June 10, 2019
Can you demonstrate that your proposed or incurred costs are reasonable? If not, then you may not be able to negotiate a desirable price or get paid for your incurred expenses. Federal Acquisition Regulations (FARs) contain cost principles and procedures. The cost principles and procedures in FAR Subpart 31.2 and in agency supplements are used in pricing negotiated fixed price contracts and contract modifications with commercial organizations whenever a cost analysis is required to be performed by FAR 15.404-1(c).
The principles are also applied whenever the contract calls for the payment of allowable costs under cost-reimbursement contracts and under the cost-reimbursement portion of time-and materials contracts.
FAR 31.201-1 addresses the composition of total cost. While the total cost of your contract includes all expenses that are properly allocable to the contract, the allowable costs to the federal government are limited to those allocable costs that are allowable pursuant to FAR Part 31 and any applicable agency supplements.
FAR 31.201-2 provides five criteria for determining allowability of your proposed or incurred costs. A cost is allowable only when it complies with the requirements for all five of the criteria. One of these criteria requires that your costs be reasonable.
How Reasonable Is Defined
A cost is reasonable if, in nature and amount, it does not exceed the amount that would be incurred by a prudent person in the conduct of competitive business. The government will not make a presumption of reasonableness just because you incurred the cost. If an initial review of the facts results in a challenge of a specific cost by a U.S. Government Contracting Officer, you have the burden of proof to establish that the cost is reasonable.
What is considered reasonable depends upon a variety of considerations and circumstances including:
- Is it the type of cost generally recognized as ordinary and necessary for the conduct of your business or the contract performance?
- Does it involve generally accepted sound business practices, arm’s length bargaining, and federal and state laws and regulations?
- Are you fulfilling your responsibilities to the government, other customers, the owners of the business, employees and the public at large?
- Are there any significant deviations from your established practices?
The reasonableness of expenses is usually demonstrated by a comparative analysis. For example, reasonableness of labor compensation can be demonstrated by comparison to salary surveys. Obtaining multiple quotes from responsible suppliers competing independently can demonstrate reasonableness of materials, subcontracts and other supplier costs. Additionally, one or more of the price analysis techniques delineated in FAR 15.404-1(b) — or when necessary cost analysis per FAR 15.404-1(c) — can also be used to demonstrate cost or price reasonableness.
Government auditors can and will challenge the reasonableness of a proposed or incurred cost. If you are unable to support the reasonableness of a proposed cost, it will be cited as either unsupported or questioned, increasing the likelihood of a lower negotiated price. If you are unable to support an incurred cost, the amount will be questioned and disallowed.
Regardless of the comparative analysis technique you choose to employ, you are responsible for accounting for costs appropriately and for maintaining records. This includes maintaining supporting documentation, which are:
- Adequate to demonstrate that costs claimed have been incurred;
- Allocable to the contract; and
- Comply with applicable cost principles in FAR subpart 31.2 and agency supplements, including reasonableness.
A Contracting Officer may disallow all or part of a claimed cost that is not adequately supported.
- Establish appropriate human resource department policies and procedures to ensure the reasonableness of labor compensation. These can include external wage and salary benchmarking.
- Establish appropriate purchasing and subcontracting policies and procedures for performance of price and/or cost analysis.
- Ensure preparation and retention of comparative analysis documentation to support the reasonableness of proposed and incurred costs.