FAR 31 Explained

🚫 FAR Part 31 Explained: Your FAR Part 31 Guide from Bay Business Group

Congratulations on winning a government contract! It’s a huge step.

To protect taxpayer dollars, the Federal Acquisition Regulation (FAR) includes a critical section: FAR Part 31—Contract Cost Principles and Procedures. This part is the ultimate rulebook for determining which costs are allowable (reimbursable) and which are unallowable (must be absorbed by your company).

For small to mid-size Government Contractors (GovCons), a lack of attention here is one of the fastest ways to trigger a DCAA (Defense Contract Audit Agency) audit, delay payments, and face penalties.

At Bay Business Group, we specialize in making this complexity manageable. We know that as you grow, you need an accounting system that’s not just accurate, but DCAA-compliant. Our expertise lies in safeguarding your profitability by ensuring every dollar you claim is allowable.

This practical guide distills the core of FAR Part 31, focusing on the most common and costly pitfalls for growing contractors: Unallowable Costs. Understanding these concepts isn’t just about compliance—it’s about protecting your cash flow and securing your future growth.

The Four-Part Test: Your Guide to Allowability

Before we get to the “unallowable” list, every cost must pass four basic tests to be considered for reimbursement. If a cost fails any one of these, it is unallowable:

• Reasonableness: Is the cost ordinary and necessary for running your business or performing the contract? Would a prudent person in a competitive business incur this cost? (Example: A $750,000 executive salary might be deemed unreasonable for a $5M company.)
• Allocability: Can the cost be assigned or charged to one or more cost objectives (like your specific contracts) in accordance with the relative benefits received?
  • Direct: Incurred specifically for one contract.
  • Indirect: Benefits multiple contracts or the overall business and can be distributed fairly.
• Applicable Standards: Does the cost comply with Generally Accepted Accounting Principles (GAAP) and, if your contracts require it, the Cost Accounting Standards (CAS)?
• FAR Limitations (The Unallowable List): Does the cost violate any specific limitations set forth in FAR Subpart 31.205? This is where you find the expressly unallowable costs.

🛑 The “Big Six” Unallowable Costs You Cannot Charge the Government

FAR Part 31.205 is a long list of specific costs, but many problems for GovCons stem from a few common, high-risk areas. Understanding these “Big Six” will help you set up controls to protect your indirect rates.

FAR 31.205-1

• Advertising and Public Relations
  • Promotional material, most trade shows, giveaways, imprinted clothing, and most non-contract-required marketing.

FAR 31.205-13

• Employee Morale, Health, Welfare
  • Employee gifts, most company parties/social activities, and recreational costs (e.g., alcohol, tickets to a sporting event).

FAR 31.205-20

• Interest and Financial Costs
  • Interest expense on loans, capital leases, or bank lines of credit. (Note: Cost of Money is a separate, complex concept.)

FAR 31.205-15

• Fines and Penalties
  • Penalties from late taxes, traffic tickets, legal costs for violating government laws/regulations.

FAR 31.205-22

• Lobbying and Political Activity
  • Costs related to influencing legislation or elections (including associated labor time and travel).

FAR 31.205-46

• Travel Costs (Excessive)
  • Costs that exceed the Federal Travel Regulation (FTR) limits (e.g., first-class airfare, luxury hotels).

Crucial Concept: Directly Associated Costs (DACs)

This is where GovCons often slip up. When an unallowable cost is incurred, any cost incurred solely as a result of the unallowable cost is also unallowable.

The most common DAC is labor: If an employee (like your CEO or Business Development lead) spends 10 hours a month on lobbying (an unallowable activity), those 10 hours of salary, benefits, and associated payroll taxes are also unallowable and must be segregated.

🛠️ The Small-to-Midsize GovCon Challenge

For a large corporation, compliance is handled by entire departments. For a growing GovCon, the challenge is that your accounting staff (often just one or two people) must be GAAP experts, payroll administrators, and FAR Part 31/DCAA compliance specialists.

This intense requirement for specialized, high-stakes compliance is often overwhelming and leads to costly errors like:

• Distorted Indirect Rates: Failing to remove unallowable costs from your Overhead and G&A cost pools inflates your indirect rates, making you over-bill the government. The result? DCAA auditors force you to pay the money back, potentially years after the contract has closed.
• Timekeeping Errors: The failure to track all employee time—including time spent on unallowable activities (like general sales or marketing)—makes it impossible to segregate unallowable labor, leading to automatic disallowance during an audit.
• Penalties: If the DCAA determines you knowingly charged expressly unallowable costs, you may be subject to a double penalty under FAR 42.709, meaning you pay back the disallowed amount plus a penalty equal to the disallowed amount.

🤝 How Bay Business Group Solves the FAR Part 31 Problem

The compliance burden of FAR Part 31 is the single best reason for small and mid-size GovCons to partner with a specialized outsourced accounting firm. Bay Business Group can provide the essential infrastructure and expertise without the huge internal salary cost.

We act as your Chief Compliance Officer and DCAA Liaison, ensuring you are audit-ready from day one.

Our Core FAR Part 31 Services Include:

• General Ledger Segregation: We design a DCAA-compliant Chart of Accounts with specific, dedicated cost codes for all high-risk, unallowable costs. This ensures unallowable expenses are tagged at the point of transaction and never accidentally enter your indirect rate calculations.
• System and Policy Implementation: We set up and monitor your accounting system to enforce:
  • Total Time Reporting: Mandating that all employees (including executives) record 100% of their working hours, ensuring unallowable labor is properly quantified and removed.
  • Consistent Cost Treatment: Ensuring a cost is always categorized the same way (e.g., advertising is always G&A and always unallowable).
• Incurred Cost Submission (ICS) Support: The annual ICS is the most critical compliance document for GovCons with cost-plus contracts. We manage the complex process of finalizing all indirect rates, confirming all unallowable costs (and their directly associated costs) have been removed, and preparing the submission to minimize audit risk.
• Audit Readiness and Response: If a DCAA audit is inevitable, having an expert accounting partner means we handle the auditor’s requests, provide the necessary supporting documentation, and explain your accounting treatment—taking the stress and risk off of your management team.

You focus on executing your government contracts; we focus on ensuring you get paid everything you are due, legally and compliantly.

Are you ready to stop worrying about audit risk and start confidently managing your indirect rates?

Reach out to us today for a consultation on making your accounting system FAR Part 31 compliant.