GovCon FAQ #7: What is an unallowable cost and how does that impact operations?

Updated on: February 26, 2021


In our industry, we like to say, “if it’s fun, it’s probably unallowable.” Unallowable costs are an essential topic when it comes to understanding the structure and plan for indirect rates. Unallowable costs, which are defined in the Federal Acquisition Regulation (FAR) part 31.205, are not to be confused with nondeductible expenses per tax returns, although there are some commonalities.   

The determination of allowable versus unallowable costs is imperative in government contracting, especially for those cost reimbursable contracts because the federal government is reimbursing the contractors for direct cost plus the applicable portion of indirect costs. Unallowable costs are those that are excluded from the pool of allocable costs. They are prohibited from being billed to the federal government because the federal government sees some of those costs are not truly supporting the company’s business and/or the labor that’s being performed on government contracts. 

For a smooth contracting process, it’s important to have unallowable accounts set up from the start. If the DCAA finds any issues in the incurred cost submission and were to go under audit, the process can be dragged out significantly and cost more time and money on the back end than anticipated. It’s important to have somebody that’s cognizant of the regulations and the rules in place with government contracts, because even setting up your chart of accounts to plan for and allow for the charging of unallowable costs is an essential business activity.  

In addition to the benefit of being able to track and record unallowable costs properly, having an accounting team in place that understands unallowable accounts and how they impact your entity can help you fully understand: 

  • What your rates look like in order to budget and plan properly 
  • Where you stand in terms of market average 
  • Where you can make internal changes to keep rates competitive with companies of your size 
  • If you’ve incorrectly included unallowable costs in your cost pools that should be updated 

Regarding the unallowable costs in your cost pools, this would result in your rates are a little bit higher than you budgeted—which can result in a number of issues both from a billing and audit perspective. If the DCAA were to come in and audit your rates as part of the incurred cost submission and identify unallowable costs in your pools, the result would be that you have overbilled the government, and result in monies being owed back. This also typically comes along with additional administrative work moving forward, which can be a burden on any company.

We frequently field these questions: Are meals unallowable? Is entertainment unallowable? Under certain circumstances and with a lot of documentation, meals could be considered either allowable or unallowable, depending on the nature of these expenses. Typically, entertainment will always be unallowable. These are areas we, and the federal government, see as risky. That’s why it’s important to have the right people on your team who can help you plan for and document everything, whether allowable or unallowable, in a way that can be supported if it were to go under audit. If you have any questions about setting up your accounting system or if you’d like to further discuss how unallowable costs can be tracked and recorded, please do reach out to us for additional information and guidance.

Next Up: GovCon FAQ #8: What resources are available to learn more about becoming a government contractor?


Our experienced professionals are well versed in accounting, consulting, tax, and audit and can help you navigate the complexities of government contracting to support, optimize, and accelerate your success. Get in touch with our team→

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