Entertainment Costs

Today we'r going to tackle a discussion on the "entertainment" cost principle. A few weeks ago, we looked at employee morale and identified some of the challenges in deciding whether particular costs should be classified as employee morale or entertainment. Its an important distinction because while employee morale costs (however narrowly defined) are generally allowable under Government contracts, entertainment costs are not.

The entertainment cost principle found in FAR 31.205-14 is rather brief. It states:

Costs of amusement, diversions, social activities, and any directly associated costs such as tickets to shows or sports events, meals, lodging, rentals, transportation, and gratuities are unallowable. Costs made specifically unallowable under this cost principle are not allowable under any other cost principle. Costs of memberships in social, dining, or country clubs or other organizations having the same purposes are also unallowable, regardless of whether the cost is reported as taxable income to the employees.

The middle sentence, "Costs made specifically unallowable under this cost principle are not allowable under any other cost principle" was added in 1995 to prevent just such arguments. Auditors might questions costs as unallowable entertainment but contracting officers were often persuaded to give those costs back because they would arguably meet the definition of one or more other cost principles. Congress had to act to tighten things up.

Auditors are ever on the alert for entertainment type activities. It could be entertainment that is part of a company's open house (the open house should be allowable but the entertainment portion is not) or entertainment that is part of a business meeting (business meetings are allowable with restrictions but a business meeting at an expensive resort is going to open up a line of inquiry.

Tomorrow, we will look at a few Board cases that help us define what is and is not allowable under this cost principle. Click here to go to Part 2.