Fixed and Variable Costs - Directly Associated Cost Considerations

CAS 405, Accounting for Unallowable Costs and FAR 31.201-6, Accounting for Unallowable Costs, both require that expressly unallowable costs, mutually agreed to be unallowable, and directly associated costs be identified and excluded from any billing, claim or proposal applicable to a Government contract.

Directly associated costs means any cost which is generated solely as a result of incurring another cost, and which would not have been incurred had the other cost not been incurred. When an unallowable cost is incurred, its directly associated costs are also unallowable.

One way to think about whether a cost is directly associated with an unallowable activity is to consider whether the cost is fixed or variable. An ASBCA case from 1992 illustrates this situation.

ASBCA No. 31359 (92-1 BCA 24698) involved a dispute between General Dynamics Corp (GD) and the Government over the allowability of corporate aircraft costs and costs of flights taken on those aircraft.

General Dynamics conceded that some of the flights on its corporate aircraft were taken in connection with unallowable activities but disputed whether only the variable costs of the conceded flights or a portion of the fixed costs of the aircraft as well as the variable costs associated with the conceded flights should be considered directly associated unallowable costs. The ASBCA's opinion noted that fixed costs were costs that would be incurred irrespective of whether the aircraft flew, whereas variable costs were costs incurred as a result of the flights taken.

The board agreed with GD that only the variable costs of the corporate aircraft met the definition of directly associated costs required by CAS 405 (and FAR 31.201-6) to be excluded with respect to the unallowable flights. The Board's rationale stated:

We believe it is confusing and even misleading to characterize "variable costs as aircraft costs. The concept of directly associated costs as articulated in CAS 405 is useful in drawing a distinction between aircraft costs and flight related costs. Variable costs are costs directly associated with a flight. In other words. if the flight had not taken place, the variable costs would not have been incurred. It follows that if a flight is unallowable, its directly associated variable costs should also be made unallowable. That simply, is what CAS 405 requires.

This fixed vs variable analysis could be considered when computing/calculating directly associated costs.