FAR Subpart 42.7

SUBPART 42.7—INDIRECT COST RATES

Subpart 42.7—Indirect Cost Rates
42.700 Scope of subpart.
This subpart prescribes policies and procedures for
establishing—
(a) Billing rates; and
(b) Final indirect cost rates.
42.701 Definition.
“Billing rate,” as used in this subpart, means an indirect
cost rate—
(1) Established temporarily for interim reimbursement
of incurred indirect costs; and
(2) Adjusted as necessary pending establishment of
final indirect cost rates.
42.702 Purpose.
(a) Establishing final indirect cost rates under this subpart
provides—
(1) Uniformity of approach with a contractor when
more than one contract or agency is involved;
(2) Economy of administration; and
(3) Timely settlement under cost-reimbursement
contracts.
(b) Establishing billing rates provides a method for interim
reimbursement of indirect costs at estimated rates subject to
adjustment during contract performance and at the time the
final indirect cost rates are established.
42.703 General.
42.703-1 Policy.
(a) A single agency (see 42.705-1) shall be responsible for
establishing final indirect cost rates for each business unit.
These rates shall be binding on all agencies and their contracting offices, unless otherwise specifically prohibited by statute. An agency shall not perform an audit of indirect cost rates
when the contracting officer determines that the objectives of
the audit can reasonably be met by accepting the results of an
audit that was conducted by any other department or agency
of the Federal Government (10 U.S.C. 2313(d) and
41 U.S.C. 254d(d)).
(b) Billing rates and final indirect cost rates shall be used
in reimbursing indirect costs under cost-reimbursement contracts and in determining progress payments under fixed-price
contracts.
(c) To ensure compliance with 10 U.S.C. 2324(a) and
41 U.S.C. 256(a)—
(1) Final indirect cost rates shall be used for contract
closeout for a business unit, unless the quick-closeout procedure in 42.708 is used. These final rates shall be binding for
all cost-reimbursement contracts at the business unit, subject

42.703-2
to any specific limitation in a contract or advance agreement;
and
(2) Established final indirect cost rates shall be used in
negotiating the final price of fixed-price incentive and fixedprice redeterminable contracts and in other situations requiring that indirect costs be settled before contract prices are
established, unless the quick-closeout procedure in 42.708 is
used.1010
42.703-2 Certificate of indirect costs.
(a) General. In accordance with 10 U.S.C. 2324(h) and
41 U.S.C. 256(h), a proposal shall not be accepted and no
agreement shall be made to establish final indirect cost rates
unless the costs have been certified by the contractor.
(b) Waiver of certification. (1) The agency head, or designee, may waive the certification requirement when—
(i) It is determined to be in the interest of the United
States; and
(ii) The reasons for the determination are put in writing and made available to the public.
(2) A waiver may be appropriate for a contract with—
(i) A foreign government or international organization, such as a subsidiary body of the North Atlantic Treaty
Organization;
(ii) A state or local government subject to OMB
Circular A-87;
(iii) An educational institution subject to OMB
Circular A-21; and
(iv) A nonprofit organization subject to OMB
Circular A-122.
(c) Failure to certify. (1) If the contractor has not certified
its proposal for final indirect cost rates and a waiver is not
appropriate, the contracting officer may unilaterally establish
the rates.
(2) Rates established unilaterally should be—
(i) Based on audited historical data or other available
data as long as unallowable costs are excluded; and
(ii) Set low enough to ensure that unallowable costs
will not be reimbursed.
(d) False certification. The contracting officer should consult with legal counsel to determine appropriate action when
a contractor’s certificate of final indirect costs is thought to be
false.
(e) Penalties for unallowable costs. 10 U.S.C. 2324(a)
through (d) and 41 U.S.C. 256(a) through (d) prescribe penalties for submission of unallowable costs in final indirect cost
rate proposals (see 42.709 for penalties and contracting officer
responsibilities).
(f) Contract clause. (1) Except as provided in
paragraph (f)(2) of this subsection, the clause at 52.242-4,
Certification of Final Indirect Costs, shall be incorporated into
all solicitations and contracts which provide for establishment
of final indirect cost rates.
42.7-1

42.704
(2) The Department of Energy may provide an alternate
clause in its agency supplement for its Management and Operating contracts.
42.704 Billing rates.
(a) The contracting officer (or cognizant Federal agency
official) or auditor responsible under 42.705 for establishing
the final indirect cost rates also shall be responsible for determining the billing rates.
(b) The contracting officer (or cognizant Federal agency
official) or auditor shall establish billing rates on the basis of
information resulting from recent review, previous rate audits
or experience, or similar reliable data or experience of other
contracting activities. In establishing billing rates, the contracting officer (or cognizant Federal agency official) or auditor should ensure that the billing rates are as close as possible
to the final indirect cost rates anticipated for the contractor’s
fiscal period, as adjusted for any unallowable costs. When the
contracting officer (or cognizant Federal agency official) or
auditor determines that the dollar value of contracts requiring
use of billing rates does not warrant submission of a detailed
billing rate proposal, the billing rates may be established by
making appropriate adjustments from the prior year’s indirect
cost experience to eliminate unallowable and nonrecurring
costs and to reflect new or changed conditions.
(c) Once established, billing rates may be prospectively or
retroactively revised by mutual agreement of the contracting
officer (or cognizant Federal agency official) or auditor and
the contractor at either party’s request, to prevent substantial
overpayment or underpayment. When agreement cannot be
reached, the billing rates may be unilaterally determined by
the contracting officer (or cognizant Federal agency official).
(d) The elements of indirect cost and the base or bases used
in computing billing rates shall not be construed as determinative of the indirect costs to be distributed or of the bases of
distribution to be used in the final settlement.
(e) When the contractor provides to the cognizant contracting officer the certified final indirect cost rate proposal in
accordance with 42.705-1(b) or 42.705-2(b), the contractor
and the Government may mutually agree to revise billing rates
to reflect the proposed indirect cost rates, as approved by the
Government to reflect historically disallowed amounts from
prior years’ audits, until the proposal has been audited and settled. The historical decrement will be determined by either the
cognizant contracting officer (42.705-1(b)) or the cognizant
auditor (42.705-2(b)).
42.705 Final indirect cost rates.
(a) Final indirect cost rates shall be established on the basis
of—
(1) Contracting officer determination procedure (see
42.705-1), or
(2) Auditor determination procedure (see 42.705-2).
42.7-2

FEDERAL ACQUISITION REGULATION
(b) Within 120 days (or longer period, if approved in writing by the contracting officer,) after settlement of the final
annual indirect cost rates for all years of a physically complete
contract, the contractor must submit a completion invoice or
voucher reflecting the settled amounts and rates. To determine
whether a period longer than 120 days is appropriate, the contracting officer should consider whether there are extenuating
circumstances, such as the following:
(1) Pending closeout of subcontracts awaiting Government audit.
(2) Pending contractor, subcontractor, or Government
claims.
(3) Delays in the disposition of Government property.
(4) Delays in contract reconciliation.
(5) Any other pertinent factors.
(c)(1) If the contractor fails to submit a completion invoice
or voucher within the time specified in paragraph (b) of this
section, the contracting officer may—
(i) Determine the amounts due to the contractor
under the contract; and
(ii) Record this determination in a unilateral modification to the contract.
(2) This contracting officer determination must be
issued as a final decision in accordance with 33.211.
42.705-1 Contracting officer determination procedure.
(a) Applicability and responsibility. Contracting officer
determination shall be used for the following, with the indicated cognizant contracting officer (or cognizant Federal
agency official) responsible for establishing the final indirect
cost rates:
(1) Business units of a multidivisional corporation
under the cognizance of a corporate administrative contracting officer (see Subpart 42.6), with that officer responsible for
the determination, assisted, as required, by the administrative
contracting officers, assigned to the individual business units.
Negotiations may be conducted on a coordinated or centralized basis, depending upon the degree of centralization within
the contractor’s organization.
(2) Business units not under the cognizance of a corporate administrative contracting officer, but having a resident
administrative contracting officer (see 42.602), with that
officer responsible for the determination. For this purpose, a
nonresident administrative contracting officer is considered
as resident if at least 75 percent of the administrative contracting officer’s time is devoted to a single contractor.
(3) For business units not included in paragraph (a)(1)
or (a)(2) of this subsection, the contracting officer (or cognizant Federal agency official) will determine whether the rates
will be contracting officer or auditor determined.
(4) Educational institutions (see 42.705-3).
(5) State and local governments (see 42.705-4).

FAC 2005–17 JUNE 14, 2007
SUBPART 42.7—INDIRECT COST RATES
(6) Nonprofit organizations other than educational and
state and local governments (see 42.705-5).
(b) Procedures. (1) In accordance with the Allowable Cost
and Payment clause at 52.216-7, the contractor shall submit to
the contracting officer (or cognizant Federal agency official)
and to the cognizant auditor a final indirect cost rate proposal.
The required content of the proposal and supporting data will
vary depending on such factors as business type, size, and
accounting system capabilities. The contractor, contracting
officer, and auditor must work together to make the proposal,
audit, and negotiation process as efficient as possible. Accordingly, each contractor shall submit an adequate proposal to the
contracting officer (or cognizant Federal agency official) and
auditor within the 6-month period following the expiration of
each of its fiscal years. Reasonable extensions, for exceptional
circumstances only, may be requested in writing by the contractor and granted in writing by the contracting officer. A
contractor shall support its proposal with adequate supporting
data. For guidance on what generally constitutes an adequate
final indirect cost rate proposal and supporting data, contractors should refer to the Model Incurred Cost Proposal in
Chapter 6 of the Defense Contract Audit Agency Pamphlet
No. 7641.90, Information for Contractors, available via the
Internet at http://www.dcaa.mil.
(2) The auditor shall submit to the contracting officer
(or cognizant Federal agency official) an advisory audit report
identifying any relevant advance agreements or restrictive
terms of specific contracts.
(3) The contracting officer (or cognizant Federal agency
official) shall head the Government negotiating team, which
includes the cognizant auditor and technical or functional personnel as required. Contracting offices having significant dollar interest shall be invited to participate in the negotiation and
in the preliminary discussion of critical issues. Individuals or
offices that have provided a significant input to the Government position should be invited to attend.
(4) The Government negotiating team shall develop a
negotiation position. Pursuant to 10 U.S.C. 2324(f) and
41 U.S.C. 256(f), the contracting officer shall—
(i) Not resolve any questioned costs until
obtaining—
(A) Adequate documentation on the costs; and
(B) The contract auditor’s opinion on the
allowability of the costs.
(ii) Whenever possible, invite the contract auditor to
serve as an advisor at any negotiation or meeting with the contractor on the determination of the contractor’s final indirect
cost rates.
(5) The cognizant contracting officer shall—
(i) Conduct negotiations;
(ii) Prepare a written indirect cost rate agreement
conforming to the requirements of the contracts;

42.705-2
(iii) Prepare, sign, and place in the contractor general
file (see 4.801(c)(3)) a negotiation memorandum covering—
(A) The disposition of significant matters in the
advisory audit report;
(B) Reconciliation of all costs questioned, with
identification of items and amounts allowed or disallowed in
the final settlement as well as the disposition of period costing
or allocability issues;
(C) Reasons why any recommendations of the
auditor or other Government advisors were not followed; and
(D) Identification of cost or pricing data submitted during the negotiations and relied upon in reaching a settlement; and
(iv) Distribute resulting documents in accordance
with 42.706.
(v) Notify the contractor of the individual costs
which were considered unallowable and the respective
amounts of the disallowance.
42.705-2 Auditor determination procedure.
(a) Applicability and responsibility. (1) The cognizant
Government auditor shall establish final indirect cost rates for
business units not covered in 42.705-1(a).
(2) In addition, auditor determination may be used for
business units that are covered in 42.705-1(a) when the contracting officer (or cognizant Federal agency official) and
auditor agree that the indirect costs can be settled with little
difficulty and any of the following circumstances apply:
(i) The business unit has primarily fixed-price contracts, with only minor involvement in cost-reimbursement
contracts.
(ii) The administrative cost of contracting officer
determination would exceed the expected benefits.
(iii) The business unit does not have a history of disputes and there are few cost problems.
(iv) The contracting officer (or cognizant Federal
agency official) and auditor agree that special circumstances
require auditor determination.
(b) Procedures. (1) The contractor shall submit to the cognizant contracting officer (or cognizant Federal agency official) and auditor a final indirect cost rate proposal in
accordance with 42.705-1(b)(1).
(2) Upon receipt of a proposal, the auditor shall—
(i) Audit the proposal and seek agreement on indirect
costs with the contractor;
(ii) Prepare an indirect cost rate agreement conforming to the requirements of the contracts. The agreement shall
be signed by the contractor and the auditor;
(iii) If agreement with the contractor is not reached,
forward the audit report to the contracting officer (or cognizant Federal agency official) identified in the Directory of
Contract Administration Services Components (see 42.203),
who will then resolve the disagreement; and
42.7-3

FAC 2005–17 JUNE 14, 2007
42.705-3
(iv) Distribute resulting documents in accordance
with 42.706.
42.705-3 Educational institutions.
(a) General. (1) Postdetermined final indirect cost rates
shall be used in the settlement of indirect costs for all costreimbursement contracts with educational institutions, unless
predetermined final indirect cost rates are authorized and used
(see paragraph (b) of this subsection).
(2) OMB Circular No. A-21, Cost Principles for Educational Institutions, assigns each educational institution to a
single Government agency for the negotiation of indirect cost
rates and provides that those rates shall be accepted by all Federal agencies. Cognizant Government agencies and educational institutions are listed in the Directory of Federal
Contract Audit Offices (see 42.103).
(3) The cognizant agency shall establish the billing rates
and final indirect cost rates at the educational institution, consistent with the requirements of this subpart, Subpart 31.3,
and the OMB Circular. The agency shall follow the procedures outlined in 42.705-1(b).
(4) If the cognizant agency is unable to reach agreement
with an institution, the appeals system of the cognizant agency
shall be followed for resolution of the dispute.
(b) Predetermined final indirect cost rates. (1)
Under
cost-reimbursement research and development contracts with
universities, colleges, or other educational institutions
(41 U.S.C. 254a), payment for reimbursable indirect costs
may be made on the basis of predetermined final indirect cost
rates. The cognizant agency is not required to establish predetermined rates, but if they are established, their use must be
extended to all the institution’s Government contracts.
(2) In deciding whether the use of predetermined rates
would be appropriate for the educational institution concerned, the agency should consider both the stability of the
institution’s indirect costs and bases over a period of years and
any anticipated changes in the amount of the direct and indirect costs.
(3) Unless their use is approved at a level in the agency
(see paragraph (a)(2) of this subsection) higher than the contracting officer, predetermined rates shall not be used when—
(i) There has been no recent audit of the indirect
costs;
(ii) There have been frequent or wide fluctuations in
the indirect cost rates and the bases over a period of years; or
(iii) The estimated reimbursable costs for any individual contract are expected to exceed $1 million annually.
(4)(i) If predetermined rates are to be used and no rates
have been previously established for the institution’s current
fiscal year, the agency shall obtain from the institution a proposal for predetermined rates.
(ii) If the proposal is found to be generally acceptable, the agency shall negotiate the predetermined rates with
42.7-4

FEDERAL ACQUISITION REGULATION
the institution. The rates should be based on an audit of the
institution’s costs for the year immediately preceding the year
in which the rates are being negotiated. If this is not possible,
an earlier audit may be used, but appropriate steps should be
taken to identify and evaluate significant variations in costs
incurred or in bases used that may have a bearing on the reasonableness of the proposed rates. However, in the case of
smaller contracts (i.e.,contracts that do not exceed the simplified acquisition threshold), an audit made at an earlier date is
acceptable if—
(A) There have been no significant changes in the
contractor’s organization; and
(B) It is reasonably apparent that another audit
would have little effect on the rates finally agreed upon and
the potential for overpayment of indirect cost is relatively
insignificant.
(5) If predetermined rates are used—
(i) The contracting officer shall include the negotiated rates and bases in the contract Schedule; and
(ii) See 16.307(g), which prescribes the clause at
52.216-15, Predetermined Indirect Cost Rates.
(6) Predetermined indirect cost rates shall be applicable
for a period of not more than four years. The agency shall
obtain the contractor’s proposal for new predetermined rates
sufficiently in advance so that the new rates, based on current
data, may be promptly negotiated near the beginning of the
new fiscal year or other period agreed to by the parties (see
paragraphs (b) and (d) of the clause at 52.216-15, Predetermined Indirect Cost Rates).
(7) Contracting officers shall use billing rates established by the agency to reimburse the contractor for work performed during a period not covered by predetermined rates.
42.705-4 State and local governments.
OMB Circular No. A-87 concerning cost principles for
state and local governments (see Subpart 31.6) establishes the
cognizant agency concept and procedures for determining a
cognizant agency for approving state and local government
indirect costs associated with federally-funded programs and
activities. The indirect cost rates negotiated by the cognizant
agency will be used by all Federal agencies that also award
contracts to these same state and local governments.
42.705-5 Nonprofit organizations other than educational
and state and local governments.
(See OMB Circular No. A-122.)
42.706 Distribution of documents.
(a) The contracting officer or auditor shall promptly distribute executed copies of the indirect cost rate agreement to
the contractor and to each affected contracting agency and
shall provide copies of the agreement for the contract files, in

FAC 2005–17 JUNE 14, 2007
SUBPART 42.7—INDIRECT COST RATES
accordance with the guidance for contract modifications in
Subpart 4.2, Contract Distribution.
(b) Copies of the negotiation memorandum prepared under
contracting officer determination or audit report prepared
under auditor determination shall be furnished, as appropriate,
to the contracting offices and Government audit offices.
42.707 Cost-sharing rates and limitations on indirect cost
rates.
(a) Cost-sharing arrangements, when authorized, may call
for the contractor to participate in the costs of the contract by
accepting indirect cost rates lower than the anticipated actual
rates. In such cases, a negotiated indirect cost rate ceiling may
be incorporated into the contract for prospective application.
For cost sharing under research and development contracts,
see 35.003(b).
(b)(1) Other situations may make it prudent to provide a
final indirect cost rate ceiling in a contract. Examples of such
circumstances are when the proposed contractor—
(i) Is a new or recently reorganized company, and
there is no past or recent record of incurred indirect costs;
(ii) Has a recent record of a rapidly increasing indirect cost rate due to a declining volume of sales without a commensurate decline in indirect expenses; or
(iii) Seeks to enhance its competitive position in a
particular circumstance by basing its proposal on indirect cost
rates lower than those that may reasonably be expected to
occur during contract performance, thereby causing a cost
overrun.
(2) In such cases, an equitable ceiling covering the final
indirect cost rates may be negotiated and specified in the
contract.
(c) When ceiling provisions are utilized, the contract shall
also provide that—
(1) The Government will not be obligated to pay any
additional amount should the final indirect cost rates exceed
the negotiated ceiling rates, and
(2) In the event the final indirect cost rates are less than
the negotiated ceiling rates, the negotiated rates will be
reduced to conform with the lower rates.
42.708 Quick-closeout procedure.
(a) The contracting officer responsible for contract closeout shall negotiate the settlement of indirect costs for a specific contract, in advance of the determination of final indirect
cost rates, if—
(1) The contract is physically complete;
(2) The amount of unsettled indirect cost to be allocated
to the contract is relatively insignificant. Indirect cost
amounts will be considered insignificant when—
(i) The total unsettled indirect cost to be allocated to
any one contract does not exceed $1,000,000; and

42.709-1
(ii) Unless otherwise provided in agency procedures,
the cumulative unsettled indirect costs to be allocated to one
or more contracts in a single fiscal year do not exceed
15 percent of the estimated, total unsettled indirect costs allocable to cost-type contracts for that fiscal year. The contracting officer may waive the 15 percent restriction based upon a
risk assessment that considers the contractor’s accounting,
estimating, and purchasing systems; other concerns of the
cognizant contract auditors; and any other pertinent information; and
(3) Agreement can be reached on a reasonable estimate
of allocable dollars.
(b) Determinations of final indirect costs under the quickcloseout procedure provided for by the Allowable Cost and
Payment clause at 52.216-7 shall be final for the contract it
covers and no adjustment shall be made to other contracts for
over- or under-recoveries of costs allocated or allocable to the
contract covered by the agreement.
(c) Indirect cost rates used in the quick closeout of a contract shall not be considered a binding precedent when establishing the final indirect cost rates for other contracts.
42.709 Scope.
(a) This section implements 10 U.S.C. 2324(a) through (d)
and 41 U.S.C. 256(a) through (d). It covers the assessment of
penalties against contractors which include unallowable indirect costs in—
(1) Final indirect cost rate proposals; or
(2) The final statement of costs incurred or estimated to
be incurred under a fixed-price incentive contract.
(b) This section applies to all contracts in excess of
$650,000, except fixed-price contracts without cost incentives
or any firm-fixed-price contracts for the purchase of commercial items.
42.709-1 General.
(a) The following penalties apply to contracts covered by
this section:
(1) If the indirect cost is expressly unallowable under a
cost principle in the FAR, or an executive agency supplement
to the FAR, that defines the allowability of specific selected
costs, the penalty is equal to—
(i) The amount of the disallowed costs allocated to
contracts that are subject to this section for which an indirect
cost proposal has been submitted; plus
(ii) Interest on the paid portion, if any, of the
disallowance.
(2) If the indirect cost was determined to be unallowable
for that contractor before proposal submission, the penalty is
two times the amount in paragraph (a)(1)(i) of this section.
(b) These penalties are in addition to other administrative,
civil, and criminal penalties provided by law.
42.7-5

FAC 2005–13 SEPTEMBER 28, 2006
42.709-2

FEDERAL ACQUISITION REGULATION

(c) It is not necessary for unallowable costs to have been
paid to the contractor in order to assess a penalty.

rate from demanding repayment of any paid portion of the disallowed cost.)

42.709-2 Responsibilities.
(a) The cognizant contracting officer is responsible for—
(1) Determining whether the penalties in 42.709-1(a)
should be assessed;
(2) Determining whether such penalties should be
waived pursuant to 42.709-5; and
(3) Referring the matter to the appropriate criminal
investigative organization for review and for appropriate
coordination of remedies, if there is evidence that the contractor knowingly submitted unallowable costs.
(b) The contract auditor, in the review and/or the determination of final indirect cost proposals for contracts subject to
this section, is responsible for—
(1) Recommending to the contracting officer which
costs may be unallowable and subject to the penalties in
42.709-1(a);
(2) Providing rationale and supporting documentation
for any recommendation; and
(3) Referring the matter to the appropriate criminal
investigative organization for review and for appropriate
coordination of remedies, if there is evidence that the contractor knowingly submitted unallowable costs.

42.709-4 Computing interest.
For 42.709-1(a)(1)(ii), compute interest on any paid portion of the disallowed cost as follows:
(a) Consider the overpayment to have occurred, and interest to have begun accumulating, from the midpoint of the contractor’s fiscal year. Use an alternate equitable method if the
cost was not paid evenly over the fiscal year.
(b) Use the interest rate specified by the Secretary of the
Treasury pursuant to Pub. L. 92-41 (85 Stat. 97).
(c) Compute interest from the date of overpayment to the
date of the demand letter for payment of the penalty.
(d) Determine the paid portion of the disallowed costs in
consultation with the contract auditor.

42.709-3 Assessing the penalty.
Unless a waiver is granted pursuant to 42.709-5, the cognizant contracting officer shall—
(a) Assess the penalty in 42.709-1(a)(1), when the submitted cost is expressly unallowable under a cost principle in the
FAR or an executive agency supplement that defines the
allowability of specific selected costs; or
(b) Assess the penalty in 42.709-1(a)(2), when the submitted cost was determined to be unallowable for that contractor
prior to submission of the proposal. Prior determinations of
unallowability may be evidenced by—
(1) A DCAA Form 1, Notice of Contract Costs Suspended and/or Disapproved (see 48 CFR 242.705-2), or any
similar notice which the contractor elected not to appeal and
was not withdrawn by the cognizant Government agency;
(2) A contracting officer final decision which was not
appealed;
(3) A prior executive agency Board of Contract Appeals
or court decision involving the contractor, which upheld the
cost disallowance; or
(4) A determination or agreement of unallowability
under 31.201-6.
(c) Issue a final decision (see 33.211) which includes a
demand for payment of any penalty assessed under
paragraph (a) or (b) of this section. The letter shall state that
the determination is a final decision under the Disputes clause
of the contract. (Demanding payment of the penalty is sepa42.7-6

42.709-5 Waiver of the penalty.
The cognizant contracting officer shall waive the penalties
at 42.709-1(a) when—
(a) The contractor withdraws the proposal before the Government formally initiates an audit of the proposal and the
contractor submits a revised proposal (an audit will be deemed
to be formally initiated when the Government provides the
contractor with written notice, or holds an entrance conference, indicating that audit work on a specific final indirect
cost proposal has begun);
(b) The amount of the unallowable costs under the proposal
which are subject to the penalty is $10,000 or less (i.e., if the
amount of expressly or previously determined unallowable
costs which would be allocated to the contracts specified in
42.709(b) is $10,000 or less); or
(c) The contractor demonstrates, to the cognizant contracting officer’s satisfaction, that—
(1) It has established policies and personnel training and
an internal control and review system that provide assurance
that unallowable costs subject to penalties are precluded from
being included in the contractor’s final indirect cost rate proposals (e.g., the types of controls required for satisfactory participation in the Department of Defense sponsored selfgovernance programs, specific accounting controls over indirect costs, compliance tests which demonstrate that the controls are effective, and Government audits which have not
disclosed recurring instances of expressly unallowable costs);
and
(2) The unallowable costs subject to the penalty were
inadvertently incorporated into the proposal; i.e., their inclusion resulted from an unintentional error, notwithstanding the
exercise of due care.
42.709-6 Contract clause.
Use the clause at 52.242-3, Penalties for Unallowable
Costs, in all solicitations and contracts over $650,000 except

FAC 2005–17 JUNE 14, 2007
SUBPART 42.7—INDIRECT COST RATES
fixed-price contracts without cost incentives or any firmfixed-price contract for the purchase of commercial items.
Generally, covered contracts are those which contain one of

42.709-6
the clauses at 52.216-7, 52.216-16, or 52.216-17, or a similar
clause from an executive agency’s supplement to the FAR.

42.7-7

This page intentionally left blank.

42.7-8

SUBPART 42.8—DISALLOWANCE OF COSTS

Subpart 42.8—Disallowance of Costs
42.800 Scope of subpart.
This subpart prescribes policies and procedures for—
(a) Issuing notices of intent to disallow costs; and
(b) Disallowing costs already incurred during the course of
performance.
42.801 Notice of intent to disallow costs.
(a) At any time during the performance of a contract of a
type referred to in 42.802, the cognizant contracting officer
responsible for administering the contract may issue the contractor a written notice of intent to disallow specified costs
incurred or planned for incurrence. However, before issuing
the notice, the contracting officer responsible for administering the contract shall make every reasonable effort to reach a
satisfactory settlement through discussions with the
contractor.
(b) A notice of intent to disallow such costs usually results
from monitoring contractor costs. The purpose of the notice is
to notify the contractor as early as practicable during contract
performance that the cost is considered unallowable under the
contract terms and to provide for timely resolution of any
resulting disagreement. In the event of disagreement, the contractor may submit to the contracting officer a written
response. Any such response shall be answered by withdrawal
of the notice or by making a written decision within 60 days.
(c) As a minimum, the notice shall—
(1) Refer to the contract’s Notice of Intent to Disallow
Costs clause;
(2) State the contractor’s name and list the numbers of
the affected contracts;
(3) Describe the costs to be disallowed, including estimated dollar value by item and applicable time periods, and
state the reasons for the intended disallowance;
(4) Describe the potential impact on billing rates and
forward pricing rate agreements;
(5) State the notice’s effective date and the date by
which written response must be received;
(6) List the recipients of copies of the notice; and
(7) Request the contractor to acknowledge receipt of the
notice.
(d) The contracting officer issuing the notice shall furnish
copies to all contracting officers cognizant of any segment of
the contractor’s organization.
(e) If the notice involves elements of indirect cost, it shall
not be issued without coordination with the contracting officer
or auditor having authority for final indirect cost settlement
(see 42.705).
(f) In the event the contractor submits a response that disagrees with the notice (see paragraph (b) of this section), the

42.803
contracting officer who issued the notice shall either withdraw
the notice or issue the written decision, except when elements
of indirect cost are involved, in which case the contracting
officer responsible under 42.705 for determining final indirect
cost rates shall issue the decision.
42.802 Contract clause.
The contracting officer shall insert the clause at 52.242-1,
Notice of Intent to Disallow Costs, in solicitations and contracts when a cost-reimbursement contract, a fixed-price
incentive contract, or a contract providing for price redetermination is contemplated.
42.803 Disallowing costs after incurrence.
Cost-reimbursement contracts, the cost-reimbursement
portion of fixed-price contracts, letter contracts that provide
for reimbursement of costs, and time-and-material and laborhour contracts provide for disallowing costs during the course
of performance after the costs have been incurred. The following procedures shall apply:
(a) Contracting officer receipt of vouchers. When contracting officers receive vouchers directly from the contractor and,
with or without auditor assistance, approve or disapprove
them, the process shall be conducted in accordance with the
normal procedures of the individual agency.
(b) Auditor receipt of vouchers. (1) When authorized by
agency regulations, the contract auditor may be authorized to
(i) receive reimbursement vouchers directly from contractors,
(ii) approve for payment those vouchers found acceptable,
and (iii) suspend payment of questionable costs. The auditor
shall forward approved vouchers for payment to the cognizant
contracting, finance, or disbursing officer, as appropriate
under the agency’s procedures.
(2) If the examination of a voucher raises a question
regarding the allowability of a cost under the contract terms,
the auditor, after informal discussion as appropriate, may,
where authorized by agency regulations, issue a notice of contract costs suspended and/or disapproved simultaneously to
the contractor and the disbursing officer, with a copy to the
cognizant contracting officer, for deduction from current payments with respect to costs claimed but not considered
reimbursable.
(3) If the contractor disagrees with the deduction from
current payments, the contractor may—
(i) Submit a written request to the cognizant contracting officer to consider whether the unreimbursed costs
should be paid and to discuss the findings with the contractor;
(ii) File a claim under the Disputes clause, which the
cognizant contracting officer will process in accordance with
agency procedures; or
(iii) Do both of the above.
42.8-1