What are Allowable Costs?

Definition: Allowable costs are those expenses specified in a contract that can be billed to the customer. For example, a contract to develop a customized lathe allows for the reimbursement of direct materials, direct labor, and a specific overhead charge as allowable costs. The seller cannot bill any other costs through to the customer. Thus, the nature of an allowable cost depends on the terms of the underlying contract.

Usually allowable costs are present in contracts between two companies. Think about allowable costs begs the question, are there unallowable costs? The answer is yes. Usually unallowable costs are referred to as non-covered or non-contracted costs. These are the costs that are over and above what the contract specifies.

What Does Allowable Costs Mean?

Allowable costs are usually present in a contracted product or service between two parties. These costs are determined by specific federal principles and sponsor guidelines, called reasonableness and allocability:

• Reasonable costs must form a fundamental part of the contract and must be in compliance with both state and federal laws. They must reflect the amount the average person would pay or expect to pay under the same circumstances. Reasonable costs should also be in line with ethical business practices and possess some degree of consistency.
• Allocability determines whether costs can be charged to federal awards, such as a grant. Such a cost must be incurred only as work that was performed under that federal award or as a closely related project and is limited by the size of the award. Like the reasonableness principle, allocable costs must be consistent.

To be reasonable, the cost must:

• Be the type of cost generally recognized as ordinary and necessary for the conduct of the contractor’s business or the contract performance;
• Be generally accepted under sound business practices, arms-length bargaining, and federal and state laws and regulations;
• Be consistent with the contractor’s responsibilities to the government, other customers, the owners of the business, employees, and the public at large; and
• Not include any significant deviations from the contractor’s established practices.

The determination of reasonableness of a particular cost depends on all of the circumstances and facts concerning the cost.

The other element of allowability is allocability of the cost to the contract. Allocability involves a determination as to whether the cost can be charged to the contract. To be allocable to the contract, the cost must:

• Be incurred specifically for the contract;
• Benefit both the contract and other work, and can be distributed to them in reasonable proportion to the benefits received; or
• Be necessary for the overall operation of the business.

If a cost is reasonable and allocable (chargeable) to the contract, then it will be allowable, unless specifically prohibited by the cost regulations.

Unallowable costs are those not covered in the contract or the organization’s rules and regulations. These will often be distinguished from allowable costs as an extension of the regulations governing them; unallowable costs can also be assumed from the limitations placed on allowable costs, such as spending more money than allocated for an expense.

Even costs made on a credit card may be allowable costs. Get the best hotel credit card to get your accommodations expenses reimbursed.

Example

Now let’s change the example slightly. Assume the contract states that the price of a coach ticket will be reimbursed. The coach tickets are still considered allowable costs because they will be reimbursed in full. The first class tickets, on the other hand, will only be partially considered allowable expenses since the government will only reimburse the cost of the coach tickets. The difference in between the two tickets is considered an unallowable cost.

Examples of some common allowable costs are listed below. This list is not exhaustive, and some items may not be allowed depending on the sponsor or program.

• Technical staff salaries and related expenses (ERE)
• Laboratory supplies (e.g. chemicals)
• Long distance phone charges
• Animals and animal care costs
• Well-justified computer costs
• Travel costs
• Specialized shop costs
• Research equipment repair and maintenance costs
• Data processing supplies
• Printing costs for technical reports
• Express mail