Cost Allocability

Under the Federal Acquisition Regulations (FAR), the only costs that a contractor can charge to a Government contract are those that are allocable and allowable under FAR Part 31 cost principles, agency supplements, and contract terms. A cost is allocable to a Government contract if it is assignable or chargeable to one or more cost objectives on the basis of relative benefits received or other equitable relationship. To be allocable, costs must meet one of three tests:

• It must be incurred specifically for the contract (i.e. a direct costs), or
• It must benefit contracts and other work and can be distributed to them in reasonable proportion to the benefits received, or
• Is necessary to the overall operation of the business, although a direct relationship to a particular cost objective cannot be shown.

There are rarely any disputes involving the first of the three tests - must be incurred specifically for a contract. However, the second and third tests require contractors to show a sufficient nexus between the cost and a Government contract. A recent opinion by the U.S. Court of Federal Claims (Teknowledge Corp. v. U.S., 2009 WL 57014) illustrates this point.

Teknowledge is an internet transaction company that provides secure transactions over the internet. In 1999, Teknowledge began developing a program for the finance services industry. In 2001, Teknowledge charged (amortized) about $285 thousand of development costs to its Government overhead pool. Teknowledge maintained that the costs were allocable because it benefited the Government through a potential increase in business, potential reduction of indirect costs charged to Government contracts, and continued viability of the company.

The court ruled that these benefits were remote and insubstantial and do not meet the requirement of the FAR standard. The court stated that there needs to exist a sufficient nexus between a given cost and a government contract. The word "benefit" as defined in the allocability test requires some showing that the cost relates to a government contract, not merely that it promotes the Government's public policy interests.