What is Really Important to Know About FAR Part 31?

Government regulations can be complex and perhaps even confusing. For those of you experienced in Government contracts and even contract audits, you have heard of the Federal Acquisition Regulation or FAR and, FAR Part 31, Contract Cost Principles and Procedures. The scope of this part describes the applicability of the cost principles and procedures in pricing and accounting for costs on contracts, subcontracts, and modifications whenever cost analysis is needed. There is a lot there, but what’s really important? Well, I will not try to duplicate what can be at least a day course within this blog, but I will highlight three areas that are really important.

Direct and Indirect Costs

First, it starts with understanding your direct and indirect costs and consistently applying them on your contracts or subcontracts. FAR 31.201-1, Composition of total costs, defines total costs as the “sum of the direct and indirect costs allocable to the contract, incurred or to be incurred.” So, it is important is properly define these terms as they apply to your company. Starting with direct costs, what exactly are those? FAR Part 2 defines direct costs as, “costs identified specifically with a contract are direct costs of that contract.” For example, an engineer working on the wiring of a developmental fighter aircraft is direct to the fighter aircraft contract since it is work specifically for that contract. An Engineer should not be charged direct on one contract and indirect on another. Next, indirect costs are defined in FAR Part 2 as, “cost not directly identified with a single final cost objective (for example a contract).” Think of indirect costs as the opposite of direct costs where it benefits all or more than one contract. For example, think of heat, light, power, and property taxes of an office or facility where that direct cost engineer is working. It can even be people and services provided to the company such as accounting, HR, purchasing departments to name a few. These benefit multiple contracts.

Select Costs

Secondly, FAR Part 31.205, Selected costs, may be what some with experience in Government contracting know and remember best. The select costs represent costs areas that have been determined to be unallowable or require specific conditions in order to be determined allowable costs. Unallowable costs are costs where the government will not reimburse you for your costs incurred. This FAR part is a lengthy section of FAR Part 31, and it is one that you and your company employees should be aware of and trained on, so you do not propose, bill, or claim unallowable costs on your Government contracts. The shortest of these is FAR 31.205-51, Costs of alcoholic beverages, states, costs of alcoholic beverages are unallowable. I guess the Government does not want to pay for contractor employees to have too good a time working on its contracts?

Additionally, FAR Part 31.201-6, Accounting for unallowable costs, states, “When an unallowable cost is incurred, its directly associated costs are also unallowable.” For example, if your CEO attends an advertising trade show where the conference meeting focus is promoting the sale of your company’s products or services and thus, is unallowable in accordance with FAR 31.205-1, Public relations and advertising costs, not only would the cost of the trade show be unallowable but also the labor costs of your CEO, as well as their travel and per diem costs associated with attending the advertising conference would be considered unallowable.

Allowability of Costs

Thirdly, when Government contract auditors review your proposals or incurred costs submissions, they review your costs for allowability of costs (FAR 31.205, mentioned above), but also allocability and reasonableness of costs. Allocability is defined in FAR Part 31.201-4 as costs that are “assignable or chargeable to one or more cost objectives on the basis of relative benefits received…incurred specifically for the contract…benefits the contract…is necessary for the overall operation of the business.” In other words, it is needed for the contract. Reasonableness is defined in FAR 31.201-3, “costs…[that] does not exceed that which would be incurred by a prudent person in the conduct of competitive business.” This is more elusive, but this is why a Government contract auditor will evaluate your labor costs and what you pay your employees. The auditors want to evaluate the steps that you took in determining reasonableness of costs, for example, in using labor surveys to determine what you pay your employees. Further, the FAR citation states, “the burden of proof shall be upon the contractor to establish that such cost is reasonable.” Therefore, it is your responsibility to prove your labor, as well as all costs incurred by your company, are in fact reasonable.

Although Government regulations such as the FAR can be daunting, understanding what is important and training your employees on the identification and consistent treatment of costs as direct, indirect, and excluding unallowable costs will assist you in being successful in wading through Government contracts and associated regulations. Redstone Government Consulting, Inc, with its experienced compliance and accounting consultants can assist contractors by providing training. Make us part of your team!