leave, military leave, employee insurance, and supplemental employment benefit plans are allowable to the extent required by law, employer-employee agreement, or an established policy of the contractor. (h) Severance pay. See 15.205-39. (i) Training and education expenses. See 15.205-44.

(j) Location allowances. "Location allowances," sometimes called "supplemental pay" or "incentive pay," are allowable to the extent consistent with § 12.105 of this chapter.

[25 F.R. 14294, Dec. 31, 1960, as amended at 26 F.R. 2616, Mar. 28, 1961; 27 F.R. 3454, Apr. 11, 1962; 30 F.R. 6013, Apr. 29, 1965]

§ 15.205-7 Contingencies.

(a) A contingency is a possible future event or condition arising from presently known or unknown causes, the outcome of which is indeterminable at a present time.

(b) In historical costing, contingencies are not normally present since such costing deals with costs which have been incurred and recorded on the contractor's books. Accordingly, contingencies are generally unallowable for historical costing purposes. However, in some cases, as for example, terminations, a contingency factor may be recognized which is applicable to a past period to give recognition to minor unsettled factors in the interest of expeditious settlement.

(c) In connection with estimates of future costs, contingencies fall into two categories:

(1) Those which may arise from presently known and existing conditions, the effects of which are foreseeable within reasonable limits of accuracy; e.g., anticipated costs of rejects and defective work; in such situations where they exist, contingencies of this category are to be included in the estimates of future cost so as to provide the best estimate of performance costs; and

(2) Those which may arise from presently known or unknown conditions, the effect of which cannot be measured so precisely as to provide equitable results to the contractor and to the Government; e.g., results of pending litigation, and other general business risks. Contingencies of this category are to be excluded from cost estimates under the several items of cost, but should be disclosed separately, including the basis upon which the contingency is computed in order to facilitate the negotiation of appropriate contractual coverage (see, for

example, §§ 15.205-16, 15.205-20, and 15.205-39).

§ 15.205-8 Contributions and donations. Contributions and donations are un

allowable.

§ 15.205-9 Depreciation.

(a) Depreciation is a charge to current operations which distribute the cost of a tangible capital asset, less estimated residual value, over the estimated useful life of the asset in a systematic and logical manner. It does not involve a process of valuation. Useful life has reference to the prospective period of economic usefulness in the particular contractor's operations as distinguished from physical life.

(b) Subject to paragraph (c) of this section, normal depreciation on a contractor's plant, equipment, and other capital facilities is an allowable element of contract cost: Provided, That the amount thereof is computed

(1) Upon the property cost basis used by the contractor for Federal income tax purposes (see Section 167 of the Internal Revenue Code of 1954, as amended); or

(2) In the case of nonprofit or taxexempt organizations, upon a property cost basis which could have been used by the contractor for Federal income tax purposes, had such organizations been subject to the payment of income tax; and in either case,

(3) By the consistent application to the assets concerned of any generally accepted accounting method, and subject to the limitations of the Internal Revenue Code of 1954, as amended, including

(1) The straight line method;

(ii) The declining balance method, using a rate not exceeding twice the rate which would have been used had the annual allowance been computed under the method described in subdivision (i) of this subparagraph; (iii) The sum method; and

of the years-digits

(iv) Any other consistent method productive of an annual allowance which, when added to all allowances for the period commencing with the use of the property and including the current year, does not, during the first two-thirds of the useful life of the property, exceed the total of such allowances which would have been used had such allowances been computed under the method described in subdivision (ii) of this subparagraph.

nization, directly or indirectly controlling, controlled by or under common control with the contractor; or

(2) Otherwise acquired by the contractor, which has been fully depreciated when a substantial portion of such depreciation was on a basis that represented, in effect, a recovery thereof as a charge against Government contracts or subcontracts; Provided, however, That if the taxpayer consolidates his normal facilities on a permanent basis into accounts corresponding to the guideline classes in accordance with Revenue

Procedure 62-21, these accounts should include all depreciable assets used in the taxpayer's trade or business, whether or not previously considered fully depreciated. This is because the assets in this type of multiple-asset account lose their individual identities and no particular item still in use can be considered as being fully depreciated. In this case, as provided in R.P. 62-21, the assets previously considered as fully depreciated should be taken into consideration in computing the amount of allowable depreciation, the class life, and the rate of growth.

If the above circumstances do not apply, a reasonable charge for the use of fully depreciated property may be agreed upon and allowed (but see § 15.107). In determining this charge, consideration should be given to cost, total estimated useful life at time of negotiation, and effect of any increased maintenance charges or decreased efficiency due to age.

[30 F.R. 6973, May 25, 1965]

§ 15.205-10 Employee morale, health, and welfare costs and credits. Reasonable costs of morale, health, and welfare activities, such as house publications, health or first aid clinics, recreational activities, and employee counseling services, incurred, in accordance with the contractor's established practice or custom in the industry or area, for the improvement of working conditions, employer-employee relations, employee morale, and employee performance, are allowable. Income generated from any of these activities shall be credited to the costs thereof unless such income has been irrevocably set over to employee welfare organizations. [29 F.R. 14835, Oct. 31, 1964]

§ 15.205-13 Fines and penalties.

Costs of fines and penalties resulting from violations of, or failure of the contractor to comply with, Federal, State and local laws and regulations are unallowable except when incurred as a result of compliance with specific provisions of the contract, or instructions in writing from the contracting officer.

§ 15.205-14 Food service and dormitory costs and credits.

Food and dormitory services include operating or furnishing facilities for cafeterias, dining rooms, canteens, lunch wagons, vending machines, living accommodations or similar types of services for the contractor's employees at or near the contractor's facilities. Reasonable losses from the operation of such services are allowable if they are allocated to all activities served. Profits (except profits irrevocably set over to an employee welfare organization of the contractor in amounts reasonably useful for the benefit of the employees at the site or sites of contract performance) accruing to the contractor from the operation of these services, whether operated by the contractor or by a concessionaire, shall be treated as a credit, and allocated to all activities served.

§ 15.205-15 Fringe benefits. (See

15.205–6(g).)

§ 15.205-16 Insurance and indemnification.

(a) Insurance includes insurance which the contractor is required to carry, or which is approved, under the terms of the contract, and any other insurance

which the contractor maintains in connection with the general conduct of his : business.

:

(1) Costs of insurance required or approved, and maintained, pursuant to the contract, are allowable.

(2) Costs of other insurance maintained by the contractor in connection with the general conduct of his business are allowable subject to the following * limitations:

(i) Types and extent of coverage shall be in accordance with sound business practice and the rates and premiums shall be reasonable under the circum!stances;

(ii) Costs allowed for business interruption or other similar insurance shall be limited to exclude coverage of profit;

(iii) Costs of insurance or of any proI vision for a reserve covering the risk of loss of or damage to Government property are allowable only to the extent that the contractor is liable for such loss or damage and such insurance or reserve : does not cover loss or damage which results from willful misconduct or lack of good faith on the part of any of the contractor's directors or officers, or other equivalent representatives, who has supervision or direction of (a) all or subIstantially all of the contractor's business, or (b) all or substantially all of the contractor's operations at any one plant or separate location in which the contract is being performed, or (c) a separate and complete industrial operation in connection with the performance of the contract;

(iv) Provisions for a reserve under an approved self-insurance program are allowable to the extent that the types of coverage, extent of coverage, and the rates and premiums would have been allowed had insurance been purchased to cover the risks; and

(v) Costs of insurance on the lives of officers, partners, or proprietors are allowable only to the extent that the insurance represents additional compensation (see § 15.205-6).

(3) Actual losses which could have been covered by permissible insurance (through an approved self-insurance program or otherwise) are unallowable unless expressly provided for in the contract, except:

(i) Costs incurred because of losses not covered under nominal deductible insurance coverage provided in keeping

with sound business practice, are allowable; and

(ii) Minor losses not covered by insurance, such as spoilage, breakage, and disappearance of small hand tools, which occur in the ordinary course of doing business, are allowable.

(b) Indemnification includes securing the contractor against liabilities to third persons and any other loss or damage, not compensated by insurance or otherwise. The Government is obligated to indemnify the contractor only to the extent expressly provided for in the contract, except as provided in paragraph (a) (3) of this section. § 15.205-17

costs.

Interest and other financial

Interest on borrowings (however represented), bond discounts, costs of financing and refinancing operations, legal and professional fees paid in connection with the preparation of prospectuses, costs of preparation and issuance of stock rights, and costs related thereto, are unallowable except for interest assessed by State or local taxing authorities under the conditions set forth in § 15.205-41. (But see § 15.205-24.) § 15.205-18 Labor relations costs.

Costs incurred in maintaining satisfactory relations between the contractor and its employees, including costs of shop stewards, labor management committees, employee publications, and other related activities, are allowable.

§ 15.205-19 Losses on other contracts.

An excess of costs over income under any other contract (including the contractor's contributed portion under costsharing contracts), whether such other contract is of a supply, research and development, or other nature, is unallowable.

§ 15.205-20 Maintenance and repair

costs.

(a) Costs necessary for the upkeep of property (including Government property unless otherwise provided for), which neither add to the permanent value of the property nor appreciably prolong its intended life, but keep it in an efficient operating condition, are to be treated as follows (but see § 15.205-9): (1) Normal maintenance and repair costs are allowable;

(2) Extraordinary maintenance and repair costs are allowable, provided such

are allocated to the periods to which applicable for purposes of determining contract costs. (But see § 15.107.)

(b) Expenditures for plant and equipment, including rehabilitation thereof, which, according to generally accepted accounting principles as applied under the contractor's established policy, should be capitalized and subjected to depreciation, are allowable only on a depreciation basis.

§ 15.205-21 Manufacturing and production engineering costs.

Costs of manufacturing and production engineering, including engineering activities in connection with the following, are allowable:

(a) Current manufacturing processes such as motion and time study, methods analysis, job analysis, and tool design and improvement; and

problems,

(b) Current production such as materials analysis for production suitability and component design for purposes of simplifying production.

§ 15.205-22 Material costs.

(a) Material costs include the cost of such items as raw materials, parts, subassemblies, components, and manufacturing supplies, whether purchased outside or manufactured by the contractor, and may include such collateral items as inbound transportation and intransit insurance. In computing material costs consideration will be given to reasonable overruns, spoilage, or defective work (unless otherwise provided in any provision of the contract relating to inspection and correction of defective work). These costs are allowable subject, however to the provisions of paragraph (b) through (e) of this section.

(b) Costs of material shall be suitably adjusted for applicable portions of income and other credits, including available trade discounts, refunds, rebates, allowances, and cash discounts, and credits for scrap and salvage and material returned to vendors. Such income and other credits shall either be credited directly to the cost of the material involved or be allocated (as credits) to indirect costs. However, where the contractor can demonstrate that failure to take cash discounts was due to reasonable circumstances, such lost discounts need not be so credited.

(c) Reasonable adjustments arising from differences between periodic physical inventories and book inventories

may be included in arriving at costs, provided such adjustments relate to the period of performance of the contract.

(d) When the materials are purchased specifically for and identifiable solely with performance under a contract, the actual purchase cost thereof should be charged to the contract. If material is issued from stores, any generally recognized method of pricing such material is acceptable if that method is consistently applied and the results are equitable. When estimates of material costs to be incurred in the future are required, either current market price or anticipated acquisition cost may be used, but the basis of pricing must be disclosed.

(e) Allowance for all materials and supplies produced by the contractor or by any division, subsidiary or affiliate of the contractor under common control (hereinafter collectively referred to as the "seller") shall be on the basis of the costs incurred in accordance with this subpart, except as follows: Where the item is regularly manufactured or is one of a line of products regularly manufactured by the seller and is substantially the same as one normally produced by and available from one or more outside sources in the open market in significant quantity (quality and other performance factors considered), allowance may be on a price basis not to exceed the lesser of the current market price or the seller's current sales price to its most favored customer (including any division, subsidiary or affiliate of the contractor under common control) for a like quantity of the item when one of the following conditions is met:

(1) The item qualifies as a "commercial item sold in substantial quantities to the general public" as defined in § 3.807--1(b) (2) (ii) through (iv) of this chapter; or

(2) The seller submits the lowest evaluated bid or proposal under conditions of "adequate price competition" as defined in § 3.807–1(b) (1) (i) and (ii) of this chapter.

Such price as may be determined in accordance with the foregoing may be adjusted upward or downward to reflect the actual cost of modification of the item by the seller for the purposes of the contract.

[25 F.R. 14294, Dec. 31, 1960, as amended at 29 F.R. 9764, July 21, 1964; 30 F.R. 14093, Nov. 9, 1965]