A contractor is responsible for accounting for costs appropriately and for maintaining records, including supporting documentation, adequate to demonstrate that costs claimed have been incurred, are allocable to the contract, and comply with applicable [FAR] cost principles … The contracting officer may disallow all or part of a claimed cost that is inadequately supported.This particular provision was added to the cost principles in 1996 (FAC 90-39). The drafters commented that although the requirement, and the contracting officer's authority to disallow inadequately supported costs were considered to be implicit in the cost principles, explicit guidance was necessary because agencies were having difficulty because the FAR was silent on the issue.
FAR 4.7 contains contractor record retention requirements. It requires contractors to make available records and other supporting evidence to satisfy contract negotiation, administration and audit requirements for three years after final payment, or the period specified in FAR 4.705, whichever period expires first. So, for example, FAR 4.705-2(a) requires contractors to maintain payroll records for four years. Obviously, for most contracts, four years will lapse before the "three years after final payment" milestone. The minimum period can also be extended by contract clause. So, for example, the Allowable Cost and Payment clause at FAR 52.216-7 provides for an extension to record retention minimums when a contractor fails to meets its due date for submitting incurred cost proposals.
Contract auditors sometimes apply FAR 31.201-2(d) inappropriately. We have seen situations where this clause was cited, not because the contractor failed to retain records, but because the auditor was not satisfied with the sufficiency of the supporting data that was provided. Most of the time this involved a judgment call by the auditors because they don't want to take the time or make the effort to consider "alternative evidence" that may be available. The thing to keep in mind here however, is that if the Government invokes 31.201-2(d), it is well established that the burden is on the Government to prove that inadequately unsupported costs are unallowable.