FAR 31.205-3—Bad debts.
Plain-English Summary
FAR 31.205-3 addresses bad debts and makes clear that losses from amounts a contractor cannot collect are not allowable costs on government contracts. It covers actual losses and estimated losses tied to uncollectible accounts receivable from customers and other claims, as well as directly associated costs such as collection expenses and legal fees. In practice, this means a contractor cannot charge the Government for write-offs, reserves, allowances, or recovery efforts related to unpaid customer debts when those debts are not collectible. The rule is designed to keep the Government from paying for ordinary business credit risk and debt-collection activity that belongs to the contractor’s commercial operations. For contractors, the practical significance is that accounting treatment, billing practices, and indirect cost pools must exclude bad debt amounts and related collection/legal costs. For contracting officers and auditors, the section provides a straightforward allowability rule for reviewing claimed costs and indirect rate proposals.
Key Rules
Bad debts are unallowable
Actual losses from uncollectible accounts receivable and other claims cannot be charged to the Government. This includes amounts written off because a customer or other debtor did not pay.
Estimated losses are also unallowable
Contractors may not recover estimated bad debt losses through reserves, allowances, or similar accruals. The rule applies even before a debt is formally written off if the amount represents an expected uncollectible loss.
Related collection costs are unallowable
Costs directly associated with trying to collect bad debts, including collection agency fees and similar expenses, are unallowable. The Government will not pay for efforts aimed at recovering amounts that ultimately prove uncollectible.
Legal costs tied to bad debts are unallowable
Legal fees and other directly associated legal costs incurred to pursue uncollectible accounts or claims are also unallowable. If the legal work is part of debt collection, it falls within this prohibition.
Applies to customer receivables and other claims
The rule is not limited to trade receivables from customers; it also covers other claims that become uncollectible. Contractors should review all receivable-type balances and claims for allowability treatment.
Responsibilities
Contractor
Exclude bad debt losses, reserves for uncollectible accounts, collection costs, and related legal costs from claimed contract costs and indirect expense pools. Maintain accounting records that clearly separate allowable receivables activity from unallowable bad debt items.
Contracting Officer
Ensure proposed or billed costs do not include bad debts or directly associated collection/legal expenses. Question any reserves, write-offs, or collection-related charges that appear in cost submissions or indirect rate proposals.
Auditor/Cost Reviewer
Test cost records and indirect pools to identify uncollectible receivables, bad debt write-offs, and related collection or legal expenses. Verify that these amounts are excluded from costs claimed under Government contracts.
Agency
Apply the allowability rule consistently in contract cost reviews, rate negotiations, and incurred cost audits. Support enforcement through clear guidance and oversight of contractor cost submissions.
Practical Implications
Contractors should not treat bad debt reserves as recoverable overhead or G&A; they are unallowable and must be removed from claimed costs.
Collection agency invoices and attorney bills tied to chasing unpaid customer accounts are also unallowable, even if the underlying debt arose from contract performance.
A common pitfall is misclassifying write-offs or allowance accounts as ordinary business expenses in indirect pools; those amounts need to be segregated and excluded.
If a receivable becomes uncollectible, the accounting write-off may be proper for financial reporting, but that does not make it allowable for Government reimbursement.
Contracting officers and auditors should look for bad debt activity in accounts receivable aging, reserve accounts, and legal expense accounts when reviewing cost submissions.
Official Regulatory Text
Bad debts, including actual or estimated losses arising from uncollectible accounts receivable due from customers and other claims, and any directly associated costs such as collection costs, and legal costs are unallowable.