SBIR/STTR Contracts - Know Cost "Eligibility" Rules

We use these pages to keep readers up to date on FAR (Federal Acquisition Regulation) cost principles (i.e. FAR Part 31) and supplemental cost principle regulations from individual agencies (e.g. DFARS or DoD FAR Supplement). Contractors need to understand however that there are many other factors that affect the allowability and eligibility of costs. Contracts and grants often contain specific limitations while agencies themselves impose their own limitations. When it comes to SBIR/STTR programs, things can get very confusing and its necessary to fully understand allowability and eligibility criteria when negotiating contract prices. Here are some examples of competing or conflicting guidance pertaining to SBIR/STTR contracts.

• Some agencies allow you to purchase equipment as a direct cost on a Phase 1 project while others do not.
• Some agencies prohibit travel in Phase 1 while others strongly encourage it and even others require it. This leads to "consistency" issues in estimating, recording, and reporting costs.
• NIH (National Institute of Health) limits Phase 1 indirect rate to 40 percent of all direct costs unless there is an approved rate on a recent Federal project. This 40 percent limitation can result in a significant hardship to small businesses.
• NSF (National Science Foundation)  limits the combination of fringe benefits and indirect costs to not more than 150 percent of direct labor.
• All agencies allow profit and commonly refer to 7 percent of total cost. However, some agencies take that to mean that profit cannot exceed 7 percent, others say that means "normally" profit should not exceed 7 percent, while still others say 7 percent is an agency average.

The eligibility of costs is usually mentioned in the agency's SBIR/STTR solicitations but usually requires some "digging" to find them. Before entering into an SBIR/STTR contract, be certain that you fully understand any unique cost eligibility requirements and restrictions that apply and query the contracting officer for others that might not be evident. Phase 1 projects are usually fixed price while Phase 2 are typically cost-reimbursable. Once Phase 1 costs are negotiated, contractors can pretty much spend the contract amount as it sees fit. Not so with Phase 2 projects. Phase 2 projects can cause the most problems to contractors because those contracts become subject to audit.

For some free training resources from the SBIR/STTR folks, see New Resources for Small Businesses Seeking R&D Funding.

Veterans Affairs - Revised Cost Principles for Education Contracts

Most of our readers have at least a passing familiarity with FAR (Federal Acquisition Regulations) cost principles (FAR Part 31). Less known are cost principles published by and unique to other executive agencies. For example, the Defense Department has added a few of its own cost principles. So has NASA, the Energy Department, and a few other agencies. Its always a good idea to familiarize yourself with those cost principles applicable to your specific contract.

The Department of Veterans Affairs has just amended its FAR Supplement (VAAR or VA Acquisition Regulations) to revise a few of its own cost principles. These particular cost principles, codified at 48 CFR 831.70000 address cost under vocational rehabilitation and education contracts. The areas covered include:

• Tuition
• Special services or courses
• Books, supplies, and equipment required to be personally owned
• Medical services and hospital care
• Consumable instructional supplies
• Reimbursement for other supplies and services.

So for example, to be allowable, tuition and enrollment fees must meet certain criteria:

1. It cannot exceed the tuition charged to similarly circumstanced non-Veteran students.
2. It must be equal to the lowest price offered or published for the entire course, semester, quarter, or term
3. Costs must be offset by any amount waived by a State or other government authority
4. Costs must be offset by any amounts the Veteran student receives from a fellowship, scholarship, grant etc.

If you are in the business of contracting with the VA for educational services, these changes are critical. You can read a summary of the changes here.

Know Your Contract Terms

The allowability of costs under Government contracts are generally covered by the cost principles contained in FAR Part 31 and the FAR supplements issued by various departments. For example, the DOD FAR Supplement (DFARS) adds additional coverage for public relations, compensation, independent research and development and bid and proposal costs, insurance and indemnification, legislative lobbying costs, external restructuring costs and most recently, costs related to counterfeit electronic parts and suspect counterfeit electronic parts. The Department of Energy FAR Supplement (DEAR) contains additional coverage for independent research and development and bid and proposal costs, insurance and indemnification, pre-contract costs, professional and consultant service costs, and costs relating to legal and other proceedings. The NASA FAR Supplement (NFS) adds additional coverage for compensation and pre-contract costs. And we could go on and discuss other agencies added requirements.

But if you stop at the FAR and the FAR Supplements, you might be setting yourself up for potential cost disallowances because often times, contracts will contain provisions that restrict contractors from claiming certain types of costs on Government contracts.

One of the first things a Government contract auditor will do upon commencing an audit, oddly enough, is to brief the Government contracts to determine whether there are any restrictions on costs that go beyond FAR Part 31 cost principles. And, such restrictions are not difficult to find. Take for example FAR 52.222-2 regarding the Government's willingness to pay overtime. The clause itself requires contracting officers to insert an amount. Usually the amount is zero and if its left blank, the wording of the clause means the amount is "zero".

Facilities Capital Cost of Money (FCCM) is generally allowable but there are certain contracts (SBIRs, for one) that do not allow contractors to claim FCCM. A lot of contractors are unaware such restrictions exist and indiscriminately apply FCCM to all of their contracts.

Some agencies set salary caps for key individuals working on their contracts (or allocated to their contracts) and when they set such caps, also require contractors to obtain pre-approval for any salary increases. In all cases, these caps are set well below the FAR ceiling limitations. Contractors are still free to pay whatever they want, they just can't claim the entire amount on Government contracts of the particular agency.

Another common restriction found in contractual documents involves insurance costs. Often times, the Government will indemnify contractors for certain risks making additional insurance coverage unnecessary. When that happens, contracts will specify that insurance is unallowable even though according to FAR, insurance costs are allowable. Sometimes however, insurance costs are still allocated to contracts through a home office allocation where details are not readily discernible. Contractors need to be aware of such prohibitions and need to understand the components that comprise home office allocations to avoid allocating unallowable costs to Government contracts.

Know the Purpose for Which Costs were Expended - Then Make Your Allowability Determination

When determining the allowability of costs under Government contracts, one needs to have a very good grasp of the FAR (Federal Acquisition Regulations) cost principles (Part 31), a copy of the tome close by and good reference material to consult when costs don't fit nicely into FAR classifications. Often it is necessary to consult several cost principles to determine whether a cost is allowable or unallowable. Sometimes, after exhausting all available resources, you just don't know and you would like some guidance from the Government before including the costs in a proposal or an incurred cost submission. Good luck on that. Contracting officers are not inclined to give "private letter rulings" like the IRS and contract auditors will certainly not go out on a limb and offer their opinions. And even if they did, it wouldn't be binding on the Government anyway. Only the contracting officer has that authority. When the cost is immaterial, especially when the inclusion or exclusion has no impact on an indirect expense rate, many contractors simply forgo the costs.

Some costs are specifically unallowable regardless of purpose. The cost of alcoholic beverages is unallowable period. There is no justification possible that would make alcohol cost allowable. Likewise, the cost of lodging and per diem in excess of GSA maximum rates is unallowable. The allowability of many costs however are determined by first understanding the purpose. Take advertising for example. Advertising that promotes the sale of products or services is unallowable. Advertising that is specifically required by contract to acquire scarce items for contract performance or disposing of scrap or surplus materials is allowable. Help wanted advertising is generally allowable as well.

Here's another example. The allowability of legal costs depends significantly on the "purpose" for which the costs were incurred. Under FAR 31.205-33, Professional and Consultant Service Costs, legal costs are allowable. However, if you look at FAR 31.205-47, Costs Related to Legal and Other Proceedings, there are several categories of legal costs that are unallowable for policy reasons. Or, for example, legal expenses incurred in connection with contract novations would fall under FAR 31.205-27, Organization Costs and therefore unallowable because the Government is not going to pay for organization, reorganization, mergers, and acquisitions. It can get even more complicated. Legal costs incurred in connection with contract terminations fall under FAR 31.205-42, Termination Costs, and not only are they allowable (if reasonable) but can be charged direct as settlement expenses even if other legal costs are charged indirect. We could further complicate this discussion by bringing in the concept of "directly associated costs" - if in-house counsel is engaged in unallowable activities, you would also need to capture the applicable fringe benefits as unallowable.

In many cases, in order to make a determination of allowable or unallowable, it is necessary to first determine the purpose of the expenditure and weigh that against all applicable FAR Part 31 cost principles.

New Guidebook on Cost Principles from DCAA

The Defense Contract Audit Agency (DCAA) has eliminated Chapter 7, Audit Guidance on Selected Areas of Costs, from its Contract Audit Manual and replaced it with a new and greatly expanded guidebook on FAR Part 31 Cost Principles. DCAA writes:

This Guidebook addresses FAR 31.2 and other areas of cost audited. In this first edition of the guidebook, we have expanded what used to be included in Chapter 7 by adding 23 additional chapters to address FAR 31.2 cost principals that had not previously been included in CAM. Initially, many sections of the guidebook are a replica of what was in Chapter 7; however, we have rewritten and updated 13 areas of cost. We will be continuing to rewrite the other chapters in this guidebook and will publish them as completed.

The 13 updated chapters include:

1. Bonus and incentive compensation (Chapter 7)
2. Depreciation (Chapter 19)
3. IR&D/B&P (Chapter 33)
4. Legal (Chapter 41)
5. Royalties (Chapter 64)
6. Pensions (Chapter 53)
7. Manufacturing and production engineering (Chapter 45)
8. Joint ventures and teaming arrangements (Chapter 37)
9. Insurance (Chapter 34)
10. Idle facilities and idle capacity (Chapter 32)
11. Patents (Chapter 52)
12. Consultants (Chapter 58)
13. Alcoholic beverages (Chapter 2)

This new guide is definitely a work in process as many of the chapters state "This chapter is currently under construction.

The cost covered by the guide are listed in alphabetical order rather than FAR Part 31 order which may be easier or more cumbersome to navigate depending upon your familiarity with FAR. It appears that each FAR cost principle is covered as well as many other types of costs not specifically covered in the FAR.

We should note that this is intended to be guidance for the contract auditor and not the final word on what is allowable or not allowable. Many disputes have risen over DCAA's interpretation of FAR and the Government does not always prevail.

You can access DCAA's new guidebook directly by clicking here. 

2014 Version of the FAR Cost Principles Guide

The FAR (Federal Acquisition Regulation) Cost Principles Guide has now been updated through FAC (Federal Acquisition Circular) 2005-76 (September 2014) and is available for download here. The previous update was January 2013 (through FAC 2005-65).

The FAR Cost Principles Guide traces all the changes to FAR cost principles since the inception of the FAR system in 1984. It is useful for determining the precise cost principle in effect at the time a particular contract was awarded. While some cost principles have not changed in the ensuing years (e.g. bad debt expense, alcoholic beverages) most have undergone some form of revision and some have even been eliminated (ADP equipment). The Compensation cost principle (FAR 31.205-6), for example, has been revised 39 times. Six of those changes were effective in 2013 and 2014. By contrast, FAR 31.205-51, Cost of Alcoholic Beverages, has never changed since its first introduction in 1986.

The Government's contract auditors are busy clearing up its backlog of old incurred cost submissions. These audits, going back to 2006 in some cases (and perhaps earlier), must evaluate costs based on the cost principles in effect during that year or, in some cases, when the contract was awarded. Any challenges to claimed costs must cite not only the correct cost principle, but the correct version of that cost principle. This guide will help ensure accuracy on everyone's part.

Thanks to a reader who alerted us that the "Guide" had been recently updated.

New Version of the FAR Cost Principles Guide Has Been Published

Note: For an update of this posting, click here.

The FAR (Federal Acquisition Regulation) Cost Principles Guide has now been updated through FAC (Federal Acquisition Circular) 2005-65 (January 2013) and is available for download here. The previous update was June 2011 through FAC 2005-52.

The FAR Cost Principles Guide traces all the changes to FAR cost principles since the inception of the FAR system in 1984. It is useful for determining the precise cost principle in effect at the time a particular contract was awarded. While some cost principles have not changed in the ensuing years (e.g. bad debt expense, alcoholic beverages) most have undergone some form of revision and some have even been eliminated (ADP equipment). The Compensation cost principle (FAR 31.205-6), for example, has been revised 33 times.

The Government is now clearing out its backlog of old incurred cost submissions. These audits, going back to 2004 (and perhaps earlier), must evaluate costs based on the cost principles in effect during that year or, in some cases, when the contract was awarded. Any challenges to claimed costs must cite the correct cost principle version.

New FAR Cost Principles Guide

The FAR Cost Principles Guide has now been updated through FAC 2005-52 (June 2011) and is available for download here. The previous update was through FAC 2005-41 (April 2010). This guide keeps track of all changes to cost principles since the FAR was first published in 1984. If there is ever a question over the allowability of costs under a particular contract, this is a great resource for determining the specific regulations in effect at the time of contract award.

A few FAR cost principles have not changed since 1984 (e.g. bad debt expense, alcoholic beverages) but most have. For example, the Compensation cost principle which covers the allowability of compensation costs has changed 30 times. That averages to more than once a year.

Can an Item be Charged Both Direct and Indirect?

Conventional wisdom says that you cannot charge a cost both direct and indirect. This is true to a certain extent because that would result in double counting. FAR (Federal Acquisition Regulations) and CAS (Cost Accounting Standards) require that each type of costs be allocated only once on on one basis to contracts and other final cost objectives. So, for example, you wouldn't charge QC labor direct to a Government contract but charge QC labor for commercial contracts to an indirect rate pool because then, the Government contract would be charged twice, once direct and once indirect. Some contractors take this idea a little too far, however, and try to force employee's into either direct or indirect. The requirements focus on "types" of costs, not categories of costs. So, QC labor is different than Management labor and both are different than Bid and Proposal labor. It is common, especially among smaller companies, for employees to wear multiple hats. One employee, in a given day, might charge work to a contract (direct), perform sustaining engineering effort (could be direct or indirect), work on a proposal for new work (indirect) and supervise some staff (indirect). Obviously, a good timekeeping system is necessary to accurately track, accumulate, and distribute these labor costs to the proper direct or indirect bucket.

For CAS covered contractors, these charging practices must be documented in a disclosure statement. But even for non-CAS covered contractors, we recommend documentation. It clarifies things for employees, ensures consistent practices, and will help when supporting incurred cost proposals or forward pricing proposals.

There are other situations, besides labor, where it would be appropriate to charge costs both direct and indirect. CAS gives a good example concerning fire protection. A contractor charges fire protection indirect but a contract requires fire protection services over and above what the contractor normally provides. The "over and above" effort can be charged direct while the normal services continue as an indirect charge. Security guard services is a similar example that we see or hear of quite often - especially in classified contracts.

FAR Cost Principles Guide - Updated

This information has been updated here.

The FAR Cost Principles Guide has been updated through FAC 2005-41 (April 2010) and is available for download here. This guide keeps track of all changes to cost principles since the FAR was first published in 1984. If there is ever a dispute over the allowability of costs under your contract(s), this is a great resource for determining the specific regulations in effect at the time of contract award.

Some FAR cost principles have not changed since 1984 (bad debt expense). Other principles have changed many times. For example, the Compensation cost principle which covers the allowability of compensation costs has changed 30 times. That averages to more than once a year.

DOE Revises Cost Principle on Legal Costs

On January 7th, the Department of Energy published a revision to its cost principle regarding the allowability of legal costs. In the DOE FAR Supplement 31.205-47, a reference to "10 CFR Part 708" has been changed to "10 CFR part 708". That's certainly a refleif for those of us who try to understand and apply these cost principles - it has been such a contentious issue. This simple change should indeed smooth out the Government contracting process and significantly ease pressure on Federal appropriations.

And speaking of the DOE FAR Supplement, there's a reminder here that contractors should be familiar with the specific FAR supplement of the Agency issuing the contract. Almost all Executive Agencies have FAR supplements and many of those affect cost principles in FAR Part 31. For example, the DOE FAR Supplement contains additional coverage on the allowability of insurance, pre-contract costs, professional and consultant services, independent research and development, and legal costs. The NASA FAR Supplement contains additional coverage on the allowability of compensation and precontract costs. The Department of Defense FAR Supplement adds additional coverage to compensation, lobbying, restructuring, and research and development. Here's a link to an index of all Agency FAR supplements.