FAR 31.205-11—Depreciation.
Plain-English Summary
FAR 31.205-11 addresses when depreciation on plant, equipment, and other capital facilities is allowable as a contract cost and when it is not. It explains how residual value affects depreciable cost, how depreciation must be handled when Cost Accounting Standards (CAS) 9904.409 applies, and what happens when CAS does not apply. The section also covers special situations involving property acquired from the Government at no cost, property priced under 31.205-26(e), fully depreciated property, impairment write-downs, sale-and-leaseback reacquisitions, and capital leases under FASB ASC 840. In practice, this cost principle is meant to keep contractors from charging the Government more depreciation than is economically justified, while still allowing recovery of legitimate capital consumption costs. It also ties depreciation treatment to the contractor’s financial accounting methods and to consistent treatment across Government and non-Government business within the same segment or common-control group. For contracting officers and auditors, the section is important because depreciation issues often affect indirect rates, forward pricing, incurred cost audits, and lease or asset restructuring transactions.
Key Rules
Depreciation is generally allowable
Depreciation on plant, equipment, and other capital facilities is an allowable contract cost, but only within the limits of this cost principle. The contractor must support the amount claimed and cannot depreciate an asset in a way that drives book value materially below residual value.
Residual value limits depreciable cost
For tangible personal property, only residual values above 10 percent of capitalized cost must be used in establishing depreciable cost. If the contractor uses the declining balance method or the class life asset depreciation range system, residual value does not have to be deducted from capitalized cost for depreciation purposes.
CAS 9904.409 controls when applicable
If the contractor is subject to CAS 9904.409, it must follow that standard for all fully CAS-covered contracts. The contractor may elect to apply the standard to other contracts as well, but once elected, it must continue until final acceptance of all deliverable items on all open negotiated Government contracts.
Non-CAS depreciation must match financial accounting
When CAS 9904.409 does not apply, allowable depreciation generally cannot exceed the amount used for financial accounting purposes. It must also be determined consistently with the depreciation policies and procedures used in the same segment for non-Government business.
No depreciation on free Government property
Depreciation, rental, or use charges are unallowable on property acquired from the Government at no cost by the contractor or by any division, subsidiary, or affiliate under common control. The Government will not pay for capital consumption on property the contractor did not pay for.
Special pricing basis may be used
If an item meets the criteria for allowance at price under 31.205-26(e), depreciation may be based on that price. The same policies and procedures must be used for all business of the using division, subsidiary, or organization under common control.
Fully depreciated property is limited
No depreciation or rental is allowed on property that is fully depreciated by the contractor or by a related division, subsidiary, or affiliate under common control. A reasonable use charge may still be negotiated and allowed, considering original cost, remaining useful life at negotiation, maintenance or efficiency effects, and depreciation previously charged to Government work.
Impairment write-downs do not increase recovery
If an asset is written down to fair value because of impairment, allowable depreciation is limited to what would have been allowed had the asset not been written down. However, permissible changes in estimates such as service life, consumption, or residual value may still change depreciation prospectively.
Sale-and-leaseback reacquisition has special rules
If the contractor reacquires property involved in a sale-and-leaseback, depreciation on the reacquired property is based on the original net book value when the contractor became a lessee, adjusted for allowable gain or loss and reduced by depreciation already included in the relevant limitation calculations.
Capital leases are treated as purchased assets
Capital leases under FASB ASC 840 are subject to this cost principle and are treated as capitalized assets whose value is recovered through depreciation or amortization over the useful or lease life, as appropriate. If the lease is a sale-and-leaseback, allowable lease costs are capped as if the contractor had retained title, and related-party lease terms cannot produce depreciation above what would have occurred in an arm’s-length lease.
Responsibilities
Contracting Officer
Ensure depreciation charges included in proposals, billing rates, and incurred cost submissions comply with FAR 31.205-11. Scrutinize special cases such as fully depreciated assets, free Government property, sale-and-leaseback transactions, capital leases, and any election to apply CAS 9904.409 to non-CAS contracts.
Contractor
Apply depreciation methods consistently, support residual values and useful lives, and ensure claimed depreciation does not exceed financial accounting amounts when CAS 9904.409 does not apply. The contractor must also exclude unallowable depreciation on free Government property, fully depreciated property, and disallowed amounts arising from impairment, leaseback, or related-party lease situations.
Contractor Accounting/Finance Organization
Maintain depreciation policies and procedures that are consistent within the same segment and across common-control entities where required. Track asset basis, residual value, impairment adjustments, lease classifications, and prior depreciation charged to Government work so the correct amount is recovered.
Auditor or DCAA
Test whether depreciation methods, asset bases, and special transaction treatments comply with FAR 31.205-11 and any applicable CAS standard. Verify that depreciation claimed for Government contracts matches the contractor’s financial accounting records and that unallowable amounts are excluded.
Agency or Government Property Official
Identify when property was acquired from the Government at no cost and ensure no depreciation, rental, or use charges are paid on that property. Coordinate with contracting personnel when property disposition, leaseback, or reacquisition issues affect allowable cost.
Practical Implications
Depreciation is often embedded in indirect rates, so errors can affect many contracts at once rather than a single invoice. Contractors should reconcile fixed-asset records, financial statements, and cost submissions before rates are finalized.
The biggest audit risks are inconsistent depreciation methods, overstated residual values, and charging depreciation on assets that are fully depreciated or obtained from the Government at no cost. These issues can lead to questioned costs and rate adjustments.
Sale-and-leaseback and capital lease transactions require close review because the allowable cost basis may be capped below the amount shown in the books or lease payments. Related-party leases are especially sensitive because the Government will not accept inflated depreciation created by non-arm’s-length terms.
If CAS 9904.409 applies, the contractor must follow it carefully and consistently; if it does not, the contractor still cannot simply choose any method it wants. The method must align with financial accounting and the same segment’s non-Government business practices.
Impairment write-downs do not automatically increase what the Government will pay over time. Contractors should treat impairment accounting and Government cost allowability as related but not identical analyses.
Official Regulatory Text
(a) Depreciation on a contractor’s plant, equipment, and other capital facilities is an allowable contract cost, subject to the limitations contained in this cost principle. For tangible personal property, only estimated residual values that exceed 10 percent of the capitalized cost of the asset need be used in establishing depreciable costs. Where either the declining balance method of depreciation or the class life asset depreciation range system is used, the residual value need not be deducted from capitalized cost to determine depreciable costs. Depreciation cost that would significantly reduce the book value of a tangible capital asset below its residual value is unallowable. (b) Contractors having contracts subject to 48 CFR9904.409, Depreciation of Tangible Capital Assets, shall adhere to the requirement of that standard for all fully CAS-covered contracts and may elect to adopt the standard for all other contracts. All requirements of 48 CFR9904.409 are applicable if the election is made, and contractors must continue to follow it until notification of final acceptance of all deliverable items on all open negotiated Government contracts. (c) For contracts to which 48 CFR9904.409 is not applied, except as indicated in paragraphs (g) and (h) of this subsection, allowable depreciation shall not exceed the amount used for financial accounting purposes, and shall be determined in a manner consistent with the depreciation policies and procedures followed in the same segment on non-Government business. (d) Depreciation, rental, or use charges are unallowable on property acquired from the Government at no cost by the contractor or by any division, subsidiary, or affiliate of the contractor under common control. (e) The depreciation on any item which meets the criteria for allowance at price under 31.205-26 (e) may be based on that price, provided the same policies and procedures are used for costing all business of the using division, subsidiary, or organization under common control. (f) No depreciation or rental is allowed on property fully depreciated by the contractor or by any division, subsidiary, or affiliate of the contractor under common control. However, a reasonable charge for using fully depreciated property may be agreed upon and allowed (but, see 31.109 (h)(2)). In determining the charge, consideration shall be given to cost, total estimated useful life at the time of negotiations, effect of any increased maintenance charges or decreased efficiency due to age, and the amount of depreciation previously charged to Government contracts or subcontracts. (g) Whether or not the contract is otherwise subject to CAS the following apply: (1) The requirements of 31.205-52 shall be observed. (2) In the event of a write-down from carrying value to fair value as a result of impairments caused by events or changes in circumstances, allowable depreciation of the impaired assets is limited to the amounts that would have been allowed had the assets not been written down (see 31.205-16 (g)). However, this does not preclude a change in depreciation resulting from other causes such as permissible changes in estimates of service life, consumption of services, or residual value. (3) (i) In the event the contractor reacquires property involved in a sale and leaseback arrangement, allowable depreciation of reacquired property shall be based on the net book value of the asset as of the date the contractor originally became a lessee of the property in the sale and leaseback arrangement- (A) Adjusted for any allowable gain or loss determined in accordance with 31.205-16 (b); and (B) Less any amount of depreciation expense included in the calculation of the amount that would have been allowed had the contractor retained title under 31.205-11 (h)(1) and 31.205-36 (b)(2). (ii) As used in this paragraph (g)(3), "reacquired property" is property that generated either any depreciation expense or any cost of money considered in the calculation of the limitations under 31.205-11 (h)(1) and 31.205-36 (b)(2) during the most recent accounting period prior to the date of reacquisition. (h) A "capital lease," as defined in Financial Accounting Standards Board’s Accounting Standards Codification (FASB ASC) 840, Leases, is subject to the requirements of this cost principle. (See 31.205-36 for Operating Leases.) FASB ASC 840 requires that capital leases be treated as purchased assets, i.e. , be capitalized, and the capitalized value of such assets be distributed over their useful lives as depreciation charges or over the leased life as amortization charges, as appropriate, except that- (1) Lease costs under a sale and leaseback arrangement are allowable only up to the amount that would be allowed if the contractor retained title, computed based on the net book value of the asset on the date the contractor becomes a lessee of the property adjusted for any gain or loss recognized in accordance with 31.205-16 (b); and (2) If it is determined that the terms of the capital lease have been significantly affected by the fact that the lessee and lessor are related, depreciation charges are not allowable in excess of those that would have occurred if the lease contained terms consistent with those found in a lease between unrelated parties.