Does the Government find most of the cost incurred by a contractor to be reasonable? I must say it does appear that way. Defense Contract Audit Agency (DCAA) FY 2023 Report to Congress shows that of the $186B incurred cost audited, there was only $1.1B in audit exceptions (.6%). So, the world is good, and we can move on. If that were only the case. Remember that while this percentage is low, this is money you have already spent that the Government will not pay you for, which directly impacts your bottom line.
What Does FAR 31.201-3 Determining Reasonableness Require?
The Federal Acquisition Regulations (FAR) 31.201-3 provides that “A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business. The reasonableness of specific costs must be examined with particular care in connection with firms or their separate divisions that may not be subject to effective competitive restraints. No presumption of reasonableness shall be attached to the incurrence of costs by a contractor. If an initial review of the facts results in a challenge of a specific cost by the contracting officer or the contracting officer’s representative, the burden of proof shall be upon the contractor to establish that such cost is reasonable.”
To put this into layman’s terms or, at least, the way most auditors think about it, “Would you have incurred this same cost had you been in a commercial business with only fixed price contracts, none of which were with the Government?” When I worked for DCAA, many auditors believed that small business owners are not concerned about the costs they incur, provided the contract has funding to cover the cost. This is simply not the case; most small business owners are focused on supporting and completing the mission of the Government program they are a part of. The last little kicker to this is that should the Government challenge the reasonableness of your cost, it is up to you to provide documentation (yes, something in writing) as to why the cost is reasonable.
If you take nothing else away from reading this article, contemporaneous documentation developed when the cost was incurred carries 10 times the weight of any good story you make up when the Government challenges you.
The cost principle goes on to provide that “What is reasonable depends upon a variety of considerations and circumstances, including:
- Whether it is the type of cost generally recognized as ordinary and necessary for the conduct of the contractor’s business or the contract performance;
- Generally accepted sound business practices, arm’s-length bargaining, and Federal and State laws and regulations;
- The contractor’s responsibilities to the Government, other customers, the owners of the business, employees, and the public at large; and
- Any significant deviations from the contractor’s established practices.”
The Government is giving you a list of areas you should address in your contemporaneous documentation should a cost be incurred that is likely to be challenged.
What Should a Contractor Do?
Develop a practice implemented within your accounting policies to:
- Have all significant transactions over a set dollar value or for an abnormal business need reviewed and approved by management;
- Any management-approved transaction should have documentation of reasonableness based on elements in FAR 31.201-3; and
- Provide written notification to the Government (your Administrative Contracting Officer, ACO or Procurement Contracting Officer, PCO with the largest contract) of a significant transaction where reasonableness may be questioned.
Key Takeaways
- If an auditor cannot find a specific FAR 31.205, Selected costs, reason to question a cost, they can always use FAR 31.201-3, Determining reasonableness, and place the burden to support the cost on you.
- Contemporaneous documentation is much more likely to gain the support of the contracting officer than any story you tell after the cost is challenged.
- Your accounting policies are only as good as you make them, so have a third party look at your practice compared to your policies before the Government does.
Navigating the complexities of FAR 31.201-3 and ensuring your costs meet the Government’s reasonableness standard can be challenging. At Redstone GCI, our team of experienced consultants, many with prior DCAA and industry backgrounds, understand what auditors look for and how to protect your bottom line. We assist government contractors with developing and strengthening accounting policies, reviewing cost documentation practices, and preparing for audits. Whether you need help implementing internal controls, training your team, or responding to a cost challenge, Redstone GCI is here to support you every step of the way. Reach out today to see how we can help safeguard your contract costs.
John is a Director with Redstone Government Consulting, Inc. providing government contract consulting services to our clients primarily related to the DFARS business systems, CAS Disclosure Statements, and DCAA/DCMA compliance preparation, advisory, and defense. Prior to joining Redstone Government Consulting, John served in a number of capacities with DCAA/DCMA for more than 30 years. Upon his retirement, he was based in Texas as an SES-level Corporate Audit Director for DCAA, managing a staff of 300 auditors at one of the largest DOD programs. Professional Experience John began his career in the late 80s working in the Clearwater, FL audit office and over the next three decades he progressed through a number of positions within both DCAA and DCMA with career highlights as DCAA Program Manager at Ft. Belvoir, Chief of Technical Programs Division, Deputy Assistant Director-Policy, Director of the DCMA Cost and Pricing Center, the SES-level Lockheed Martin Corporate Audit Director, and Director of Integrity and Quality Assurance. John’s three decades of experience in performing and leading DCAA auditors and DCMA reviewers provides a wealth of expertise to our clients. John’s role, not only in the performance of audits, but also in the development of audit policy affords him unique insights into the defense of audit findings and the linkage of audit program steps to the underlying regulatory framework. He is an expert in FAR, DFARS, and other agency acquisition regulation, as well as a subject matter expert in the Cost Accounting Standards having reviewed and provided audit feedback on many of the largest and most complex cost accounting practices during his tenure with the DCAA. John’s tenure with DCAA and DCMA came at a critical time during each agency’s history where a number of changes were occurring such as the response to the ICS backlog, development of audit approaches to the DFARS Business Systems and implementation of new audit initiatives as a result of Congressional oversight through the NDAA process. John’s leadership at the DCMA Cost & Pricing center saw oversight of all major DOD pricing actions, leadership of should cost review teams, the Commercial Pricing group and many other areas of strategic value to our clients. His involvement in these and other Agency initiatives is of great value to our clients due to his in depth understanding of DCAA and DCMA’s internal policy directives. Education John holds a Master of Business Administration and a B.A. in Accounting from the University of South Florida. Certifications Certified Information Systems Auditor State of Alabama Certified Public Accountant