Yesterday, we defined "directly associated costs" and described how directly associated costs related to unallowable costs, are also unallowable, if material (or significant). FAR provides some general criteria for assessing significance but a lot of judgment is still required in assessing materiality.
Contractors should be aware of and concerned that the Government's bent is to set the materiality threshold as low as possible so that they can disallow more costs thereby reducing the costs charged to Government contracts. Often times, the Government's position is not defensible in view of the FAR criteria. We know of cases where auditors positions relative to directly associated costs have not sustained by contracting officers (remember, auditors are advisory only and the contracting officer makes the final decisions).
As a general practice, contractors should review their unallowable costs from time to time and brainstorm for potential directly associated costs. Any costs directly associated with unallowable costs or activities should be set aside and charged to an "unallowable" account. However, remember the "but for" rule - the costs would not have been incurred had the other cost not been incurred. This suggests that fixed costs (as differentiated from variable costs) will seldom meet the definition of directly associated costs. And even if a particular fixed cost did meet that definition, it is unlikely that it would be material in amount.