Unallowable Costs — FAR 31.205 Selected Costs and the Penalties That Follow
Also known as: Selected costs, expressly unallowable costs, FAR 31.205 unallowables
What you do here: Identify, segregate, and exclude expressly unallowable costs — before they reach a voucher or a rate
At a Glance
- Who it applies to
- Every contractor billing or pricing from cost; the penalty provision reaches contracts over the FAR 42.709 threshold other than fixed-price contracts without cost incentives
- What it obligates
- Identify unallowable costs when incurred, exclude them from billings, claims, and indirect rate pools, and account for them separately
- Governing authority
- FAR 31.205 (selected costs), FAR 31.201-6 (accounting for unallowable costs), FAR 42.709 and FAR 52.242-3 (penalties)
- Directly associated costs
- A cost generated solely as a result of incurring an unallowable cost is itself unallowable
- The stakes
- A penalty equal to the disallowed cost — doubled if the cost had already been determined unallowable before you claimed it
What It Is
FAR 31.205 is the long list. It works through dozens of specific cost categories — the FAR calls them 'selected costs' — and states for each whether it is allowable, unallowable, or allowable only within limits. Some are flatly unallowable: entertainment (31.205-14), alcoholic beverages (31.205-51), fines and penalties resulting from violations of law (31.205-15), bad debts (31.205-3), lobbying and most political activity (31.205-22), contributions and donations (31.205-8), interest on borrowings however represented (31.205-20), and the costs of organizing, reorganizing, or raising capital (31.205-27). Others are allowable with conditions and caps: compensation for personal services (31.205-6, subject to a statutory cap on the compensation of contractor employees set annually by the Office of Federal Procurement Policy), travel (31.205-46, limited to Federal Travel Regulation per diem rates), public relations and advertising (31.205-1, unallowable except for narrow purposes such as recruitment and required notices), employee morale and welfare (31.205-13), and legal and other proceedings costs (31.205-47, which can be entirely unallowable depending on the outcome of the proceeding). Two mechanics matter as much as the list. First, FAR 31.201-6 requires you to identify unallowable costs and exclude them from any billing, claim, or proposal, and it extends the rule to 'directly associated costs' — a cost generated solely as a result of incurring another cost, and which would not have been incurred had the other cost not been incurred. If a lobbying trip is unallowable, the airfare, the hotel, and the salary of the employee for the hours spent lobbying are unallowable too. Second, FAR 42.709 and its clause FAR 52.242-3 put teeth in it: if a contractor includes an expressly unallowable indirect cost in a proposal for settlement of indirect costs, the contracting officer assesses a penalty equal to the disallowed cost, doubled if the cost had already been determined unallowable for that contractor before the claim was submitted.
When It Applies
- Continuously, as costs are booked — the practical compliance moment is at data entry, not at audit.
- When you compute fringe, overhead, and G&A rates, which must exclude unallowable costs from the pools.
- When you submit an incurred cost proposal for settlement of final indirect rates, where the FAR 42.709 penalty attaches.
- When you price a proposal, a change order, an REA, or a claim from cost data.
- When you charge travel, meals, conferences, marketing, legal fees, or executive compensation — the categories that generate most findings.
Key Features
| Feature | What It Means |
|---|---|
| A category-by-category list | FAR 31.205 addresses dozens of specific cost types, each with its own rule — flatly unallowable, allowable, or allowable within stated limits. |
| 'Expressly unallowable' is a legal term | A cost named and stated to be unallowable by the FAR (or by contract terms) is 'expressly unallowable' — that is the category the FAR 42.709 penalty attaches to. |
| Directly associated costs travel with it | FAR 31.201-6 makes the travel, labor, and other costs incurred solely to carry out an unallowable activity unallowable as well. |
| Segregation is required, not optional | FAR 31.201-6 requires unallowable costs to be identified and excluded — an adequate accounting system does this with dedicated ledger accounts. |
| Penalties can double | FAR 42.709: a penalty equal to the disallowed cost, and twice that amount if the cost had previously been determined unallowable for that contractor. |
| Caps and partial allowability abound | Travel is limited to FTR per diem, compensation to a statutory cap, advertising to narrow purposes — 'partly allowable' is as common as 'unallowable'. |
The SDVOSB Angle
The unallowable-cost categories that trip up SDVOSBs are rarely the exotic ones. They are business development and marketing costs miscoded as allowable overhead, conference and trade-show spending that mixes allowable technical attendance with unallowable entertainment, travel booked above the Federal Travel Regulation per diem, and the legal fees of a status protest or a size protest defense. That last one deserves attention: FAR 31.205-47 makes the costs of certain proceedings unallowable depending on the nature and outcome of the proceeding, so a firm defending its SDVOSB eligibility should not assume the legal bill is a billable overhead item. There is also a structural point small firms miss. Because an SDVOSB typically has a small indirect base, a modest amount of unallowable cost left in a pool moves the resulting rate by a much larger percentage than it would at a large prime — so the same $30,000 of miscoded marketing spend that would be a rounding error elsewhere can visibly inflate your G&A rate, make you look expensive in a price evaluation, and then generate a give-back at rate settlement. Segregating unallowables in the chart of accounts from day one costs almost nothing; reconstructing them three fiscal years later under audit costs a great deal.
How to Comply
- Create dedicated unallowable-cost accounts (entertainment, alcohol, lobbying, contributions, interest, bad debts, fines, and a general unallowable account) and code costs there when booked.
- Train whoever codes expenses on the common FAR 31.205 categories — most unallowable costs enter the books through routine expense reports.
- Split mixed events: the allowable technical portion of a conference from the unallowable entertainment and alcohol portion, with documentation.
- Cap travel reimbursement at Federal Travel Regulation per diem rates for the locality, per FAR 31.205-46.
- Charge the directly associated costs — labor hours, airfare, lodging — of an unallowable activity to the unallowable account too.
- Exclude all unallowable costs from indirect pools before computing billing and final rates, and certify the incurred cost proposal only after that scrub.
Watch Out For
- Assuming any cost not on the FAR 31.205 list is automatically allowable — it must still be reasonable, allocable, and consistent with the contract.
- Missing directly associated costs, which are where most penalty assessments actually originate.
- Booking business development and bid-and-proposal spending without distinguishing what FAR 31.205-18 allows from unallowable selling and lobbying.
- Reimbursing travel above the Federal Travel Regulation per diem and charging the excess to a contract.
- Treating legal fees from a protest, an investigation, or a dispute as ordinary overhead — FAR 31.205-47 often says otherwise.
- Waiting until the incurred cost proposal to scrub the pools; by then the same unallowable costs have already inflated the provisional rates you billed on.
Run the Numbers
Frequently Asked
What costs are unallowable under FAR 31.205?
FAR 31.205 addresses dozens of 'selected costs' individually. Costs that are flatly unallowable include entertainment (31.205-14), alcoholic beverages (31.205-51), bad debts (31.205-3), fines and penalties resulting from violations of law (31.205-15), lobbying and most political activity (31.205-22), contributions and donations (31.205-8), interest on borrowings (31.205-20), and organization or reorganization costs including raising capital (31.205-27). Many other categories are allowable only within limits — travel is capped at Federal Travel Regulation per diem rates (31.205-46), compensation is subject to a statutory cap and a reasonableness test (31.205-6), advertising is unallowable except for narrow purposes such as recruitment (31.205-1), and the costs of legal and other proceedings may be unallowable depending on the outcome (31.205-47).
What is a 'directly associated cost'?
Under FAR 31.201-6, a directly associated cost is a cost generated solely as a result of incurring another cost, and which would not have been incurred had the other cost not been incurred. When a cost is unallowable, its directly associated costs are unallowable too. The practical effect is that if an activity is unallowable — a lobbying meeting, for example — then the airfare, lodging, meals, and the labor hours of the employees who participated are also unallowable, even though travel and labor are ordinarily allowable cost categories. Missing directly associated costs is one of the most common sources of questioned costs and penalties.
What is the penalty for including unallowable costs in a claim?
Under FAR 42.709 and the clause at FAR 52.242-3, if a contractor includes in a proposal for settlement of indirect costs a cost that is expressly unallowable under a cost principle in the FAR or an executive agency supplement, the contracting officer assesses a penalty equal to the amount of the disallowed cost allocated to the contract, plus interest. If the cost had already been determined unallowable for that contractor before the proposal was submitted, the penalty is twice the amount of the disallowed cost. The penalty provision applies to contracts above the threshold stated in FAR 42.709-1, other than fixed-price contracts without cost incentives.
Can I still spend money on unallowable items?
Yes. Unallowability is a reimbursement rule, not a spending prohibition. Your company can hold a holiday party, buy a table at a charity gala, retain a lobbyist, or take out a loan — those are lawful business expenses. What you cannot do is bill them to a federal contract, include them in a cost-based price, or leave them in an indirect cost pool whose rate you charge the government. Those costs have to be funded out of profit and commercial revenue, which is exactly why unallowable costs belong in your profit target when you build a price rather than in your rates.
Primary Sources
- FAR 31.205 — Selected costs
- FAR 31.201-6 — Accounting for unallowable costs
- FAR 42.709 — Penalties for unallowable costs
- FAR 52.242-3 — Penalties for Unallowable Costs (clause)
- FAR 31.205-46 — Travel costs
- FAR 31.205-6 — Compensation for personal services
Plain-English reference, not legal, accounting, or tax advice. Cost allowability and accounting determinations are fact-specific, and the FAR, the Cost Accounting Standards, and the statutory dollar thresholds quoted here are amended and escalated for inflation over time. Always read the current FAR text and the cost and payment clauses in your specific contract, confirm the applicable thresholds and your accounting treatment with the contracting officer or cognizant administrative contracting officer, and consult a qualified government-contract accountant or counsel before relying on a cost position, signing a certificate, or submitting a claim.
Change log (1)
- LaunchedPublished the federal cost principles, indirect rates & government accounting requirements reference covering how the government decides what an SDVOSB may charge it — the five allowability tests of FAR 31.201-2, reasonableness and allocability (FAR 31.201-3 / 31.201-4), the expressly unallowable costs of FAR 31.205 with directly associated costs (FAR 31.201-6) and the FAR 42.709 / 52.242-3 penalty, the direct-vs-indirect consistency rule (FAR 31.202 / 31.203), the fringe/overhead/G&A pool-and-base structure behind a wrap rate, provisional billing rates (FAR 42.704), the incurred cost submission and final indirect rate settlement (FAR 52.216-7(d) / 42.705 / 42.708 quick closeout), the adequate accounting system tested on the SF 1408 (FAR 16.301-3 / 9.106), timekeeping and labor charging with floor checks and total time accounting, DCAA audits versus DCMA administrative contracting officer determinations, certified cost or pricing data and defective pricing (FAR 15.403-1 / 15.403-4 / 15.406-2 / 52.215-10), and the Cost Accounting Standards with the small-business exemption at 48 CFR 9903.201-1 — each with an at-a-glance quick-facts card, a when-it-applies list, a key-features table, an SDVOSB-specific angle, a how-to-comply checklist, watch-outs, FAQPage, Article, Dataset, and BreadcrumbList structured data, primary-source FAR / U.S.C. / CFR citations, and cross-links into the glossary, contract types, payment methods, thresholds, clauses, forms (SF 1408), regulation explainers, contracting roles, how-to guides, FAQ, and the price-to-win, size-standard, win-probability, and limitations-on-subcontracting calculators.