How to Identify, Track, and Exclude Unallowable Costs in QuickBooks Online

Government contractors deal with a unique set of rules when it comes to expenses. FAR Part 31 lays out the specific guidelines on what you can and cannot charge to the government. If unallowable costs slip through, you could face compliance problems or see expenses disallowed in an audit.

However, QuickBooks Online, when set up the right way, can help you stay on top of these requirements. Let’s break down how to identify, track, and exclude unallowable costs in QuickBooks Online.

Understanding Unallowable Costs

Simply put, unallowable costs are business expenses that the government won’t reimburse under a contract. FAR Part 31 spells them out clearly. Some are always unallowable (like alcohol), while others depend on the circumstances. A few common examples include:

• Alcoholic beverages - FAR 31.205-51
• Entertainment expenses (concerts, sporting events, golf outings, etc.) – FAR 31.205-14
• Lobbying and political contributions - FAR 31.205-22
• Fines and penalties – FAR 31.205-15
• Certain advertising and public relations costs – FAR 31.205-1
• Donations and charitable contributions – FAR 31.205-8
• Travel costs beyond per diem limits – FAR 31.205-46

Review FAR Part 31 and know which costs fall into this category. A little up-front awareness saves a lot of hassle later. Below is an example of the type of excerpt you would find in FAR Part 31.

Setting Up Your Chart of Accounts

The first step in QuickBooks is to build a chart of accounts that makes it clear which costs are unallowable.

• Cost Pool: Create a separate cost pool specifically for Unallowable accounts.
• Subaccounts: Add each of your unallowable expense accounts as sub accounts to your cost pool. These are the accounts you will code transactions to. This list does not have to be all inclusive since it can always be modified later (add or remove accounts as needed).
• Labels: Use clear naming conventions to avoid confusion for staff coding expenses.
• Restructure: If you already have a few unallowable accounts but they are not segregated appropriately in your chart of accounts, you will want to adjust your chart of accounts to get them moved to the correct cost pool, etc.

Properly organizing these accounts keeps unallowable costs out of indirect rate calculations, gives employees clearer guidance when coding expenses, and makes it easier to demonstrate compliance during audits and prepare accurate incurred cost submissions. 

Coding & Monitoring Unallowable Costs

Once your chart of accounts is structured, the real work begins with consistent oversight. Identifying unallowable costs is not a “set it and forget it” process. It requires ongoing review and documentation to withstand audits and keep your indirect rate calculations clean.

• Internal Consistency: Train staff who code transactions, so they know the difference between allowable and unallowable. Misclassification often happens at the entry point, not during the review.
• Transaction-Level Support: Attach receipts and explanations directly in QuickBooks Online. It can save hours down the road if the transaction ever comes back up.
• Monthly Close Check: During each month-end close, review all unallowable accounts. Look for expenses that may have been misclassified and reclassify if necessary.

Consistent monitoring ensures that unallowable costs are identified and segregated before they impact indirect rates or trigger audit findings. By combining clear staff training, proper documentation, and regular month-end reviews, contractors can maintain stronger internal controls. QuickBooks Online supports these efforts by providing a system to track, document, and report on unallowable costs. However, regular oversight remains essential.

Building a Strong Compliance Framework

QuickBooks Online doesn’t replace strong accounting processes, but with the right setup and consistent review, it can support your compliance framework and reduce risk. Managing unallowable costs is an ongoing responsibility that requires both awareness of FAR Part 31 and the right accounting structure in QuickBooks Online. A well-designed chart of accounts, regular transaction monitoring, and proper documentation create a system that not only meets government requirements but also strengthens audit readiness.

Government contractors must also ensure their processes, policies, and staff training are aligned with compliance standards. Redstone GCI works with contractors to set up compliant QuickBooks accounting systems, provide outsourced accounting services, prepare incurred cost submissions, evaluate business systems, and deliver training and guidance across accounting, contracts, and compliance. Our team of experts helps government contractors maintain accuracy, reduce questioned costs, and keep their government contracts on track.