The Federal Acquisition Regulations (FAR) describes in detail expenses that the government will not reimburse contractors for in the FAR part 31. The FAR describes expenses that are not allowable and also describes a system to separate these costs to prevent charging to the government. This system should not only isolate these costs but insure that they are prevented from being billed either directly to the government or in indirect billings. Any audit will evaluate to make sure that these costs are properly segregated and kept out of the billing. I did a blog about a year ago about unallowable expenses that summarized the types of expenses covered by the FAR.
So what are some of the pitfalls and problems that contractors encounter with improper accounting of unallowable costs? I typically think that there can be 3 main mistakes related to unallowable costs:
- The unallowable cost was included as an allowable direct cost
- The unallowable cost was included as an allowable indirect cost
- An allowable expense is classified as an unallowable expense
Let's look at the first first one. There are many examples of this but I will use a common situation that may be used for illustration here. Let's suppose that per a contract the contractor included travel expenses for an employee to visit a construction site. Let's further assume that air travel is the most reasonable way to reach the site (Reasonableness and Allocability are two of the main factors to be considered when determining allowability of a cost per FAR 31.201-2). The employee, however, books his flight in first class and flies first class to and from the site. The cost for the first class airfare is included in the direct costs to the contract when submitted to the government. The government disallows the expense under FAR 31.205-46:
Airfare costs in excess of the lowest priced airfare available to the contractor during normal business hours are unallowable except when such accommodations require circuitous routing, require travel during unreasonable hours, excessively prolong travel, result in increased cost that would offset transportation savings, are not reasonably adequate for the physical or medical needs of the traveler, or are not reasonably available to meet mission requirements. However, in order for airfare costs in excess of the above standard airfare to be allowable, the applicable condition(s) set forth above must be documented and justified.
There are a couple of penalties that may apply. The overcharge of the direct cost as well as the mis-allocation of the indirect cost base. The difference between the first class airfare and the "lowest priced airfare" is an overcharge and subject to refund. The indirect rates were also mis-calculated. For instance, the indirect expenses should have been allocated over all costs, including the unallowable costs. Since these costs were not included in the indirect base, the government paid a higher indirect cost allotment than was required and again this would be subject to refund. In addition, the interest on the difference between the correct billings and the improperly calculated billings would be due.
The second case is a little less complex. In this case, the indirect cost pool is larger than it should be by including the unallowable cost. The government would want to recover the difference between the properly calculated rate (by removing the unallowable from the pool) and any interest on funds. This could result in a number of previous billings to the government which would require a re-adjustment as well as calculating interest on the differences noted.
In the third case above, the allowable expense was not used in the calculation of the billings to the government and therefore the contractor "lost" that reimbursement. This could result in a lower revenue and/or a lower fee on the contract as not all costs (either direct or indirect, depending on the cost) were covered that might have otherwise been reimbursed by the government.
As you can see, any of the three scenarios will result in a penalty to the contractor. Not knowing exactly whether or not an expense is unallowable is costly. Having an expert help with this is highly advisable. It is even better if the expert has extensive experience with DCAA auditors so that they have a good feel for the interpretation of these regulations as well. This is exactly what ReliAscent offers to our clients. Call me if you would like to discuss.