Thursday, June 17, 2010

Cost Reasonableness

Costs proposed on or charged to Government contracts must be allocable, allowable, and reasonableness. Of these three fundamental tenets governing the propriety of costs, the one that requires us to exercise a lot of judgment is reasonableness. FAR 31.201-3 lays out the "prudent persone" test. FAR considers a cost to be reasonable if in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business. But what exactly is a prudent person?

To help you apply the prudent person test, there are four questions that you can ask yourselves. These questions have evolved over the years, sometimes as a result of litigation. Of course, no test can address every conceivable situation but if you can answer "yes" to these four questions, you should have a good shot at supporting a cost's reasonableness.

  1. Is the type of cost generally recognized as necessary in conducting business?
  2. Is the cost consistent with sound business practice, law, and regulation, and are purchases conducted on an "arm’s-length" basis?
  3. Does your action reflect a responsible attitude toward the Government, other customers, the owners of the business, the employees, and the taxpayer?
  4. Is it consistent with established practices?

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