Avoiding Unallowable Costs in Billing

A government contractor records a cost, bills it to a cost-reimbursement contract, and moves on. Months later, a DCAA auditor reviews the incurred cost submission and flags that same cost as unallowable. Knowing how unallowable costs for government contracts work is what stands between a clean billing and that finding, and it is the job of a compliance program to catch these costs early.

A single flagged cost rarely stops at the cost itself. It can trigger repayment, interest, and penalties, and it puts the rest of your billings under sharper review.

Our team at Barclay Group works with government contractors to help you identify, segregate, and exclude unallowable costs before they ever reach an invoice, applying FAR Part 31 and DCAA standards to the accounting system that produces your billings.

Why Government Contractors Choose Barclay Group

Choosing who handles your government contract accounting comes down to one question: Do they understand how the rules actually reach your billings? For a small contractor without in-house compliance staff, that understanding is the difference between catching an unallowable cost in the ledger and explaining it to an auditor later.

As a single-source partner, we bring accounting, compliance, contract management, CFO-level oversight, and proposal pricing under one roof, so cost allowability lives inside the same system that runs your books.

What Government Contractors Say About Barclay Group

“The Barclay Group is very knowledgeable on issues related to government contracting. They can quickly and patiently address client needs related to federal contracts and are delightful to work with.” — Kajal K.

“The Barclay Group has been a fantastic company to work with. Jacob and his team exhibit a true commitment to professionalism and partnership in everything they do.” — Hunter T.

“The Barclay Group helped us at short notice when we needed their time and expertise. They steered us through a demanding US Govt requirement and have prepared us for the future demands. Excellent service and professional delivery.” — Alex C.

What Are Unallowable Costs in Government Contracts?

An unallowable cost is any cost that, under FAR Part 31 or the terms of your contract, cannot be charged, billed, claimed, or proposed on a government contract. The Federal Acquisition Regulation sets the test for allowability in FAR 31.201-2, and the specific cost principles in FAR 31.205 name many costs that fail it.

Unallowable does not mean illegal. The cost can be a legitimate business expense that you record and pay like any other. You still cover it. You simply keep it out of anything the government reimburses. That distinction is the point: cost allowability is not about spending less, it is about keeping unallowable costs out of what the government pays.

Allowable vs. Unallowable Costs: How the FAR Draws the Line

The FAR draws the line between allowable vs unallowable costs using five tests, and a cost has to meet all of them to be allowable under FAR 31.201-2. A cost must be reasonable (FAR 31.201-3), allocable to the contract (FAR 31.201-4), consistent with the Cost Accounting Standards or generally accepted accounting principles, within the terms of the contract, and within any limits set in FAR subpart 31.2.

Reasonableness is often where contractors get caught. A cost is reasonable if it reflects what a prudent person would pay in a competitive market. Book first-class airfare when coach was available, and the amount can be trimmed to what was reasonable, even though the travel itself was allowable.

Common Examples of Unallowable Costs (FAR 31.205)

FAR 31.205 lists specific cost principles, and many of them name costs that are unallowable in whole or in part. Common examples include:

• Financing and accounting items: interest and other financial costs (FAR 31.205-20), bad debts (FAR 31.205-3), and organization costs (FAR 31.205-27)
• Entertainment and hospitality: entertainment and social activities (FAR 31.205-14) and alcoholic beverages (FAR 31.205-51)
• Influence and image: lobbying and political activity (FAR 31.205-22), most advertising and public relations (FAR 31.205-1), and contributions or donations (FAR 31.205-8)
• Penalties and losses: fines and penalties (FAR 31.205-15) and losses on other contracts (FAR 31.205-33)

Some are unallowable in full, others only under certain conditions, which is why the exact wording of each principle matters.

Expressly Unallowable vs. Directly Associated Costs

Two terms come up constantly in a DCAA review, and they work together. An expressly unallowable cost is one that a regulation or your contract names as unallowable in direct terms, such as the cost categories listed in FAR 31.205. A directly associated cost, defined in FAR 31.201-6, is a cost incurred solely because another cost was incurred, one that would not exist if the first cost had not been incurred.

Picture a trade show that is unallowable as advertising. The booth fee is expressly unallowable, and the airfare, hotel, and staff labor spent attending are directly associated costs that follow it out of your billings. Both come out, and both matter for your indirect rates. If an unallowable cost stays in an overhead or G&A pool, it lifts the rates you charge across every contract, which is exactly what an auditor looks for.

Penalties for Including Unallowable Costs

When an expressly unallowable cost shows up in a claim or final rate proposal, FAR 42.709 lets the government assess a penalty. A level-one penalty equals the amount of the disallowed cost allocated to the contract, plus interest. A level-two penalty doubles that amount when the same cost had already been determined unallowable for your company in a prior year.

These penalties sit on top of repaying the cost itself, and they surface during the DCAA incurred cost audit, when auditors test your annual submission against the cost principles. A pattern of flagged costs invites closer review of everything else you have billed.

How to Account for and Avoid Unallowable Costs

FAR 31.201-6 puts the duty on the contractor: identify unallowable costs, segregate them into separate accounts, and keep them out of every billing, claim, incurred cost submission, and forward pricing proposal. Meeting that duty takes a system, not a year-end cleanup.

In practice, that means a FAR-compliant accounting system that codes costs correctly as they post, indirect cost pools kept clear of unallowable items, monthly screening tied to your billing cycle, written allowability policies, and staff who know how to apply them.

We build and run that discipline. Through outsourced accounting and DCAA compliance support, we keep your books coded correctly day to day, and we carry the same screening into your incurred cost submissions and indirect rate calculations. The result is a FAR-compliant accounting system that catches an unallowable cost in the ledger, long before it reaches an invoice.

Frequently Asked Questions About Unallowable Costs

Can an Unallowable Cost Still Be a Legitimate Business Expense?

Yes. An unallowable cost can be a legitimate expense you record and pay like any other. The label only governs federal contracts: the cost cannot be billed, claimed, or proposed on a government contract or built into the rates you charge. You still cover it, just not with government dollars.

Do Unallowable Costs Have to Come Out of Indirect Cost Pools Too?

Yes. They have to be removed from overhead and G&A pools, not just direct billings. Even then, they still absorb their allocable share of indirect costs, so they cannot escape an allocation by hiding in a pool. Clean indirect cost pools keep your billed rates defensible.

What Records Help Defend Cost Allowability in a DCAA Audit?

The strongest defense is documentation built as you go: segregated account detail showing unallowable costs set aside, screening records, written allowability policies, and the source documents behind each cost. When your system shows a cost was identified and excluded on purpose, a DCAA review moves faster and finds less.

How Often Should a Small Contractor Screen Costs for Allowability?

Monthly is the practical standard. Screening each month, tied to your billing cycle, keeps unallowable costs out of invoices in real time, and a fuller review before each incurred cost submission catches anything that slipped through. Waiting until year-end turns a routine task into a scramble.

Keep Your Billings Clean. Talk to Barclay Group About Unallowable Cost Compliance Today.

An unallowable cost is easiest to handle before it reaches an invoice, and hardest after a DCAA reviewer has found it. The contractors who stay out of trouble are the ones whose accounting system screens for allowability every month, not the ones who react to a finding. Barclay Group works mainly with government contractors, which means cost allowability is not a service we added later. It is the discipline we build into your books.

Call us at (757) 960-8485 or reach us through our contact form to talk through how your costs are screened today.