(Editor’s Note. We have encountered numerous instances of auditors identifying a cost as "interest" or "tantamount to interest" and alluding to the interest cost principle, disallowing the cost. The following describes instances of when unallowable "interest costs" are not unallowable and is based on an article by Neil O’Donnell and Patricia Meagher of the law firm of Rodgers, Joseph, O’Donnell and Quinn in the October 1998 issue of the CP&A REPORT.)

Much of the common wisdom that interest is not recoverable stems from the cost principle "Interest and other financial costs" now appearing at FAR 31.205-20. The text reads as follows:

"Interest on borrowings (however represented); bond discounts; costs of financing and refinancing capital (net worth plus long-term liabilities), legal and professional fees paid in connection with preparing prospectuses, costs of preparing and issuing stock rights, and directly associated costs are unallowable except for interest assessed by State or local taxing authorities under conditions specified in 31.205-41 (Taxes)".

While the principle does restrict recovery of interest as a contract cost, the principle contains an important limitation: it prohibits the recovery of interest on borrowing, not interest recovery in general. In addition, the prohibition against interest on borrowing is offset in part by the recognition of the cost of money invested in capital covered by Cost Accounting Standards 414 and 417. Though we will not discuss these here, they provide the opportunity to recover imputed interest cost incurred as a result of contract performance in another form.

The regulatory history of the "interest" cost principle as well as recent interpretations in two cases indicate there are opportunities to recoup interest costs in contract performance.

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