RGCI - Cost Accounting Standard (CAS) 405 – Accounting for Unallowable Costs

Comparison to FAR

Like CAS 401 and CAS 402 (see previous blog posts on these CAS Standards), CAS 405 is part of modified CAS coverage and is one of the first CAS standards a company encounters. Compliance with this standard will likely not call for any changes to the company’s cost accounting system if the company is compliant with FAR 31.201-6 (Accounting for Unallowable Costs) because the FAR clause has more requirements than CAS 405.

FAR 31.201-6 and CAS 405-20 read:

(a) Costs expressly unallowable or mutually agreed to be unallowable, including costs mutually agreed to be unallowable directly associated costs, shall be identified and excluded from any billing, claim, or proposal applicable to a Government contract.

(b) Costs which specifically become designated as unallowable as a result of a written decision furnished by a contracting officer pursuant to contract disputes procedures shall be identified if included in or used in the computation of any billing, claim, or proposal applicable to a Government contract. This identification requirement applies also to any costs incurred for the same purpose under like circumstances as the costs specifically identified as unallowable under either this paragraph or paragraph (a) of this subsection.

Note: There are minor difference in the way these clauses are written in FAR 31.201-6 and CAS 405-20, but no material difference.

CAS Specific

CAS 405 provides definitions for several key terms:

  • Directly associated cost means any cost which is generated solely as a result of the incurrence of another cost, and which would not have been incurred had the other cost not been incurred.
  • Expressly unallowable cost means a particular item or type of cost which, under the express provisions of an applicable law, regulation, or contract, is specifically named and stated to be unallowable.
  • Unallowable cost means any cost which, under the provisions of any pertinent law, regulation, or contract, cannot be included in prices, cost reimbursements, or settlements under a Government contract to which it is allocable.

There are several ways that costs can be deemed unallowable:

  • Under the provisions of FAR 31.205
  • Written decision of a contracting officer pursuant to a contract dispute
  • Be directly associated with any unallowable cost
  • Mutually agreed to be unallowable
  • Direct costs not contractually authorized – may later become allowable if authorized but must be accounted for in a manner which permits it to be readily separated from costs that are contractually authorized
  • Cost overrun - shall be identified in terms of the excess of allowable costs over the ceiling amount, rather than through specific identification of particular cost items or cost elements.

Key Point - Allocability

All unallowable costs, including directly associated unallowable costs, must be accounted for using the same cost accounting principles governing the allocability of allowable costs. If the unallowable costs would normally be part of an indirect cost (pool) allocation base, then that unallowable cost shall remain in the base. This also holds true for directly associated costs. If a directly associated cost would normally be part of an indirect cost pool to be allocated over a base which includes the associated unallowable costs, such directly associated cost shall be retained in the indirect cost pool and be allocated through the regular allocation process. This results in the directly associated costs being allocated over the base containing the unallowable cost with which it is associated.

Example of Accounting for Unallowable Costs in an Overhead Pool

The company’s disclosed practice is to charge all costs related to the purchase of manufacturing equipment to the manufacturing overhead pool, which is allocated based on direct manufacturing labor. The company’s consultant determined the manufacturing overhead pool included $150,000 of unallowable interest on the latest purchase of equipment. This $150,000 was included in the $1,200,000 proposed manufacturing overhead.



Proposed Total Company

Total Unallowable Cost

Allowable Total Company

Direct Labor





Mfg. overhead @120%





Total cost input (a+b)





G&A expense


$   100,000



G&A (d/c)


4.545 %



Total Cost





*rounding difference

Although the company identified $150,000 of expressly unallowable cost, the true impact of the unallowable costs on the proposed contract was more due to directly associated cost. If the company simply reduced the proposed total price by $150,000 to $2,150,000, then it would be in noncompliance with CAS 405 because it failed to identify the directly associated $6,825 of unallowable G&A expense as required by CAS 405.

The real emphasis of CAS 405. The company must exclude all unallowable costs, including directly associated costs, from all proposals and billings. Be sure to contact us if you have any questions about what are directly associated costs. Watch for our next blog on another CAS standard that comes into effect with modified CAS coverage, 406 - Cost Accounting Period.

CAS Applicability Information and Resources DOWNLOAD NOW

Written by Cheryl Anderson

Cheryl Anderson Cheryl Anderson has been a Director with Redstone Government Consulting, Inc., since 2013. She provides Government Contract Consulting services to our government contractors primarily related to equitable adjustment claims, terminations, CAS Disclosure Statements, and DCAA audit expectations. Prior to joining Redstone Government Consulting, Cheryl served in a number of capacities with DCAA for more than 35 years. Upon her retirement, she was a regional audit manager with DCAA. Professional Experience Cheryl began her DCAA career in 1978 as an auditor-trainee with the Ingalls Resident Office in Pascagoula, Mississippi. After instructing at the Defense Contract Audit Institute for four years, Cheryl returned to the Eastern Region in 1990, holding various audit positions before ultimately becoming a Regional Audit Manager in August, 2005. Cheryl had overall management responsibility for audits performed by approximately 200 employees. During her tenure with DCAA, Cheryl was involved in conducting or managing a variety of compliance audits; to include cost proposals, incurred cost submissions, systems, Cost Accounting Standards, claims, defective pricing, financial capability and agreed-upon procedures. Cheryl directly supported the government litigation team on a contract dispute and has prepared and presented various lectures and seminars to DCAA staff. In addition, Cheryl served as an instructor for the Government Audit Training Institute for more than 20 years. Cheryl currently specializes in preparing clients for more complex DCAA audits, providing advice on FAR cost principles and contracts regulatory provisions, and in assisting clients in anticipating and addressing audit. Education Cheryl earned a Bachelor of Science degree in Accounting from Auburn University at Montgomery and a Master of Business Administration degree from Wichita State University. Cheryl also has completed courses at OPM’s management and executive development centers, and at the Federal Executive Institute. Certifications State of Georgia Certified Public Accountant State of Alabama Certified Public Accountant

About Redstone GCI

Redstone GCI is a consulting firm focused on fulfilling the needs of government contractors in all areas of compliance. With a singular mission to help contractors through the multiple layers of “red tape,” we allow contractors to focus on what they do best – support their mission with the U.S. Government. We are home to a group of consultants made up of GovCon industry professionals, CPAs, attorneys, and retired government audit and acquisition professionals.

Our focus and knowledge of audit and compliance functions administered by DCAA and DCMA will always be at the heart of what we do. However, for the past decade, we’ve strategically grown to support other areas of the government contractor back-office with that same level of focus and expertise. We’ve added expertise in contracts management, subcontract administration, proposal pricing, various software systems, HR and employment law, property administration, manufacturing, data analytics/reporting, Grant specialists, M&A, and many other areas. When we see a trend in the needs of contractors, we act to ensure we can provide the best expertise in the market to fulfill those needs.

One thing our clients can be certain of is that with the Redstone GCI Team in your corner, there is no problem too big and no issue too technical for our team to tackle.

Topics: Contracts & Subcontracts Administration, DCAA Audit Support, Government Regulations, Cost Accounting Standards (CAS), Federal Acquisition Regulation (FAR)