Suppose you’re a small business diving into the world of Small Business Innovation Research (SBIR) or Small Business Technology Transfer (STTR) contracts. In that case, you’re likely thrilled about the funding but nervous about the rules. Enter FAR Part 31.2, the Federal Acquisition Regulation’s cost principles for commercial organizations. This section is your roadmap for determining which costs you can charge to your federal contract and which will land you in hot water with auditors like the Defense Contract Audit Agency (DCAA). For SBIR/STTR newbies and small businesses, mastering FAR 31.2 is the key to getting paid, staying compliant, and avoiding audit nightmares. Let’s unpack its core principles, debunk myths, and equip you with tools to navigate this critical regulation.
What Is FAR 31.2, and Why Does It Matter?
FAR Part 31.2, “Contracts with Commercial Organizations,” outlines the cost principles that govern how for-profit entities, like most SBIR/STTR recipients, manage and claim costs on federal contracts. It applies primarily to cost-reimbursement agreements, common in SBIR/STTR Phase II, but also impacts fixed-price contracts during audits or financial reviews. The goal? Ensure taxpayer dollars are spent on allowable, reasonable, and allocable costs, protecting the government and your bottom line.
Why should you care? As a small business, your cash flow hinges on getting reimbursed for legitimate costs. A single FAR 31.2 misstep claiming an unallowable cost, like a team outing, can lead to disallowed expenses, payment delays, or a DCAA audit that feels like a full-time job. Get it right, and you’ll build trust with contracting officers, streamline payments, and position your business for growth.
The Core of FAR 31.2: The Three Cost Tests
FAR 31.201 sets the foundation with three tests every cost must pass to be reimbursable. These are your guiding stars:
- Allowability (FAR 31.201-2)
A cost is allowable if it meets five criteria: reasonable, allocable, compliant with Generally Accepted Accounting Principles (GAAP), consistent with contract terms, and not prohibited by FAR 31.205. This last part is critical; FAR 31.205 lists specific unallowable costs, like entertainment, lobbying, or alcohol.
Example: Salaries for engineers on your SBIR prototype are allowable. A company party to celebrate a milestone is unallowable, per FAR 31.205-14. - Reasonableness (FAR 31.201-3)
A cost is reasonable if it reflects what a prudent business would pay in similar circumstances. This standard is subjective and contextual, so auditors compare your costs to market norms for your industry, stage, location, etc. For instance, spending $10,000 on software when a $2,000 alternative works just as well will raise red flags. (You can justify the difference with documentation that points to specific technical or functionality differences. More on this in another article.)
Example: Paying $200/hour for a specialized consultant is reasonable if it’s the industry rate. Paying $500/hour without justification? Not so much. - Allocability (FAR 31.201-4)
A cost is allocable if it benefits the contract. Direct costs, like materials for your STTR project, are straightforward. Indirect costs, like office utilities, must be allocated proportionally across all projects using a consistent method (e.g., square footage or labor hours).
Example: An employee splitting time 70% on SBIR and 30% on commercial work must have their salary allocated accordingly, backed by timesheets.
FAR 31.205: The Unallowable Costs Minefield
FAR 31.205 is the heart of FAR 31.2, detailing specific unallowable costs, no matter how reasonable they seem. Common pitfalls for SBIR/STTR contractors include:
- Entertainment (FAR 31.205-14): No charging for team-building events or client dinners.
Advertising (FAR 31.205-1): Marketing to boost your brand is off-limits, but recruiting ads may be allowable.
- Interest and Fines (FAR 31.205-15, 31.205-17): Loan interest or penalties for late taxes are unallowable.
- Travel Excesses (FAR 31.205-46): First-class flights or luxury hotels are out unless justified by contract needs.
Small businesses often assume “small” unallowable costs slip through. They don’t. A $500 unallowable expense can trigger a DCAA finding, so vigilance is key.
Myths and Traps for SBIR/STTR Newbies
Let’s debunk some misconceptions:
- Myth 1: “FAR 31.2 only applies to big contractors.” Wrong. Even SBIR Phase I recipients need compliant cost systems for cost-reimbursement contracts.
- Myth 2: “I don’t need documentation.” False. Costs can be disallowed without receipts, timesheets, or quotes, per FAR 31.201-2(d).
- Myth 3: “All R&D costs are allowable.” Not quite. Costs must still meet FAR 31.2’s tests, and unallowables like lobbying are off-limits.
A common trap is weak timekeeping. If your team logs hours weekly instead of daily or doesn’t tie them to specific contract tasks, auditors may reject labor costs, your most significant expense. Another is claiming unallowable costs, like advertising, thinking they’re “business development.” Check FAR 31.205 first.
Real-World Lesson
An SBIR Phase II contractor claimed $15,000 for “miscellaneous” costs without receipts. The DCAA disallowed it, citing FAR 31.201-2’s documentation rule, costing the company dearly. Another small business used daily timesheets and QuickBooks to track costs passed an audit, and secured full reimbursement. Preparation was the game-changer.
Your FAR 31.2 Compliance Task List
Ready to tackle FAR 31.2? Here’s a beginner’s basic task list:
- Cost Compliance Checklist:
- Is the cost allowable per FAR 31.205?
- Is it reasonable with market evidence (e.g., vendor quotes)?
- Is it allocable to the contract with clear records?
- Do I have documentation (receipts, timesheets)?
- Timekeeping Rule: Use a DCAA-compliant tool like Harvest. Log hours daily (e.g., “SBIR Phase II, Task 1”) with weekly supervisor approval.
- Accounting Setup: Configure QuickBooks for job cost accounting. Separate direct (e.g., lab supplies) and indirect (e.g., rent) costs. Flag unallowable costs like entertainment.
- Training: Hold a 30-minute team session on FAR 31.205 unallowable costs and timekeeping. A quick quiz reinforces the basics.
