Contract Cost Principles and Procedures

This analysis covers FAR Part 31 - Contract Cost Principles and Procedures, focusing on the scope, definitions, and applicability of cost accounting standards in federal procurement.

Overview

FAR Part 31 provides the regulatory framework for determining the allowability, reasonableness, and allocability of costs associated with federal contracts. It serves as the mandatory basis for pricing negotiated contracts, determining reimbursement under cost-type contracts, and settling costs in contract terminations or modifications.

Key Rules

• The Five Components of Allowability: For a cost to be allowed, it must meet five specific criteria:
  1. Reasonableness: It does not exceed what a prudent person would incur in a competitive business.
  2. Allocability: It is incurred specifically for the contract or benefits both the contract and other work.
  3. Standards: It complies with Cost Accounting Standards (CAS) or Generally Accepted Accounting Principles (GAAP).
  4. Contract Terms: It must not be prohibited by specific clauses within the contract.
  5. FAR Subpart 31.2 Limitations: It must not be listed as unallowable (e.g., entertainment, lobbying, or alcoholic beverages).
• Direct vs. Indirect Costs: Costs must be consistently treated. A cost cannot be charged directly to a contract if other costs incurred for the same purpose in like circumstances have been allocated as indirect costs.
• Expressly Unallowable Costs: Certain costs (defined in 31.205) are strictly forbidden. If a contractor includes these in a proposal, they may be subject to interest and penalties.
• Advance Agreements: Under FAR 31.109, the government and contractors are encouraged to reach written agreements before incurring costs in "gray areas" (such as specialized relocation or unique research) to avoid future disputes.
• Entity-Specific Subparts: Cost principles vary by the type of organization:
  • 31.2: Commercial Organizations.
  • 31.3: Educational Institutions.
  • 31.6: State, Local, and Tribal Governments.
  • 31.7: Nonprofit Organizations.

Responsibilities

• Contracting Officer (CO): Responsible for determining cost reasonableness, negotiating final indirect cost rates, and incorporating the correct cost principles into the contract by reference.
• Contractor: Must maintain an accounting system capable of segregating unallowable costs from allowable ones, certifying indirect cost rate proposals, and providing "cost or pricing data" when required.
• Defense Contract Audit Agency (DCAA) / Auditors: Responsible for auditing contractor records to ensure compliance with FAR Part 31 and identifying "questioned costs" that do not meet allowability criteria.
• Agency Head: Responsible for approving deviations from these cost principles when necessary for specific programs.

Practical Implications

• Audit Preparedness: In real-world scenarios, a commercial contractor must ensure their accounting software can "flag" and exclude costs like "business meals" that include alcohol or "public relations" costs that are purely promotional, as these are unallowable under Subpart 31.2.
• Negotiation Leverage: Understanding Part 31 allows contractors to justify higher "reasonableness" for costs incurred under emergency or specialized conditions, provided they have documented the "prudent person" rationale.
• Fixed-Price Trap: Even in Fixed-Price contracts, Part 31 applies if a modification is negotiated based on cost analysis. Contractors often mistakenly believe Part 31 only applies to Cost-Reimbursement contracts; however, it is the standard for almost any price negotiation involving cost data.
• Construction Equipment: For A&E and construction contracts (31.105), the use of "predetermined schedules" for equipment ownership costs (like the Army Corps of Engineers' manuals) often replaces actual cost data, simplifying but also constraining how contractors can claim expenses for heavy machinery.