Direct and indirect costs must be segregated, and then they are divided into allowable versus unallowable costs.
FAR uses five factors to determine whether costs are allowable:
- The reasonableness of the cost.
- Whether the cost can be allocated directly to a contract or to an indirect cost pool.
- The guidelines set out by the Cost Accounting Standards (CAS) Board, if they apply. If they aren’t relevant, use routine accounting principles as identified by GAAP, and practices that fit the situation.
- The terms of the contract.
- Any limitations in FAR Subpart 31.2.
Reasonableness of the cost can be subjective. What does “reasonableness” mean? And what if we think a cost is reasonable, but the government does not?
There are some guidelines there, as well.
Ask yourself these questions:
- Would the cost be generally acknowledged as usual, normal and necessary for your business or for fulfilling the contract? An example of this would be whether the cost of your company’s web site would be determined unallowable as it could be considered advertising. However, if this is a normal, usual and necessary, this cost would be allowable
- Is the cost part of sound business practices, objective bargaining, and — a big most importantly — is it in line with Federal and state laws and rules
- Does the cost meet your obligations to the government, other customers and anyone else directly or indirectly involved?
- Does it represent any major departure from your customary business practices?