According to FAR (Federal Acquisition Regulations) 31.205-7, a "contingency" is a possible future event or condition arising from presently known or unknown causes, the outcome of which is indeterminable at the present time.
The allowability of costs for contingencies depends upon whether one is addressing historical costs or prospective costs. In the case of historical costs, contingencies are almost never allowable because such costing deals with costs incurred and recorded on a contractor's books. One exception to this rule might be in the case of contract terminations where a contingency factor may be recognized when it is applicable to a past period to give recognition to minor or unsettled factors in the interest of expediting settlement.
Contingencies included in estimates of future costs are sometimes allowable and sometimes not. If the contingency is based on current conditions and the impact is foreseeable with reasonable limits. An example of this would be a provision for rejects or defective work.
On the other hand, contingencies included in estimates of future costs are unallowable if the contingency is based on known or unknown conditions and the impact cannot be measured accurately enough to provide equitable results to the contractor and to the Government. For example, the outcome of a lawsuit could impact future costs however the outcome of the lawsuit is uncertain as would be the impact on costs.
In practice, estimates for contingencies in proposals are very difficult to support and sustain when negotiating contracts. When proposed, the Government will consistently challenge the cost, requiring contractors to prove that the estimates are based on current conditions and the impact is foreseeable. Where historical costs and trends can be used, contractors have improved chances of sustaining their positions.