DCAA Unallowable Costs: FAR Part 31 Cost Principles and What the Government Won't Pay For

Not every cost a government contractor incurs can be billed to the government, even indirectly through an overhead or G&A pool. FAR Part 31 sets out the cost principles that govern allowability on cost-reimbursement, time-and-materials, and CAS-covered contracts, and FAR 31.205 lists specific categories the government will not pay for under any circumstances. These are not judgment calls the contracting officer negotiates case by case. They are named, and a contractor’s accounting system has to identify and exclude them before they ever reach a government invoice, a proposal, or an incurred cost submission.

What costs are unallowable under FAR 31.205?

FAR 31.205 runs through more than 50 numbered subsections, each covering a specific type of cost. The categories that generate the largest share of DCAA audit findings, across contractors of every size, are a much shorter list.

• Entertainment costs (FAR 31.205-14): amusement, social activities, and related costs, including meals, tickets, and facility rentals for entertainment purposes. Unallowable regardless of whether the event has a business purpose.
• Alcoholic beverages (FAR 31.205-51): unallowable outright, with no exceptions and no partial allowability.
• Bad debts (FAR 31.205-3): losses from uncollectible accounts receivable and any related collection costs.
• Contributions and donations (FAR 31.205-8): charitable giving of cash, property, or services, regardless of the recipient or the contractor’s motive.
• Fines, penalties, and mischarging costs (FAR 31.205-15): any fine or penalty resulting from a violation of law, and the cost of correcting a labor mischarging violation once identified.
• Interest and other financial costs (FAR 31.205-20): interest on borrowed capital is generally unallowable, with a narrow exception for facilities capital cost of money computed under CAS 414 and CAS 417.
• Lobbying and political activity costs (FAR 31.205-22): costs of influencing legislation, elections, or referenda, including a substantial portion of costs associated with certain trade association dues that fund lobbying.
• Organization costs (FAR 31.205-27): costs of forming a corporation or partnership, including incorporation fees and related legal costs.
• Goodwill (FAR 31.205-49): amortization, expensing, write-off, or write-down of goodwill is unallowable regardless of how it is treated for financial reporting.
• Advertising and public relations costs (FAR 31.205-1): unallowable outside a specific set of exceptions, covered below.

What’s the difference: expressly vs partially unallowable?

Not every category on the list is a flat no. FAR 31.205 distinguishes between costs that are unallowable in full and costs that are allowable up to a defined limit, and the accounting treatment differs for each.

• Expressly unallowable costs are named specifically in a cost principle with no allowable portion at all: entertainment, alcohol, lobbying, fines and penalties, and bad debts all fall here. There is no dollar threshold or reasonableness test that makes any part of these costs allowable.
• Partially allowable costs have a stated cap, and only the excess is unallowable. Travel costs are allowable up to the federal per diem rate, with the excess unallowable. Senior executive compensation is allowable up to a benchmark published annually by the Office of Federal Procurement Policy under FAR 31.205-6(p) (roughly $668,525 for calendar 2025 for the five most highly compensated executives at a business unit), with compensation above the cap unallowable.
• Directly associated costs are a separate concept, and one that trips up contractors who only screen the obvious line items. A cost that would be allowable standing alone can become unallowable if it results directly from an unallowable activity. The airfare and hotel cost of attending an event whose entertainment costs are unallowable, or the administrative time spent preparing an unallowable lobbying submission, becomes unallowable by association even though travel and labor are ordinarily allowable categories.

What’s the advertising and public relations exception?

Advertising is a useful illustration of how FAR 31.205 actually works, because the general rule is a flat unallowable, and the exceptions are narrow and specific rather than a broad carve-out for “legitimate business advertising.”

• The general rule under FAR 31.205-1 is that advertising and public relations costs are unallowable.
• Recruitment advertising is an exception: help-wanted ads for specific open positions are allowable, and are covered separately under compensation-related cost principles.
• Advertising required by the contract itself, or by law (certain notices, for example), is allowable.
• Costs of participating in trade shows and exhibits to demonstrate equipment, or to acquire scarce items, can be allowable in narrow circumstances tied to a specific procurement need.
• General image advertising, sponsorships aimed at public goodwill, and marketing collateral aimed at winning commercial or government business are not covered by these exceptions and remain unallowable, even when a business case exists for the spend.

What’s the FAR 42.709 penalty, and how does it work?

Including unallowable costs in a final indirect cost rate proposal is not simply corrected after the fact with no consequence. FAR 42.709 establishes a specific monetary penalty, separate from the disallowance itself, that applies to contracts exceeding $1 million (excluding firm-fixed-price contracts without cost incentives and firm-fixed-price commercial item purchases).

• If a cost is expressly unallowable under a specific FAR or CAS cost principle, or was previously determined unallowable for that same contractor before the current proposal was submitted, the penalty equals the amount of the disallowed cost allocated to the contracts covered by the proposal, plus interest on any portion already paid.
• If the contractor knew the cost was unallowable at the time it was included in the proposal, the penalty doubles: two times the disallowed amount.
• There is no dollar threshold that exempts a contractor from the penalty once a cost is found expressly unallowable, and payment to the contractor is not a precondition for the penalty to apply. The one relief valve is a waiver under FAR 42.709-6, which the contracting officer can grant in specific circumstances but is not obligated to.
• These penalties are separate from, and in addition to, whatever administrative, civil, or criminal penalties apply under other law, including the False Claims Act for a knowing submission.

How do I segregate unallowable costs in my accounting?

The government does not expect a contractor never to incur an unallowable cost. It expects the accounting system to identify and exclude those costs before they reach a billing, proposal, or incurred cost submission, which is one of the specific criteria in DFARS 252.242-7006.

• The cleanest structure is a dedicated general ledger account for each unallowable category (entertainment, alcohol, contributions, fines, lobbying), so the classification happens at the point of entry rather than through a year-end scrub.
• A year-end scrub approach, reviewing the whole indirect pool after the fact and pulling out anything unallowable, works in theory but fails in practice more often than not, because it depends on someone remembering every FAR 31.205 category and reviewing every transaction, months after the fact, with no flag on the account itself.
• Executive compensation above the FAR cap and travel costs above per diem need their own tracking, since these are partial rather than full exclusions and require a calculation, not just a flag.

What happens when unallowable costs surface during an audit?

If DCAA finds unallowable costs during an incurred cost audit that the contractor did not catch, the costs become a questioned cost in the audit report, subject to negotiation with the contracting officer, and potentially subject to the FAR 42.709 penalty described above if the contract value and cost type meet the threshold.

• A contractor that discovers unallowable costs on its own, before DCAA does, should consider a voluntary disclosure to the contracting officer. It does not eliminate the disallowance, but it demonstrates good faith and materially reduces the risk that the finding is treated as a knowing submission rather than an oversight.
• A pattern of unallowable costs across multiple years, especially in a category previously flagged, is what moves a finding from a routine questioned cost toward the kind of “knowing or reckless disregard” standard that opens False Claims Act exposure, covered in more detail in the guide on the DCAA audit process.

What should I do next?

The fastest way to reduce unallowable cost exposure is structural, not a periodic review. Build the chart of accounts so unallowable categories are flagged when the transaction is recorded, keep the compensation and travel caps current every year, and treat a prior year’s finding as a standing instruction to check that the same cost is not still being coded the same way.

• DCAA compliant accounting system requirements, where unallowable cost segregation fits into the full system adequacy picture
• DCAA incurred cost submission, where unallowable costs must be identified on Schedule J before rates are proposed
• DCAA indirect rate structure, why an unallowable cost left in a pool overstates every rate built from it
• Cost Accounting Standards applicability, where CAS 405 adds a consistency requirement to unallowable cost accounting for CAS-covered contractors

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.