What are Allowable Costs?

Allowable costs are those expenses specified in a contract that can be billed to the customer. These costs are usually capped at what is considered a reasonable amount; to verify that this is the case, allowable costs are frequently audited by the purchasing entity to ensure that they are reasonable. The concept is frequently applied to contracts in which the buyer is a government entity.

Examples of Allowable Costs

Here are several examples of allowable costs:

Direct labor costs. A government contractor hires engineers to work on a defense project. The wages and salaries paid to these employees, including overtime related to the contract, are considered allowable costs because they directly contribute to contract performance. These costs must be reasonable, documented, and specifically tied to the project.
Materials and supplies. A construction company working on a federally funded bridge project purchases steel, concrete, and safety equipment. These materials are necessary for completing the project and are explicitly listed in the contract as reimbursable expenses. Proper receipts and documentation must be maintained to justify these costs.
Travel expenses. A consulting firm working on a government contract requires employees to travel to different client sites. Costs such as airfare, lodging, meals, and transportation are allowable if they comply with contract terms and federal travel regulations (e.g., per diem limits). Extravagant or personal travel expenses, however, are not allowable.
Equipment depreciation. A research lab purchases high-tech lab equipment for a government-funded research project. Instead of billing the full purchase price upfront, the company can charge the depreciation expense as an allowable cost over the equipment’s useful life. This ensures fair cost distribution across multiple projects using the same equipment.
Subcontractor costs. A defense contractor hires a specialized software firm to develop a security system as part of a military contract. The subcontractor’s fees are an allowable cost as long as the subcontract is pre-approved and aligns with contract requirements. These costs must be reasonable and supported by invoices and agreements.
Employee benefits. A government contractor provides health insurance, retirement contributions, and paid time off to employees working on a federal contract. Since these benefits are part of the employee compensation package and meet industry standards, they are allowable costs. However, excessive or unreasonable benefits beyond industry norms may not be reimbursed.
Utilities and facility costs. A contractor working on an IT project rents an office space dedicated to contract activities. The costs for electricity, water, and internet services used for the project are allowable if they are allocated properly and not for unrelated business activities. If a facility is used for multiple projects, only a proportional share of utility costs can be billed.
Training and certification. An aerospace contractor provides specialized training for employees working on a new aviation technology project. Since the training is directly related to contract requirements and improves employee performance on the project, the cost is allowable. However, general professional development or unrelated certifications may not be covered.
Quality control and testing. A pharmaceutical company conducting clinical trials under an FDA-funded contract must perform extensive product testing. Costs for laboratory analysis, third-party quality audits, and compliance testing are allowable because they ensure the final product meets contract specifications. These expenses must be properly documented and justified.
Indirect administrative costs. A research firm working on a government-funded study incurs administrative costs such as payroll processing, IT support, and office supplies. If the contract allows for indirect cost reimbursement, a portion of these expenses may be allowable under an agreed-upon indirect cost rate. However, indirect costs must be consistently applied and follow established cost allocation guidelines.