FAR 31.203—Indirect costs.
Plain-English Summary
FAR 31.203 explains how contractors must identify, group, and allocate indirect costs to final cost objectives under the cost principles. It covers the basic distinction between direct and indirect costs, how indirect cost pools must be accumulated, how allocation bases must be selected and protected from improper fragmentation, when allocation methods must be revised, how offsite locations may require separate groupings, what base period to use for allocating indirect costs, special considerations for Government-owned contractor-operated (GOCO) plants, and the rule that indirect costs meeting the definition of an excessive pass-through charge are unallowable. The section also distinguishes between contracts subject to full CAS coverage and other contracts, directing full-CAS contracts to the applicable CAS rules and applying the FAR/CAS principles in paragraphs (b) through (h) to all others. In practice, this section is about making sure indirect costs are distributed fairly and consistently based on benefit received, not shifted selectively to favor one contract or another. It is central to contractor accounting system design, indirect rate development, proposal pricing, incurred cost submissions, and audit support because it governs both the structure of cost pools and the bases used to spread them.
Key Rules
Full CAS controls first
For contracts subject to full CAS coverage, indirect cost allocation must follow the applicable CAS provisions. For all other contracts, the allocation rules in FAR 31.203(b) through (h) apply.
Indirect costs after direct charging
Once direct costs are identified and charged directly, the remaining costs are indirect and must be allocated to intermediate or multiple final cost objectives. A cost cannot be treated as indirect for one final cost objective if, in like circumstances, the same type of cost is treated as direct for that or another final cost objective.
Use logical cost pools
Indirect costs must be accumulated in logical groupings that reflect why the costs were incurred. Each grouping should be designed so it can be allocated using a common base that measures the benefits received by the cost objectives.
Do not fragment the base
After an allocation base is accepted, the contractor may not remove individual elements from that base to reduce the share of indirect costs. All items properly includable in the base must bear their pro rata share, even if some of those items are unallowable as direct contract costs.
Revise methods when business changes
Indirect allocation methods may need to change when there are significant changes in the business, subcontracting, asset programs, inventories, sales or production volume, manufacturing processes, products, or other relevant circumstances.
Separate offsite groupings when needed
Costs associated with offsite locations may need separate cost groupings to ensure indirect costs are distributed equitably based on the benefits received by the affected cost objectives.
Use the proper base period
The base period for allocating indirect costs is the cost accounting period in which the costs are incurred and accumulated for allocation. For full or modified CAS coverage, the contractor must follow CAS 9904.406; otherwise, the base period is generally the fiscal year used for GAAP financial reporting.
Apply special care to GOCO plants
GOCO plants may require more precise cost groupings, detailed account screening, and carefully developed distribution bases because corporate or division G&A may have little relationship to the plant’s actual dependence on those services.
Excessive pass-through charges are unallowable
Indirect costs that meet the definition of an excessive pass-through charge under FAR 52.215-23 are unallowable and cannot be recovered.
Responsibilities
Contracting Officer
Ensure the solicitation and contract structure reflect the correct cost accounting requirements, including whether CAS coverage applies and whether indirect cost treatment is consistent with FAR 31.203. Review proposed indirect cost structures, question improper base fragmentation or inconsistent direct/indirect treatment, and enforce unallowability of excessive pass-through charges when applicable.
Contractor
Classify costs consistently as direct or indirect, accumulate indirect costs in logical pools, select allocation bases that reflect benefits received, avoid fragmenting bases, revise methods when business conditions change, use the proper base period, and exclude excessive pass-through charges from reimbursement. Maintain accounting records and support that demonstrate the reasonableness and consistency of the allocation method.
Agency/Auditors
Evaluate whether the contractor’s indirect cost pools, allocation bases, and base periods comply with FAR and CAS requirements. Test for consistency, verify that like costs are treated alike, and assess whether changes in business conditions or special operating environments such as GOCO plants require revised allocation methods.
Cost/Accounting Personnel
Design and operate the accounting system so indirect costs are grouped and allocated in accordance with the cost principles, monitor changes in operations that affect allocation methods, and ensure the base includes all properly includable elements regardless of allowability for direct charging purposes.
Practical Implications
This section is a major audit focus because it affects indirect rates, provisional billing, final indirect cost rates, and cost allowability. A weak allocation structure can lead to questioned costs, rate adjustments, or repayment.
Contractors should watch for inconsistent treatment of the same cost type across contracts or business units. If a cost is direct in one place and indirect in another under like circumstances, that is a red flag.
Do not try to lower indirect rates by removing unallowable items from the allocation base if those items belong in the base. FAR requires the base to include all properly includable elements, even if some are unallowable for direct reimbursement.
Significant operational changes can make old allocation methods obsolete. Mergers, subcontracting shifts, production changes, or major capital programs may require a new pool structure or base to keep allocations equitable.
GOCO environments often need more granular accounting than standard commercial operations. Corporate G&A may not track well to plant operations, so contractors should expect closer scrutiny and should document why the chosen base is fair and representative.
Official Regulatory Text
(a) For contracts subject to full CAS coverage, allocation of indirect costs shall be based on the applicable provisions. For all other contracts, the applicable CAS provisions in paragraphs (b) through (h) of this section apply. (b) After direct costs have been determined and charged directly to the contract or other work, indirect costs are those remaining to be allocated to intermediate or two or more final cost objectives. No final cost objective shall have allocated to it as an indirect cost any cost, if other costs incurred for the same purpose, in like circumstances, have been included as a direct cost of that or any other final cost objective. (c) The contractor shall accumulate indirect costs by logical cost groupings with due consideration of the reasons for incurring such costs. The contractor shall determine each grouping so as to permit use of an allocation base that is common to all cost objectives to which the grouping is to be allocated. The base selected shall allocate the grouping on the basis of the benefits accruing to intermediate and final cost objectives. When substantially the same results can be achieved through less precise methods, the number and composition of cost groupings should be governed by practical considerations and should not unduly complicate the allocation. (d) Once an appropriate base for allocating indirect costs has been accepted, the contractor shall not fragment the base by removing individual elements. All items properly includable in an indirect cost base shall bear a pro rata share of indirect costs irrespective of their acceptance as Government contract costs. For example, when a cost input base is used for the allocation of G&A costs, the contractor shall include in the base all items that would properly be part of the cost input base, whether allowable or unallowable, and these items shall bear their pro rata share of G&A costs. (e) The method of allocating indirect costs may require revision when there is a significant change in the nature of the business, the extent of subcontracting, fixed-asset improvement programs, inventories, the volume of sales and production, manufacturing processes, the contractor’s products, or other relevant circumstances. (f) Separate cost groupings for costs allocable to offsite locations may be necessary to permit equitable distribution of costs on the basis of the benefits accruing to the several cost objectives. (g) A base period for allocating indirect costs is the cost accounting period during which such costs are incurred and accumulated for allocation to work performed in that period. (1) For contracts subject to full or modified CAS coverage, the contractor shall follow the criteria and guidance in 48 CFR9904.406 for selecting the cost accounting periods to be used in allocating indirect costs. (2) For contracts other than those subject to paragraph (g)(1) of this section, the base period for allocating indirect costs shall be the contractor’s fiscal year used for financial reporting purposes in accordance with generally accepted accounting principles. The fiscal year will normally be 12 months, but a different period may be appropriate ( e.g., when a change in fiscal year occurs due to a business combination or other circumstances). (h) Special care should be exercised in applying the principles of paragraphs (c), (d), and (e) of this section when Government-owned contractor-operated (GOCO) plants are involved. The distribution of corporate, division or branch office G&A expenses to such plants operating with little or no dependence on corporate administrative activities may require more precise cost groupings, detailed accounts screening, and carefully developed distribution bases. (i) Indirect costs that meet the definition of "excessive pass-through charge" in 52.215-23 , are unallowable.