that highlighted key information every contractor, especially small businesses, should know. The Technology Systems, Inc. ASBCA No. 59577 reads like a soap opera. It starts with some ups and downs. There were audit findings in Fiscal Year (FY) 2001, which the contractor and the Administrative Contracting Officer (ACO) negotiated. For FY 2002 to 2006, the contractor’s indirect rates were accepted as proposed. This was followed by relationship issues during the FY 2007 audit between the Defense Contract Audit Agency (DCAA) auditor and the contractor (No surprise to most of us). Then, a period of separation occurred, from FY 2009 to 2013, when DCAA decided that proposal pricing supporting new contract awards was the priority. During this time, the contractor’s FY 2007 incurred cost audit was shelved, along with significant potential questioned costs. Then, in an act of desperation, the ACO issued a Contracting Officer’s Final Decision (COFD) based on a DCAA memorandum for the FY 2007, which questioned costs to avoid the statute of limitations running out. Ok, enough of the soap opera, let’s go through the things you need to know.

Does Arguing That the Same Cost Was Not Questioned/Disallowed in a Prior Year Prevail?

Absolutely not. While there was a dissenting opinion based on the theory of “retroactive disallowance” by one judge, the rest of the Board would have nothing to do with it.

Here is how the Board came to its decision. The decision was based on the concept of “estoppel,” which is a part of the theory of “retroactive disallowance.”

The Board based its decision on a 1984 Supreme Court case (Heckler v. Community Health Services of Crawford County, Inc., 467 U.S. 51), which found, “the Government may not be estopped on the same terms as any other litigant.” Then, the Federal Circuit Court in 1989 (Henry v. United States, 870 F.2d 634, 637) found that “affirmative misconduct [has been recognized] as an element of an estoppel claim against the government.” The Board has held that affirmative misconduct is a prerequisite for invoking equitable estoppel against the government. The Board stated: “The government’s failure to challenge…costs in prior audits (without more) was not enough to give…reasonable belief that such costs would never be challenged in the future.”

The way we read this statement by the Board is that the fact that a cost was not questioned in a prior audit places no limitation on the cost being questioned in the future. However, the “without more” makes this more than a blanket statement to stand in all cases. We believe that if the parties discussed a subjective area of cost allowability, such as what is adequate documentation to support the allowability of a type of cost, a future auditor or contracting officer cannot simply ignore this agreement and neither would the Board.

What You Need to Know

Just because the Government has not questioned a cost in the past does not mean they will not question that cost in the future. Never assume things are good when dealing with the Government. If you have discussed the allowability of a cost or the level of documentation required with anyone in the Government, send them an email confirming the discussion. Make sure to copy the contracting officer if he or she was not the government representative you were dealing with. This is not going to make a clearly unallowable cost allowable. However, it will hopefully improve your case where there is significant subjectivity as to the allowability, and the government has agreed on what it expects from you.

When Does the Statute of Limitations Start for Incurred Cost?

When you have submitted an adequate Incurred Cost Proposal (ICP). The Board stated, “that it was legally impossible for the government to issue its COFD before the submission of the ICP, because the legal bases for the government’s unilaterally establishing the indirect costs,…presupposed action upon a ‘final’ ICP submitted by the contractor...Since no COFD approving or disapproving portions of the FY 2007 ICP could have been issued until after the submission of said proposal…, and the ability to assert such a government claim is a prerequisite to claim accrual,…it is impossible for the statute to have begun to run…prior to the submission of…[the] ICP.”

What You Need to Know

Never wait on the Government. As soon as you submit your ICP, start working with the ACO and buying commands to close out contracts. There is the option of “quick closeout” under FAR 42.708 and even conversion from cost type to fixed price. The more contracts you can take off the table, the better.

Does FAR 31.205-33(f) Require a “Work Product” to Make a Consultant Cost Allowable?

No, it does not. The Board states, “The government labors under the false impression that the FAR requires a consultant to create ‘work product’ merely for the purposes of proving its costs [are allowable].” “Though the FAR language in question is not as clear as we might like, it can be read - as we read it here - to impose no such requirement.”

The Board examined the FAR 31.205-33(f) language that the government held out as requiring the generation of a “work product” to support the allowability for professional and consultant service costs. FAR 31.205-33(f) provides that costs for services rendered are allowable only when supported by evidence of the nature and scope of the service provided. FAR 31.205-33(f)(3) addresses “work products and related documents, such as trip reports indicating persons visited and subjects discussed, minutes of meetings, and collateral memoranda and reports.” The government argues that the FAR’s statement that the evidence “shall include...work products” makes this a mandatory documentation requirement. The Board found, “The problem with this interpretation of the FAR is that it does not account for the case in which the consultant never created such documents. Moreover, it does not account for the case where…the invoices include the data that the FAR defines as work product, such as persons visited and subjects discussed.” The Board goes on to point out that DCAA’s own audit manual, provides that, “[t]he auditor should not insist on a work product if other evidence provided is sufficient to determine the nature and scope of the actual work performed.” The Board concluded, “that FAR 31.205-33(f) may require the provision of a consultant’s work product, if it exists, but is not so rigid as to require its creation when it would not otherwise be necessary for the consultant to perform its duties.” “As with most things, the proper amount of documentation and work product to be expected will largely depend on the scope of work performed, and we do not conclude that the FAR intended to impose ‘make work’ upon consultants that would only lead to higher costs to the contractor, which would then be imposed upon the taxpayer.”

What You Need to Know

Make sure the scope of work set forth in your consultant agreements and the invoices provide adequate information as to the work performed and that the work was related to an allowable activity. Do not concur with an audit finding based on the fact that the consultant did not produce a “work product.”

Does Special Tax Treatment Allow for Current Period Expensing Impact Your Cost Accounting for Government Contracts?

No, it does not. FAR 31.205-11(c) provides that for contracts not covered by cost accounting standards (CAS), “allowable depreciation shall not exceed the amount used for financial accounting purposes, and shall be determined in a manner consistent with the depreciation policies and procedures followed in the same segment on non-Government business.” This addresses the expensing of the cost of an asset in the current period as well. The Board confirmed that a contractor’s cost accounting must be consistent with its financial accounting practice for assets and not tax treatment.

This is one of the many joys of contracting with the government; the contractor must maintain records to support its cost accounting, financial accounting, and tax accounting. This is especially true for assets, as the accounting treatment under tax is often significantly different than that allowed under financial accounting (i.e., expensing and depreciating the value of assets).

What You Need to Know

Even small businesses should establish a capitalization and depreciation policy consistent with generally accepted accounting principles (GAAP) and follow it for both financial and cost accounting purposes.

Is a Contractor Limited to the Same Per Diem Rates that are Given to Government Employees?

Yes, they are. FAR 31.205-46(a)(2) provides that “costs incurred for lodging, meals, and incidental expenses…shall be considered to be reasonable and allowable only to the extent that they do not exceed on a daily basis the maximum per diem rates in effect at the time of travel as set forth in the”

• Federal Travel Regulations, prescribed by the General Services Administration, for travel in the contiguous United States;
• Joint Travel Regulation, Volume 2, DoD Civilian Personnel, Appendix A, prescribed by the Department of Defense, for travel in Alaska, Hawaii, and outlying areas of the United States; and
• Standardized Regulations (Government Civilians, Foreign Areas), Section 925, “Maximum Travel Per Diem Allowances for Foreign Areas,” prescribed by the Department of State, for travel in areas not covered above.

The fact that, in most cases, contractors are not provided with access to government rates by hotels has no impact whatsoever. The Board confirmed this requirement.

This is another one of the many joys of contracting with the government; the contractor must expend a significant amount of time and resources to manage the FAR allowability requirements, even if the costs claimed are relatively immaterial. This is one of DCAA’s favorite areas to audit. An auditor can always find some questioned cost related to travel.

What You Need to Know

Even small businesses should establish a travel policy consistent with FAR 31.205-46 and understand that every trip for a government contract is going to eat into your bottom line.

Are Bonuses an Allowable Cost?

Maybe, it is going to take work on your part. FAR 31.205-6(f), Bonuses and incentive compensation, states:

(1) Bonuses and incentive compensation are allowable, provided the

(i) Awards are paid or accrued under an agreement entered into in good faith between the contractor and the employees before the services are rendered or pursuant to an established plan or policy followed by the contractor so consistently as to imply, in effect, an agreement to make such payment; and

(ii) Basis for the award is supported.

(Emphasis added)

The Board starts by stating “bonus plan lack[ing] measurable metrics and…essentially subject to the unfettered discretion of those who would benefit from it,” are unallowable. The Board goes on to state:

[A] bonus award must be made pursuant to an agreement or well-established plan or policy, and there must be support for the basis of the award. An underlying feature of the jurisprudence applying this FAR provision is an intent to avoid a company’s “in-group” using the bonus pool as a means of distributing company profits amongst themselves. In Nolan Brothers, Inc. v. United States, 43 7 F .2d 1371 (Ct. Cl. 1971), the Court of Claims noted that payment of bonuses from a family-owned corporation to officers who were members of the family “justified close scrutiny” to ensure that the bonuses were not a disguised “distribution of the corporation’s earnings.” And in Northlich, Stolley, Inc. v. United States, 368 F.2d 272 (Ct. Cl. 1966), a tax case cited by the court in Nolan Brothers, the Court of Claims expressed similar concerns when the officers to whom the compensation was paid were “in complete control of the corporation’s affairs.”

[The Board’s] prior cases have similarly expressed discomfort with, and rejected, bonus plans that give too much leeway in making bonus awards to those who would benefit from them. In SplashNote Systems, Inc., ASBCA No. 57403,…[The Board] disallowed the use of a bonus plan because its “lack of specificity, constraints, or parameters contribute[d] to the conclusion that [the] bonus was a distribution of profit.” [The Board] noted in Boeing Aerospace Operations, Inc., ASBCA Nos. 46274, 46275,…that we “would not endorse ‘a policy which would permit payments to be made or not made in the unlimited discretion of management or...the kind of policy that was not consistently or clearly defined.’” (quoting General Electric Co., ASBCA No. 28753, 89-1 BCA·21…). This is consistent with the notion that, in order to be able to judge whether there is a supported basis for a bonus award, see FAR 31.205-6(f)(1)(ii), there must be some clearly defined criteria for making the award in the first instance.

Note: The Boeing and GE cases are prior to 2000, so no public link is available.

The Board found that “because…[the] bonus policy lacked specificity and constraints…and effectively provided ‘unlimited discretion’ to management…[the Board] hold[s] that it is not a compensable cost” (i.e., unallowable).

Over the past few years, thanks mostly to the use of Independent Public Accountants (IPAs) by DCAA for the audits of small businesses, we have not seen bonuses questioned, provided the contractor had been giving bonuses as part of its compensation package for several years. The amount was reasonable as a percentage of the total amount of compensation, and the total amount of compensation was reasonable based on FAR 31.205-6(b). However, in 2025, we have seen a significant increase in questioned bonus costs due to the lack of an adequate plan or policy, as well as a documented basis for the awarded amount.

What You Need to Know

Even small businesses should establish a bonus policy consistent with FAR 31.205-6(f). The policy needs to include:

• Specific criteria, parameters, and restrictions;
• Clarify that management must stay within the criteria, parameters, and restrictions and cannot unilaterally not payout bonuses; and
• Require that each bonus and its amount be supported by a basis that is tied to the criteria, parameters, and restrictions.

A memorandum from the president and owner of the contractor is not going to be adequate support.

As a side note, documentation showing that the bonuses are “holiday bonuses” will be questioned as gifts to employees, which are unallowable under FAR 31.205-13(b).

Is Consent to Subcontract Required to Get Subcontract Costs Reimbursed?

Yes, you need to comply with FAR 52.244-2. FAR 52.244-2(c), states:

If the Contractor does not have an approved purchasing system, consent to subcontract is required for any subcontract that- (Emphasis added)

(1) Is of the cost-reimbursement, time-and-materials, or labor-hour type; or

(2) Is fixed-price and exceeds-

(i) For a contract awarded by the Department of Defense, the Coast Guard, or the National Aeronautics and Space Administration, the greater of the simplified acquisition threshold, as defined in FAR 2.101 on the date of subcontract award, or 5 percent of the total estimated cost of the contract; or

(ii) For a contract awarded by a civilian agency other than the Coast Guard and the National Aeronautics and Space Administration, either the simplified acquisition threshold, as defined in FAR 2.101 on the date of subcontract award, or 5 percent of the total estimated cost of the contract.

The Board states, “we entertain little doubt that the subcontracts were performed pursuant to the statements of work of the contracts and were thus allocable costs. The problem for [the contractor]…- a problem that it does not address - is that the support letter it received from the COTR stakes out no position on the reasonableness of the costs of the subcontractors. This omission is fatal to [the contractor’s]…attempts to provide an after-the-fact justification of these subcontracts. See FAR 52.244-2(e)(1)(vii) (requiring contractor’s provision of information for determination of price reasonableness). Thus, the government properly disallowed the…subcontract costs.”

In this case, the contractor testified “that it generally did not seek pre-approval for its actions because it had found it difficult to contact the ACO.”

The Board does not address the FAR 52.244-2(f) statement that:

Unless the consent or approval specifically provides otherwise, neither consent by the Contracting Officer to any subcontract nor approval of the Contractor’s purchasing system shall constitute a determination-

(1) Of the acceptability of any subcontract terms or conditions;

(2) Of the allowability of any cost under this contract; or

(3) To relieve the Contractor of any responsibility for performing this contract.

Regardless, the Board has found that where the contractor does not document consent to subcontract, the subcontract costs are going to be unallowable and disallowed.

We have numerous clients who, due to the non-responsiveness of many ACOs or contracting officers, have simply stopped investing the resources in attempting to gain consent to subcontract. We would not recommend this practice as it will likely put significant costs at risk.

What You Need to Know

Even small businesses should establish a consent to subcontract policy consistent with FAR 52.244-2. The policy needs to address:

• Follow-up actions for non-responses, ACOs;
• A requirement to send a final email stating that, due to the ACO’s non-response, the contractor plans to award the subcontract to limit the impact on the program and deliveries; and
• Should the program or deliveries be impacted, a request for equitable adjustment will be filed under the changes clause of the contract.

Inaction is going to cost you in the end.

Support for Cost Allowability and Audit Readiness

The Redstone Government Consulting team helps contractors navigate cost allowability by interpreting government requirements, maintaining compliant accounting systems, and applying FAR Part 31. We work with clients to address audit findings, update policies, and prepare incurred cost submissions and closeout packages. Our team also provides training and guidance across accounting, contracts, and compliance, along with support for business systems and software such as Costpoint, Unanet, and QuickBooks for GovCon. Our integrated support helps contractors strengthen internal controls, reduce the risk of questioned costs, and efficiently manage contracts through audits and closeout.