Direct vs. indirect costs in a GovCon business
Every dollar your company spends lands in one of three places: charged directly to a contract, pooled into an indirect rate, or set aside as unallowable. Getting the split right is the foundation of everything else — rates, billing, and the annual submission all run off it.
The three buckets
| Bucket | Definition | Examples |
|---|---|---|
| Direct | Identified specifically with a single final cost objective — one contract or task order. | Labor of engineers charging the contract, travel for that contract, subcontractor and ODC purchased for that contract. |
| Indirect | Incurred for a common purpose, not identifiable with one contract without disproportionate effort. | Fringe benefits, program-management overhead, facilities, accounting, HR, corporate management. |
| Unallowable | Allowable-cost rules exclude it from any government charge. Still a real business cost — still in your P&L — just never billed. | Entertainment, alcohol, lobbying, most advertising, fines and penalties, interest, bad debts. |
You record it, you just record it somewhere it can never reach a contract. And it stays in the allocation base for G&A even though it is out of the pool.
The consistency rule
FAR 31.202 says no cost may be charged as direct if other costs incurred for the same purpose in like circumstances have been charged as indirect. The reverse holds too. This is the rule that gets contractors in trouble more than any judgment call about a single expense.
The classic example is travel. Some contractors charge all travel direct. Some pool it in overhead. Either can be defensible. What is not defensible is charging it direct when a contract will reimburse it and pooling it when the contract will not. The same applies to bid and proposal effort, recruiting, training, and small tools.
Write the treatment down, apply it everywhere, and change it only at a fiscal year boundary with a documented reason.
Working through a call
- Can you name the single contract that caused this cost? If not, it is indirect.
- If you can name it, would it take disproportionate effort to trace? If so, treat it indirect and be consistent about it.
- Is the cost type named in FAR 31.205 as unallowable, or expressly unallowable under the contract? If so, it goes to the unallowable account regardless of who caused it.
- Does the contract itself restrict the treatment — a ceiling on ODCs, a requirement that travel follow the Joint Travel Regulations? Contract terms override your general practice.
- Record the decision in your cost accounting practices so the next person makes the same call.
The gray zone that costs money
- Uncompensated overtime on salaried exempt staff. If an engineer works 50 hours and charges 50, the effective hourly rate falls and the cost spreads across whatever they charged. If they charge 40, the other 10 hours of effort are absorbed. Total-time accounting is the cleaner answer and the one auditors expect.
- Idle or bench time. It is indirect. It cannot be parked on a contract because the contract has budget left.
- Bid and proposal. Indirect, and separately identified. Proposal work charged to a running contract is a mischarge.
- Subcontractor management. Direct if the contract calls for it and you can trace it. Overhead if it is general program administration.
- Owner compensation. Split between the direct work the owner actually performs and the indirect executive time. Reasonableness is tested separately.
Frequently asked
Can the same type of cost be direct on one contract and indirect on another?
Only if the circumstances genuinely differ, and you can explain how. FAR 31.202 requires like treatment in like circumstances. Auditors look specifically for costs that turn direct when a contract will reimburse them.
Where do unallowable costs go if they cannot be billed?
Into dedicated unallowable accounts in your general ledger. They remain company expenses and stay in the G&A allocation base, but they are removed from the indirect cost pool so they never reach a government contract.
How do we handle time an employee spends between contracts?
It is indirect — typically overhead. Charging bench time to a contract with budget remaining is one of the most common and most serious labor mischarges.
Is subcontractor cost direct?
Subcontract cost incurred to perform a specific contract is direct. Some contractors apply a reduced or capped G&A to subcontract dollars; whatever you choose, apply it consistently and disclose it.
Related
Indirect rate structure: fringe, overhead, and G&A
How the three-tier pool and base structure works, how the rates stack, and what changes when you use a value-added G&A base.
Read →Unallowable costs and how to segregate them
What FAR Part 31 makes unallowable, how to screen for it during the year rather than at year end, and why segregation has to be structural.
Read →Building a GovCon chart of accounts
A chart of accounts that segregates direct, indirect, and unallowable costs by construction — so compliance is a byproduct of posting, not a cleanup project.
Read →