FAR 31.205-7—Contingencies.
Plain-English Summary
FAR 31.205-7 explains how contractors and contracting officers should treat contingencies in cost accounting and cost estimating. It defines what a contingency is, states the general rule that contingency costs are unallowable for historical costing purposes, and then distinguishes between two types of contingencies for future cost estimates: those tied to known conditions with reasonably predictable effects, and those tied to known or unknown conditions whose effects cannot be measured precisely. The section also explains when a contingency factor may be recognized in past-period costs, such as in termination settlements, to account for minor unsettled matters and speed resolution. In practice, this rule helps ensure that estimated costs are realistic without allowing speculative or inequitable amounts to be built into individual cost elements. It also requires separate disclosure of certain contingencies, including the basis for the estimate, so the Government can evaluate whether contractual coverage is appropriate. The section is important because it affects proposal pricing, incurred cost submissions, termination claims, and the negotiation of contract terms that may need explicit risk coverage.
Key Rules
Define contingency broadly
A contingency is any possible future event or condition, whether caused by known or unknown factors, whose outcome cannot be determined now. This broad definition captures both ordinary business risks and more uncertain events such as litigation.
Historical costs exclude contingencies
Contingency costs are generally unallowable when contractors are reporting historical costs because those costs should reflect amounts actually incurred and recorded on the books. The rule prevents speculative amounts from being charged as if they were real incurred costs.
Limited recognition in settlements
A contingency factor may sometimes be recognized for a past period when needed to account for minor unsettled matters, especially in termination situations. The purpose is to expedite settlement, not to create a general allowance for uncertain costs.
Known risks belong in estimates
Contingencies arising from presently known and existing conditions with reasonably foreseeable effects must be included in future cost estimates. Examples include expected rejects or defective work, because these are part of the best estimate of performance cost.
Unmeasurable risks stay out of line items
Contingencies arising from known or unknown conditions that cannot be measured precisely enough for equitable treatment of both parties must be excluded from individual cost estimates. Examples include pending litigation, where the amount and outcome are too uncertain to allocate directly to specific cost elements.
Separate disclosure is required
Excluded contingencies should still be disclosed separately, along with the basis for the computation, so the parties can negotiate appropriate contractual coverage. This disclosure supports informed pricing, risk allocation, and contract administration.
Related cost principles may apply
The rule points to other FAR provisions, such as 31.205-6(g) and 31.205-19, where specific contingency-related treatment may be addressed. Contractors should check those provisions when a contingency overlaps with compensation, insurance, or other specialized cost areas.
Responsibilities
Contractor
Identify contingencies correctly, include foreseeable risks in future cost estimates when they are part of the best estimate of performance cost, exclude highly uncertain contingencies from individual cost elements, and disclose excluded contingencies separately with the basis for the estimate. The contractor must also avoid charging general contingency amounts as historical incurred costs unless a limited exception applies.
Contracting Officer
Review proposed costs and disclosures to determine whether contingencies have been treated consistently with FAR 31.205-7, whether foreseeable risks are properly built into estimates, and whether excluded contingencies need separate contractual coverage. The contracting officer should use the disclosure to negotiate fair risk allocation and avoid paying speculative amounts through ordinary cost elements.
Government Auditor or Reviewer
Evaluate whether claimed or proposed costs reflect actual incurred costs rather than unallowable contingency reserves, and whether the contractor’s estimates are supported by a reasonable basis. Auditors should also verify that separately disclosed contingencies are not improperly embedded in line-item costs.
Agency
Ensure acquisition personnel apply the contingency rule consistently in pricing, settlement, and cost allowability reviews, and use separate disclosures to decide whether special contract terms or coverage are needed. Agencies should also coordinate with other applicable FAR cost principles when contingencies overlap with specialized cost categories.
Practical Implications
Contractors should build predictable risks into estimates, but only when the risk is reasonably measurable; otherwise, they should disclose it separately instead of burying it in direct or indirect cost lines.
A common pitfall is treating a reserve or cushion as if it were an allowable incurred cost. Under this rule, historical cost submissions should reflect actual recorded costs, not speculative allowances.
For proposals and terminations, the distinction between foreseeable and unmeasurable contingencies matters a lot: one affects the estimate itself, while the other may require separate explanation and negotiation.
Separate disclosure is not optional when the contingency is excluded from line-item estimates; failing to explain the basis can lead to pricing disputes, audit questions, or disallowed costs.
Contracting officers should watch for hidden contingency loading in labor, materials, overhead, or G&A rates, especially where the contractor is trying to recover litigation risk, warranty uncertainty, or other speculative exposures through ordinary cost elements.
Official Regulatory Text
(a) "Contingency," as used in this subpart, means a possible future event or condition arising from presently known or unknown causes, the outcome of which is indeterminable at the present time. (b) Costs for contingencies are generally unallowable for historical costing purposes because such costing deals with costs incurred and recorded on the contractor’s books. However, in some cases, as for example, terminations, a contingency factor may be recognized when it is applicable to a past period to give recognition to minor unsettled factors in the interest of expediting settlement. (c) In connection with estimates of future costs, contingencies fall into two categories: (1) Those that may arise from presently known and existing conditions, the effects of which are foreseeable within reasonable limits of accuracy; e.g., anticipated costs of rejects and defective work. Contingencies of this category are to be included in the estimates of future costs so as to provide the best estimate of performance cost. (2) Those that may arise from presently known or unknown conditions, the effect of which cannot be measured so precisely as to provide equitable results to the contractor and to the Government; e.g., results of pending litigation. Contingencies of this category are to be excluded from cost estimates under the several items of cost, but should be disclosed separately (including the basis upon which the contingency is computed) to facilitate the negotiation of appropriate contractual coverage. (See, for example, 31.205-6 (g) and 31.205-19 .)