FAR 42.709-2—General.
Plain-English Summary
FAR 42.709-2 explains how the Government calculates penalties for certain unallowable indirect costs included in a contractor’s indirect cost proposal. It covers three core topics: the basic penalty for expressly unallowable indirect costs, the enhanced double penalty when the contractor already knew the cost was unallowable before submitting the proposal, and the fact that these penalties are separate from any other administrative, civil, or criminal remedies. It also makes clear that the Government does not need to have actually paid the unallowable cost to assess a penalty. In practice, this section is a deterrent against including improper indirect costs in proposals and a strong incentive for contractors to screen, document, and remove unallowable costs before submission. For contracting officers and auditors, it provides the penalty framework used when evaluating disallowed indirect costs under covered contracts.
Key Rules
Basic penalty amount
If an indirect cost is expressly unallowable under an applicable FAR cost principle or agency supplement that defines selected cost allowability, the penalty equals the amount of disallowed costs allocated to covered contracts for which an indirect cost proposal was submitted, plus interest on any portion that was already paid.
Double penalty for prior knowledge
If the contractor had already determined the indirect cost was unallowable before submitting the proposal, the penalty is doubled. In that case, the penalty is two times the amount of the disallowed costs identified in the basic penalty calculation.
Separate from other remedies
These penalties do not replace other consequences. They are in addition to any administrative, civil, or criminal penalties that may apply under other laws or regulations.
Payment not required
The Government may assess a penalty even if the unallowable cost was never actually paid to the contractor. The mere inclusion of the unallowable cost in the proposal can trigger the penalty framework.
Responsibilities
Contractor
Exclude expressly unallowable indirect costs from indirect cost proposals, identify costs that have already been determined unallowable, and ensure proposal submissions do not expose the company to penalties, interest, or additional enforcement action.
Contracting Officer
Apply the penalty rules when covered indirect costs are found to be expressly unallowable, determine whether the enhanced double penalty applies, and ensure the penalty is assessed in addition to any other available remedies.
Auditor / DCAA or other audit support
Identify expressly unallowable indirect costs, determine whether costs were previously known to be unallowable, and support the calculation of disallowed amounts and any associated interest.
Agency
Enforce the penalty framework for covered contracts and coordinate any additional administrative, civil, or criminal actions that may arise from the same conduct.
Practical Implications
Contractors should treat indirect cost proposal preparation as a compliance exercise, not just an accounting task, because expressly unallowable costs can create direct financial penalties.
The biggest risk is not only including an unallowable cost, but including one the contractor already knew was unallowable; that can double the penalty exposure.
Interest can increase the cost of noncompliance when any portion of the disallowed amount has already been paid, so timing matters.
The Government does not need proof that the contractor was reimbursed before assessing a penalty, so simply submitting the cost can be enough to trigger consequences.
Strong internal controls, legal review of selected cost items, and documentation of allowability decisions are critical to avoid penalties under this section.
Official Regulatory Text
(a) The following penalties apply to contracts covered by this section: (1) If the indirect cost is expressly unallowable under a cost principle in the FAR, or an executive agency supplement to the FAR, that defines the allowability of specific selected costs, the penalty is equal to- (i) The amount of the disallowed costs allocated to contracts that are subject to this section for which an indirect cost proposal has been submitted; plus (ii) Interest on the paid portion, if any, of the disallowance. (2) If the indirect cost was determined to be unallowable for that contractor before proposal submission, the penalty is two times the amount in paragraph (a)(1)(i) of this section. (b) These penalties are in addition to other administrative, civil, and criminal penalties provided by law. (c) It is not necessary for unallowable costs to have been paid to the contractor in order to assess a penalty.