Costs Related to Extraordinary Reviews of Incurred Costs

Most contractors doing business with the Federal Government are subject to the FAR Part 31 cost principles among which FAR 31.201-6 requires contractors to identify and exclude unallowable costs from any billing, claim, or proposal applicable to a Government contract. How contractors go about doing this varies widely. The most efficient way to identify and exclude unallowable costs is to make a determination at the time the expense is first recorded and drop it in the appropriate "bucket"; allowable or unallowable. That method assumes that (i) contractors have someone reasonably familiar with FAR Part 31 in their accounting departments to make those determinations and (ii) that their accounting systems are set up to record and segregate unallowable costs. More common among small contractors is the ritual of "scrubbing" records for potentially unallowable costs at the time a submission is made. So, for example, contractors submitting annual incurred cost submission will follow due diligence to identify and exclude unallowable costs from its indirect cost expense pools.

Contract auditors, namely DCAA or Defense Contract Audit Agency, have, from time to time, taken the position that costs associated with scrubbing accounts to identify unallowable costs are unreasonable. They rationalize that the need for "scrubbing" is a direct result of "earlier negligence" in establishing, maintaining, and/or implementing adequate systems of internal controls to identify and exclude such costs at the time of original entry. Advancing that logic, since the cost of "scrubbing" is unreasonable and unreasonable costs are unallowable according to FAR 31.201-3, contract auditors should be questioning those costs. The idea here is that if contractors had done it right the first time (and the Government paid for that), there wouldn't have had to be a second time.

Although we haven't seen auditors take this position in many years, the guidance still exists and has been carried over into DCAA's new Selected Areas of Costs Guidebook: FAR 31.205 Cost Principles. See Chapter 17, Section 17-2). Contractors should be aware that the policy exists and be prepared to address it should it ever be invoked. If it is, the auditor's logic and report will follow this outline:

1. The costs are not of a type generally recognized as ordinary and necessary for the conduct of the contractor's business or the performance of a contract. The costs are duplicative of costs incurred for the same purpose in prior periods. The Government has already reimbursed the contractor for the costs of preparing billings and claims for reimbursement. The fact that this task was not adequately accomplished does not entitle the contractor to additional reimbursement. 
2. The costs are the result of the contractor's failure to follow the requirements of generally accepted sound business practices and contract terms. 
3. The costs result from actions taken which were not those of a prudent businessman in the circumstances, considering his responsibilities to the owners of the business, his employees, his customers, the Government, and the public at large