FAR 31.201-6—Accounting for unallowable costs.
Plain-English Summary
FAR 31.201-6 explains how contractors must identify, segregate, and exclude unallowable costs from Government contract billings, claims, and proposals, and how to treat the costs that are directly associated with those unallowable costs. It covers expressly unallowable costs, mutually agreed unallowable costs, costs made unallowable by a contracting officer’s written decision, and the related concept of directly associated costs. The section also addresses accounting practices for unallowable costs under CAS 9904.405, the use of statistical sampling, the effect of penalty provisions under 42.709, advance agreements under FAR 31.109, burden of proof when sampling is challenged, and how to handle directly associated costs in cost pools. It further explains how to judge materiality, including treatment of salary costs tied to proscribed activities and when directly associated costs become unallowable under selected cost principles in 31.205. In practice, this rule is a compliance and cost-accounting control requirement: contractors must have systems that prevent unallowable costs from being billed or proposed and that can withstand audit and contracting officer review.
Key Rules
Exclude unallowables from submissions
Expressly unallowable costs and mutually agreed unallowable costs, including their mutually agreed directly associated costs, must be identified and kept out of any billing, claim, or proposal tied to a Government contract. This is a direct prohibition on charging or seeking reimbursement for those amounts.
Directly associated costs follow the cost
A directly associated cost is one incurred solely because another cost was incurred and would not exist otherwise. If the underlying cost is unallowable, the directly associated cost is also unallowable, subject to the materiality and pool-handling rules in later paragraphs.
CO decisions create broader identification duties
If a contracting officer issues a written decision designating a cost, or its directly associated cost, as unallowable, the contractor must identify and exclude that cost when it appears in or is used to compute a billing, claim, or proposal. The same identification duty extends to costs incurred for the same purpose under like circumstances.
Follow CAS 9904.405 methods
Contractors must use the accounting and presentation practices for unallowable costs described in CAS 9904.405. This means the contractor’s cost accounting system and disclosures must align with the CAS requirements for segregating and presenting unallowable costs.
Statistical sampling is allowed with safeguards
Statistical sampling may be used to identify and segregate unallowable costs only if the sample is unbiased and representative, large-dollar or high-risk transactions are separately reviewed, and the method permits audit verification. If a sampled indirect cost is subject to 42.709 penalties, the projected amount from that sample is also subject to the same penalties.
Advance agreements are strongly preferred
Use of statistical sampling should be addressed in an advance agreement under FAR 31.109 with the cognizant administrative contracting officer or other Federal official. The agreement should spell out the sampling process, and the cognizant auditor must be consulted before the agreement is made.
Contractor bears proof if sampling is challenged
If there is no advance agreement and the contracting officer or representative challenges the sampling method after an initial review, the contractor must prove that the method satisfies the regulatory criteria. This places the evidentiary burden on the contractor in a dispute.
Handle directly associated costs in pools carefully
If a directly associated cost sits in a cost pool allocated over a base that already includes the unallowable cost, the directly associated cost may remain in the pool because the unallowable cost will absorb its allocable share. In all other cases, material directly associated costs must be removed from the pool as unallowable.
Materiality controls whether purge is required
Materiality depends on the dollar amount, the cumulative effect of all directly associated costs in the pool, and the ultimate effect on Government contract cost. Salary costs tied to proscribed activities are treated as directly associated costs to the extent of time spent on the activity, using total company time as the comparison base, with limited treatment of after-hours work.
Selected cost items may trigger direct-cost unallowability
When a specific cost principle in 31.205 says directly associated costs are unallowable, those costs are unallowable only if material, unless allowing them would violate public policy. This creates a materiality screen for many, but not all, directly associated costs.
Responsibilities
Contractor
Identify expressly unallowable, mutually agreed unallowable, and CO-designated unallowable costs; exclude them from billings, claims, and proposals; account for directly associated costs correctly; follow CAS 9904.405; use only compliant statistical sampling methods; maintain support for materiality judgments; and prove the adequacy of sampling if challenged without an advance agreement.
Contracting Officer
Issue written decisions when designating costs as unallowable; review and, if necessary, challenge statistical sampling methods; ensure unallowable costs are excluded from Government submissions; and use advance agreements under FAR 31.109 where appropriate to establish acceptable sampling practices.
Cognizant Administrative Contracting Officer or Federal Official
Enter into advance agreements on statistical sampling methods under FAR 31.109 and define the basic characteristics of the sampling process. This official should coordinate with the cognizant auditor before finalizing any such agreement.
Cognizant Auditor
Provide input before an advance agreement on statistical sampling is executed, helping assess whether the proposed method is auditable and consistent with cost-accounting requirements.
Accounting/Cost Accounting Staff
Implement the accounting system controls needed to segregate unallowable costs, track directly associated costs, determine materiality, maintain audit-ready records, and ensure cost pools and allocation bases are adjusted correctly.
Government Contracting Community
Apply the rule consistently in evaluating billings, claims, proposals, and incurred cost submissions, including enforcement of penalty provisions when applicable and review of like circumstances for costs made unallowable by decision.
Practical Implications
Contractors need a reliable process to flag unallowable costs early, because the rule applies not just to direct charges but also to claims, billings, and proposals that use those costs in any way.
The biggest compliance risk is failing to identify directly associated costs, especially salary time, fringe, and other support costs tied to unallowable activities.
Statistical sampling can reduce administrative burden, but only if the method is defensible, documented, and audit-verifiable; otherwise the contractor may have to prove compliance after the fact.
Materiality matters, but it is not a free pass: even small directly associated costs may need attention if they accumulate or materially affect Government contract cost.
Advance agreements are a practical safeguard; without one, a contractor using sampling should expect closer scrutiny and a heavier burden if the method is questioned.
Official Regulatory Text
(a) Costs that are expressly unallowable or mutually agreed to be unallowable, including mutually agreed to be unallowable directly associated costs, shall be identified and excluded from any billing, claim, or proposal applicable to a Government contract. A directly associated cost is any cost that is generated solely as a result of incurring another cost, and that would not have been incurred had the other cost not been incurred. When an unallowable cost is incurred, its directly associated costs are also unallowable. (b) Costs that specifically become designated as unallowable or as unallowable directly associated costs of unallowable costs as a result of a written decision furnished by a contracting officer shall be identified if included in or used in computing any billing, claim, or proposal applicable to a Government contract. This identification requirement applies also to any costs incurred for the same purpose under like circumstances as the costs specifically identified as unallowable under either this paragraph or paragraph (a) of this subsection. (c) (1) The practices for accounting for and presentation of unallowable costs must be those described in 48 CFR 9904.405 , Accounting for Unallowable Costs. (2) Statistical sampling is an acceptable practice for contractors to follow in accounting for and presenting unallowable costs provided the criteria in paragraphs (c)(2)(i), (c)(2)(ii), and (c)(2)(iii) of this subsection are met: (i) The statistical sampling results in an unbiased sample that is a reasonable representation of the sampling universe. (ii) Any large dollar value or high risk transaction is separately reviewed for unallowable costs and excluded from the sampling process. (iii) The statistical sampling permits audit verification. (3) For any indirect cost in the selected sample that is subject to the penalty provisions at 42.709 , the amount projected to the sampling universe from that sampled cost is also subject to the same penalty provisions. (4) Use of statistical sampling methods for identifying and segregating unallowable costs should be the subject of an advance agreement under the provisions of 31.109 between the contractor and the cognizant administrative contracting officer or Federal official. The advance agreement should specify the basic characteristics of the sampling process. The cognizant administrative contracting officer or Federal official shall request input from the cognizant auditor before entering into any such agreements. (5) In the absence of an advance agreement, if an initial review of the facts results in a challenge of the statistical sampling methods by the contracting officer or the contracting officer’s representative, the burden of proof shall be on the contractor to establish that such a method meets the criteria in paragraph (c)(2) of this subsection. (d) If a directly associated cost is included in a cost pool that is allocated over a base that includes the unallowable cost with which it is associated, the directly associated cost shall remain in the cost pool. Since the unallowable costs will attract their allocable share of costs from the cost pool, no further action is required to assure disallowance of the directly associated costs. In all other cases, the directly associated costs, if material in amount, must be purged from the cost pool as unallowable costs. (e) (1) In determining the materiality of a directly associated cost, consideration should be given to the significance of- (i) The actual dollar amount, (ii) The cumulative effect of all directly associated costs in a cost pool, and (iii) The ultimate effect on the cost of Government contracts. (2) Salary expenses of employees who participate in activities that generate unallowable costs shall be treated as directly associated costs to the extent of the time spent on the proscribed activity, provided the costs are material in accordance with paragraph (e)(1) of this subsection (except when such salary expenses are, themselves, unallowable). The time spent in proscribed activities should be compared to total time spent on company activities to determine if the costs are material. Time spent by employees outside the normal working hours should not be considered except when it is evident that an employee engages so frequently in company activities during periods outside normal working hours as to indicate that such activities are a part of the employee’s regular duties. (3) When a selected item of cost under 31.205 provides that directly associated costs be unallowable, such directly associated costs are unallowable only if determined to be material in amount in accordance with the criteria provided in paragraphs (e)(1) and (e)(2) of this subsection, except in those situations where allowance of any of the directly associated costs involved would be considered to be contrary to public policy.