Disallowed costs: Overview, definition, and example
What are disallowed costs?
Disallowed costs are expenses that are not eligible for reimbursement or payment, typically under a contract, government funding, or grant agreement. These costs are considered inappropriate, unnecessary, or outside the scope of what is allowed by the terms of the agreement. They can include things like personal expenses, unauthorized purchases, or expenditures that exceed budget limits.
In many contracts or funding agreements, particularly those involving government grants or loans, disallowed costs are clearly outlined to prevent misuse of funds. If an entity tries to claim or use these disallowed costs, they may face penalties, including financial penalties or the loss of future funding.
Why are disallowed costs important?
Disallowed costs are important because they ensure that funds are used appropriately and in accordance with the terms of an agreement. By identifying and prohibiting certain types of expenses, organizations can avoid fraud, waste, and abuse of funds. This protects both the party providing the funding (such as a government agency or investor) and the party receiving the funds (like a business or nonprofit).
In the context of government grants, for instance, ensuring that disallowed costs are not charged to the grant prevents misuse of taxpayer money. For businesses, it helps maintain compliance with contractual agreements and keeps financial operations in check.
Understanding disallowed costs through an example
Imagine you’ve received a government grant to fund a research project. According to the grant agreement, any personal expenses, such as meals for the research team or personal travel costs, are disallowed. If you mistakenly use grant funds to cover these personal expenses, those costs would be considered disallowed.
As part of your regular reporting, you submit an expense report that includes personal travel costs. Upon review, the grant issuer identifies these expenses as disallowed, and you are required to repay the money or face penalties.
In this case, understanding the list of disallowed costs ahead of time would have helped avoid these mistakes and ensured that only eligible expenses were claimed.
Example of a disallowed costs clause
Here’s an example of how a disallowed costs clause might appear in a contract:
“The Contractor shall not charge the Client for any expenses that are not directly related to the project or not expressly authorized under this Agreement. Any costs related to personal items, entertainment, non-business travel, or expenses exceeding the agreed-upon budget limit are considered disallowed costs and will not be reimbursed.”
Conclusion
Disallowed costs are critical to ensuring that funds are spent responsibly and according to the rules of an agreement. By understanding which costs are allowed and which are disallowed, you can avoid penalties, maintain compliance, and protect the integrity of your financial transactions. Whether managing grants, contracts, or business expenses, it’s essential to be clear on what constitutes disallowed costs to prevent mistakes and safeguard your finances.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.