Are Company Christmas Parties Considered Employee Morale or Entertainment?

A recent DCAA (Defense Contract Audit Agency) incurred cost audit report questioned the cost of a company "Holiday/Christmas Party" on the basis that the cost was unallowable entertainment pursuant to FAR 31.205-14. The contractor countered that the costs were allowable under the employee morale cost principal at FAR 31.205-13.

The contracting officer receiving the audit report was confused so the issue was kicked upstairs for an expert DoD opinion. The so-called experts could not or would not address the issue, kicking in back to the contracting officer and the contracting officer's legal council. They wrote:

This is a gray area where resolutions are dependent upon interpretations of highly specific facts. I recommend you collect all of the available facts related to the event and then talk with your legal folks. Only then will you be able to make a determination is this has to do with FAR 31.205-13, Employee Morale, Health, Welfare, Food Service, and Dormitory Costs and Credits, or FAR 31.205-14, Entertainment Costs.

The cost of office parties is often contentious but we would not necessarily agree that it is a gray area. The regulations are not unclear. Contract auditors often question such costs without having all of the facts. Contractors however, don't help themselves when they fail to provide the salient facts to the auditors.

The questions that need to be asked and answered are (i) what is the primary purpose of the event and (ii) are the costs reasonable?

In a BCA (Board of Contract Appeals) case that is now 30 years old, the Board disallowed costs incurred in connection with a company holiday party, concluding that the because clients were invited, the purpose of the event was primarily entertainment. The Board stated that "To be an allowable cost, it must be clearly documented that an event's purpose was to improve employee morale, that the event benefited employees and not outside participants (such as spouses or other non-government clients), and that the costs were reasonable."

Contractors planning to claim the cost of holiday parties (and other like events) must clearly document the primary purpose of the event, ensure the costs are reasonable, and also exclude the portion of costs that are unallowable under other cost principles (e.g. alcoholic beverages).

Facts and documentation will go a long way toward avoiding contract disputes.