FAR 42.709-5—Computing Interest.
Plain-English Summary
FAR 42.709-5 explains how to calculate interest when a contractor has already been paid for costs later found to be expressly unallowable under the cost principle penalty provisions in FAR 42.709-2(a)(1)(ii). It covers four core topics: when the overpayment is deemed to have occurred, how to handle situations where costs were not paid evenly throughout the fiscal year, which Treasury interest rate applies, the period over which interest must be computed, and how to identify the paid portion of the disallowed costs with help from the contract auditor. In practice, this section ensures the Government can recover not only the disallowed amount but also the time value of money associated with the overpayment. It creates a standardized method for calculating interest so that contractors, auditors, and contracting officers use the same assumptions and avoid disputes over timing or rate. The rule matters because even a relatively small unallowable cost can generate additional liability if it was paid earlier in the fiscal year or remained outstanding for a long period before the demand letter is issued.
Key Rules
Midyear overpayment assumption
For purposes of interest calculation, the overpayment is treated as having occurred at the midpoint of the contractor’s fiscal year, and interest is treated as beginning then. If the cost was not paid evenly over the fiscal year, an alternate equitable method must be used instead of the midpoint assumption.
Treasury interest rate applies
The interest rate is not negotiated case by case; it must be the rate specified by the Secretary of the Treasury under Pub. L. 92-41 (85 Stat. 97). This ties the calculation to the applicable federal interest rate in effect under the statute.
Interest runs to demand letter
Interest is computed from the date of overpayment through the date of the demand letter for payment of the penalty. The calculation therefore stops at the demand letter date, not at some later collection date, unless another rule separately changes the period.
Paid portion only
Interest is charged only on the portion of the disallowed cost that was actually paid by the Government. The rule does not apply interest to amounts that were disallowed but never paid.
Auditor consultation required
The paid portion of the disallowed costs must be determined in consultation with the contract auditor. This ensures the interest base reflects the audit record and the actual payment history rather than an estimate made in isolation.
Responsibilities
Contracting Officer
Apply the FAR interest-computation method when pursuing the penalty under 42.709-2(a)(1)(ii), use the correct Treasury rate, and issue the demand letter that marks the end date for interest computation.
Contract Auditor
Work with the contracting officer to determine what portion of the disallowed cost was actually paid and provide audit support for the interest base and payment timing.
Contractor
Provide accurate fiscal-year, payment, and cost records needed to identify when the overpayment occurred and what portion of the disallowed cost was paid.
Agency
Ensure the penalty and interest are calculated consistently with FAR and Treasury requirements and that supporting documentation is retained for the demand and collection action.
Practical Implications
The midpoint-of-fiscal-year rule is a simplifying assumption, but it can materially affect the amount of interest owed, especially when costs were incurred or paid early in the year.
If payments were uneven, using the midpoint automatically may be wrong; parties should use a more equitable method that better matches actual payment timing.
The interest rate must come from the Treasury rate in effect under the cited statute, so using a commercial rate, contract rate, or outdated Treasury rate is a common error.
Only the paid portion of the disallowed cost is subject to interest, so careful reconciliation of invoices, vouchers, and audit findings is essential.
The demand letter date is the cutoff for interest computation under this section, so delays in issuing the letter can increase the Government’s recovery and should be tracked closely.
Official Regulatory Text
For 42.709-2 (a)(1)(ii), compute interest on any paid portion of the disallowed cost as follows: (a) Consider the overpayment to have occurred, and interest to have begun accumulating, from the midpoint of the contractor’s fiscal year. Use an alternate equitable method if the cost was not paid evenly over the fiscal year. (b) Use the interest rate specified by the Secretary of the Treasury pursuant to Pub.L.92-41 (85 Stat. 97). (c) Compute interest from the date of overpayment to the date of the demand letter for payment of the penalty. (d) Determine the paid portion of the disallowed costs in consultation with the contract auditor.