The Cost of Non-Compliance: How FAR & CAS Compliance Mistakes Can Undermine Your Entire Contract Strategy

Summary of Keypoints

• FAR and CAS non-compliance can eliminate opportunities before award or destroy profitability after award, causing proposal rejections, cost disallowances, billing suspensions, or forced contract type changes that undermine otherwise strong technical performance.
• Common compliance failures include indefensible indirect rate structures, double-charging costs, and inclusion of unallowable expenses, which lead to proposal inadequacy determinations, DCAA audit findings, and costly retroactive rate adjustments across multiple contracts.
• Inadequate accounting systems create systemic risk, as DCAA system disapprovals can block access to cost-reimbursement contracts, restrict future awards, and negatively affect cash flow and growth strategy under FAR requirements.
• Disallowed costs during incurred cost audits often result in significant repayments, sometimes hundreds of thousands of dollars, due to misallocations, inconsistent cost treatment, undocumented practices, or CAS violations affecting multiple fiscal years.
• Non-compliance damages contractor reputation and teaming prospects, as audit findings become part of the government record, influencing contracting officer responsibility determinations and prime contractor due diligence decisions.

Months of perfecting your technical approach, combined with solid past performance have put you in the running for a contract award. Your team has the credentials and you have priced competitively. Then your proposal gets rejected because your indirect rates don’t comply with Cost Accounting Standards.

On the contrary, you win the contract, perform brilliantly, and two years later, DCAA disallows $400,000 in costs because your allocation methodology violated FAR Part 31. Now you are stuck writing a check back to the government while trying to explain to your CFO how this happened.

This is the hidden cost of non-compliance. By the time you discover the problem, it’s already undermined everything else you have built.

This pattern repeats itself within the GovCon community with those who think compliance is separate from strategy. They believe FAR and CAS are checklist items for the accounting team to handle while leadership focuses on winning work and delivering performance. That separation is precisely what creates the vulnerability.

Take a look at how FAR and CAS non-compliance destroys contract strategies and what it actually costs when you get it wrong.

The Immediate Cost: Lost Proposals Before You Even Compete

Non-compliance does not wait until after the award to hurt you. It kills opportunities during the evaluation process when your cost volume is rejected for inadequacy.

According to FAR Part 15, contracting officers must determine whether proposed costs are reasonable and realistic before awarding cost-reimbursement contracts. That determination requires evaluating your indirect rate structure, allocation methodology, and cost accounting practices. If those practices don’t comply with FAR and CAS requirements, your proposal is deemed inadequate regardless of how strong your technical approach is.

Indirect Rates That Can’t Be Defended

Indirect rates are calculated by dividing cost pools by allocation bases. Simple math, but CAS 418 requires that the allocation of indirect costs to cost objectives be based on beneficial or causal relationships. If your overhead allocation base does not reflect the actual driver of overhead expenses, you are violating CAS even if you are not formally CAS-covered.

Contractors allocate facilities costs based on direct labor when they operate multiple sites with vastly different facility sizes and costs. That allocation does not reflect causation. Some contracts benefit more from facility usage than others, but the allocation methodology treats them all the same.

When evaluators review this structure, they see an allocation method that doesn’t make logical sense. Even if the resulting rate seems reasonable, the methodology itself raises questions. Those questions turn into deficiency notices, requests for additional information, and eventually a determination that the cost data is inadequate.

The contractor never makes it to the technical evaluation. They are out before the competition even begins.

Cost Allocations That Create Double-Charging

FAR 31.201-4 prohibits double-charging costs to the government. That sounds straightforward until you start looking at how contractors actually structure cost pools.

A common mistake is including costs in both the overhead and G&A pools when they should be in only one. Maybe you include IT support in overhead because it supports project teams, but you also include it in G&A because it supports the entire company. Now you are recovering IT costs twice, once through the overhead rate and once through G&A.

During proposal evaluation, DCAA reviews your rate structure and identifies the double-charging. Your proposed rates are questioned, your cost data is deemed unreliable, and your proposal fails the adequacy test.

Even worse, if DCAA does not catch it during pre-award review and you win the contract, they will find it during incurred cost audit. Then you are repaying the overcharged amounts from multiple contracts, often with interest.

Unallowable Costs That Inflate Your Rates

FAR Part 31.205 lists dozens of cost categories that are unallowable or limited in their allowability. These include entertainment costs, advertising expenses that don’t meet specific criteria, contributions and donations, excessive compensation above certain thresholds, interest on borrowings, and penalties and fines.

If your indirect rate calculations include unallowable costs that you have not identified and excluded, your rates are artificially high. When DCAA audits your proposal, they will recalculate your rates excluding the unallowable costs. Your newly adjusted rates might make your proposal uncompetitive, or they might be so different from what you proposed that the government questions whether you understand cost accounting requirements at all.

According to DCAA guidance, contractors must have systems in place to identify and exclude unallowable costs. If you don’t, it signals that your accounting system does not meet adequacy standards, which is grounds for proposal rejection.

The Hidden Cost: Accounting System Disapprovals That Block Growth

Even if you get through proposal evaluation, non-compliance can catch up with you during accounting system reviews. An inadequate accounting system does not just cause problems on one contract, but can block your entire growth strategy.

What DCAA Looks for in System Reviews

When you bid on cost-reimbursement contracts, DCAA may conduct an accounting system audit to determine whether your system is adequate for government work. According to their audit guidance, they evaluate 18 specific criteria, including proper segregation of direct and indirect costs, identification of unallowable costs, accumulation of costs by contract, adequacy of the timekeeping system, and compliance with CAS, if applicable.

If your system fails to meet these criteria, DCAA issues a report noting deficiencies. That report goes into the government’s system and affects your ability to win future contracts.

Contracting officers see that your accounting system is inadequate. They know that awarding you a cost-reimbursement contract creates risk because you are unable to account for costs properly. So they either don’t award you the contract or restrict you to fixed-price work only.

The Ripple Effect on Contract Types

Winning new contracts isn’t the only thing inadequate accounting systems prevent you from. They can force modifications to existing contracts that change the risk profile and profitability.

Suppose you are performing a cost-reimbursement contract and DCAA determines your accounting system is inadequate. In that case, they may recommend that the contracting officer suspend your billing or convert the contract to a different type. A suspension of billing destroys your cash flow. A conversion to fixed-price transfers all cost risk to you, potentially turning a profitable contract into a loss.

Per FAR 16.301-3, the government should use cost-reimbursement contracts only with contractors that have adequate accounting systems and controls. If your system is inadequate, you shouldn’t have cost-reimbursement contracts. The government has the right to remedy that situation mid-performance.

The Expensive Cost: Disallowed Costs and Contract Adjustments

The most expensive consequence of non-compliance comes during incurred cost audits when DCAA disallows costs you have already billed and been paid for. Now you are returning money to the government while still incurring expenses.

How Cost Disallowances Happen

Every year, contractors performing cost-reimbursement contracts must submit an incurred cost submission showing actual costs incurred and claimed. DCAA audits these submissions to verify that claimed costs are allowable, allocable, and reasonable under FAR Part 31.

During these audits, DCAA reviews your cost accounting practices, rate calculations, and supporting documentation. They are looking for violations of FAR cost principles, CAS non-compliance, unallowable costs that weren’t excluded, misallocated costs, unsupported costs, and changes in accounting practices without proper disclosure.

When they find problems, they disallow the costs. Those disallowances flow through multiple fiscal years because your accounting practices affected every contract you performed during those years.

According to DCAA audit statistics, they questioned billions in contractor costs annually. Not all questioned costs become sustained disallowances, but contractors typically end up repaying 50-70% of questioned amounts after negotiations.

Real Examples of What This Costs

A mid-sized defense contractor included legal fees from an internal investigation in their G&A pool. Those fees totaled $175,000 and were spread across all contracts through the G&A rate. DCAA determined the fees were unallowable under FAR 31.205-47 because they related to proceedings involving fraud allegations. The contractor had to repay the full amount plus adjust future billing rates to prevent continued overcharging.

An IT contractor changed their overhead allocation base from direct labor dollars to total cost input without filing a CAS Disclosure Statement or notifying the government. The change resulted in a 6% shift in overhead allocation between contracts. DCAA determined this violated CAS 401 and required the contractor to recalculate rates using the disclosed methodology. The cumulative adjustment exceeded $800,000 across three years of contracts.

A professional services firm allocated business development costs directly to contracts when they were pursuing contract-specific opportunities, but included similar BD costs in overhead when pursuing general opportunities. DCAA found this treatment inconsistent and violative of FAR 31.205-18 and CAS 402. All business development costs were deemed indirect, requiring rate recalculations that disallowed $320,000 in direct charges.

These are not extreme cases. These are typical audit findings that happen when contractors don’t understand how FAR and CAS rules affect everyday accounting decisions.

The Strategic Cost: Damaged Reputation and Lost Opportunities

Beyond the immediate financial impact, non-compliance damages your reputation in ways that affect future opportunities for years to come.

How Information Gets Shared

When DCAA issues audit reports noting deficiencies or sustaining cost disallowances, those reports go into government systems accessible to contracting officers across agencies. Your compliance history becomes part of your contractor record.

Contracting officers check this history before awarding contracts. They look for patterns of accounting system deficiencies, significant cost disallowances, CAS non-compliance issues, and repeated audit findings in the same areas.

If your record shows compliance problems, contracting officers view you as higher risk. They may require additional oversight, impose special contract terms, or simply award to a competitor with a cleaner compliance record.

According to FAR 42.1501, contracting officers can use DCAA reports as a basis for determining contractor responsibility. A history of non-compliance can disqualify you from awards.

The Impact on Prime-Sub Relationships

In addition to affecting your direct relationship with the government, non-compliance affects your ability to work as a subcontractor on team bids.

Prime contractors conduct due diligence on potential teammates. They review past performance, accounting systems, and compliance history. If you have accounting system deficiencies or a history of disallowed costs, prime contractors see you as a liability.

They worry that your inadequate systems will create problems that jeopardize the entire team’s performance. They’re concerned that DCAA audits of your subcontract costs will question costs that the prime has already billed. They don’t want your compliance issues becoming their compliance issues.

So they team with someone else. Your non-compliance has now cost you teaming opportunities that were central to your growth strategy.

The Preventable Cost: What You Should Be Doing Instead

The frustrating thing about all of these costs is that they are entirely preventable. Sophisticated systems or massive compliance infrastructure are unnecessary. Instead, build FAR and CAS principles into your accounting practices from the beginning.

Align Your Accounting System With FAR Requirements

Your accounting system should be designed to meet FAR 31 cost principles and DCAA adequacy criteria. That means properly segregating direct and indirect costs, identifying and excluding unallowable costs before calculating rates, accumulating costs by contract using adequate job costing, maintaining timekeeping systems that meet DCAA standards, and documenting policies and procedures for cost accounting.

These are not burdensome requirements, but sound accounting practices that help you understand your actual cost structure. When you build them into your system from day one, compliance becomes automatic rather than an afterthought.

Structure Indirect Rates According to CAS Principles

Even if you are not CAS-covered, following CAS principles for indirect rate allocation makes your rates more defensible and more accurate. CAS requires that costs be accumulated in logical pools, that allocation bases reflect beneficial or causal relationships, that similar costs be treated consistently, and that accounting practices be disclosed and followed consistently.

These principles aren’t arbitrary rules. They are methods for ensuring that costs are allocated logically. When your rate structure follows these principles, evaluators and auditors can understand your methodology and verify that costs are appropriately allocated.

Maintain Supporting Documentation Proactively

One of the biggest causes of disallowed costs is inadequate documentation. Contractors incur costs legitimately but can’t provide the supporting evidence needed to demonstrate allowability or allocability during audits.

Build documentation requirements into your accounting processes. When costs are incurred, require that supporting documentation be attached. When allocating resources, document the rationale. When accounting policies are established or changed, document the decision process.

This documentation serves multiple purposes. It supports costs during audits. It provides guidance to accounting staff for consistent treatment. It also creates an audit trail that demonstrates you are managing costs deliberately rather than haphazardly.

Get Expert Help Before Problems Develop

The contractors who avoid compliance problems are usually those working with Government Contracts CPAs who understand the FAR and CAS requirements. General practice CPAs who file your taxes aren’t going to cut it. These are specialists who know government contract cost accounting and can design systems that comply with requirements while supporting your business strategy.

The investment in expert guidance pays for itself many times over by preventing disallowances, avoiding system deficiencies, streamlining proposal preparation, and maintaining the clean compliance record you need to compete for the best opportunities.

The Bottom Line

You can have the strongest technical capability in your industry, with flawless past performance and the most impressive team. However, if your cost accounting practices don’t comply with FAR and CAS requirements, you are building your contract strategy on a foundation that will eventually fail.

The cost of non-compliance isn’t only financial, though the financial costs can be severe. It’s strategic. It limits your ability to compete for the work you want and damages relationships with customers and teammates. Non-compliance diverts leadership attention from growth to remediation.

The cruelest part is that most of this cost is invisible until it’s too late. You don’t see the proposals that never made it past adequacy review, or those that contracting officers decided were too risky based on your compliance history. You never hear about the teams you weren’t invited to join because of your accounting system deficiencies.

The only thing you see are the immediate problems: the disallowed costs, the deficiency notices, and the suspended billing. By then, the strategic damage is already done.

The contractors who succeed long-term in government contracting understand that compliance isn’t separate from strategy. It’s the foundation that makes strategy executable. Get the foundation wrong, and everything else you build is at risk.

Ready to build compliance into your contract strategy before it costs you the opportunities you’ve worked hard to create? Let’s talk about what a solid foundation actually looks like for your business.