Key Facts
- Governed by 2 CFR 200 Subpart E (§§ 200.405–200.476) — the federal cost principles that apply to all non-federal entities receiving federal financial assistance.
- Seven-part allowability test — a cost must be necessary, reasonable, allocable, consistently applied, GAAP-compliant, not double-charged, and documented. Failing any one criterion makes the cost unallowable.
- Expressly unallowable categories include: lobbying (§ 200.450), alcoholic beverages (§ 200.423), entertainment (§ 200.438 — with narrow exceptions), fines and penalties (§ 200.441), bad debts (§ 200.426), and fundraising (§ 200.442).
- Unallowable ≠ illegal — most unallowable costs are legitimate organizational expenses. They simply cannot be charged to federal awards. They must be covered by other funding sources.
- Self-identification is strongly preferred — catching and correcting an unallowable charge before audit is treated very differently from an auditor-identified finding. Organizations should conduct quarterly internal cost reviews.
Summary
The federal government does not simply ask whether a cost was spent on the right program activities. Every cost charged to a federal award must independently satisfy the allowability criteria in 2 CFR 200 Subpart E — criteria that test reasonableness, necessity, allocation method, documentation, and conformance with specific cost category rules. An expense that is 100% program-related can still be unallowable if it's entertainment, if it lacks documentation, or if it was budgeted in a way that doesn't reflect actual organizational accounting practices. The result: disallowed costs, repayment demands, and — in cases involving repeated or knowing mischarges — potential suspension, debarment, or criminal referral. Most unallowable cost findings, however, come not from intentional fraud but from organizations that never systematically reviewed whether their cost allocation practices meet federal standards.
The Allowability Test: All Seven Criteria Must Be Satisfied
Under 2 CFR 200.405, a cost is allowable only if it meets all of the following standards simultaneously — not just some of them:
Necessary and reasonable. The cost must be necessary for the performance of the federal award and must not exceed what a prudent person would pay under the same circumstances. "Reasonable" is judged by whether the organization applied sound business practices, competitive market prices, and consistent consideration of its own obligations to the federal government. A first-class airfare for domestic travel is not reasonable. A $1,200 laptop for grant program staff is probably reasonable; a $4,500 laptop for the same function is questionable.
Allocable. A cost is allocable to a federal award if it is incurred specifically for the award, benefits both the award and other work proportionately and can be distributed reasonably, or is necessary to the overall operation of the organization and assignable at least in part to the award. You cannot allocate 100% of a shared cost to one federal award unless 100% of the benefit is attributable to that award.
Consistent treatment. Costs incurred for the same purpose in like circumstances must be treated consistently as either direct or indirect. You cannot charge travel as a direct cost on one grant and as an indirect cost on another — your written accounting policies must be applied uniformly across all funding sources, federal and non-federal.
Adequate documentation. Costs must be supported by documentation that establishes what was purchased, why it was necessary for the grant, and that payment was made. Invoices, contracts, receipts, and timesheet records are the minimum. Verbal agreements and undocumented charges cannot be defended at audit regardless of how program-relevant they were.
Always-Unallowable Costs Under 2 CFR 200
The following cost categories are expressly unallowable under 2 CFR 200 Subpart E. No amount of program relevance or prior practice makes these costs chargeable to a federal award:
Lobbying costs (§ 200.450). Costs of influencing federal, state, local, or tribal government legislative or regulatory decisions. This includes staff time spent drafting legislation, meeting with legislators about pending policy, or participating in advocacy coalitions. It does not prohibit education and outreach about your program — the line is whether the activity is designed to influence a specific legislative outcome or merely inform stakeholders about your work.
Entertainment (§ 200.438). Costs of amusements, social activities, and related incidental expenses — meals, tickets, gratuities — when the primary purpose is entertainment rather than a bona fide programmatic meeting. A staff retreat with team-building activities is entertainment. A training conference with planned meal sessions is potentially allowable if the agency approves it. The practical test: if you removed the entertainment from the event, would the programmatic objective still be fully achievable? If yes, the entertainment is unallowable.
Alcoholic beverages (§ 200.423). Absolutely prohibited regardless of context. If alcohol appears on any invoice charged to a federal grant — including a line item on a catered event receipt — the full cost of the alcohol is disallowable, and depending on the auditor's assessment, the entire event cost may be questioned.
Fundraising (§ 200.442). Costs of raising capital or soliciting contributions, including staff time spent on development activities, donor cultivation events, grant proposal writing for non-federal funders, and annual fund campaigns. If your development director spends 20% of her time on federal proposal development and 80% on private fundraising, only the 20% is allocable to federal awards.
Fines, penalties, and damages (§ 200.441). Any fines, penalties, damages, or other settlements resulting from violations of law or breach of contract — including late-payment penalties to vendors — are unallowable. This includes penalties assessed by regulatory agencies.
Pre-award costs (§ 200.458). Costs incurred before the award start date are generally unallowable unless the awarding agency provides written authorization for pre-award costs in the Notice of Award. Without that authorization, charging any cost incurred before the official start date — including staff time spent preparing for program launch — creates a disallowed cost.
GrantMetric Analysis
- The most common source of unallowable costs at nonprofits isn't fraud — it's unwritten allocation methodology. Organizations that charge costs to federal grants based on what feels proportionate, rather than on a documented methodology that can be consistently applied and audited, generate unallowable cost findings routinely. The specific issue: a program director whose salary is split 60/40 between two programs, but whose payroll is charged based on an informal estimate from the executive director rather than actual timesheets or a written cost allocation plan. When the auditor asks for the allocation basis and the answer is "we divided it that way," there is no defensible basis for the charge. The fix requires a cost allocation plan — a written document, updated annually, that specifies the methodology for allocating shared costs across programs — but most small nonprofits have never written one.
- Unallowable costs must still be in your accounting system — just in a separate, clearly-marked pool. A common misunderstanding: organizations try to keep unallowable costs "off the books" to avoid the appearance of commingling them with federal funds. This creates a worse problem. Federal auditors reviewing your indirect cost rate or testing your cost allocation expect to see your complete organizational expenses — including unallowable items — in your accounting system. Unallowable costs should be coded to a separate general ledger account (e.g., "Unallowable - Lobbying," "Unallowable - Entertainment") so that auditors can confirm they were not charged to any federal award. An accounting system that doesn't show certain organizational expenses at all raises more questions than one that clearly separates allowable from unallowable.
Gray Areas: Costs That Are Allowable Under Specific Conditions
Several cost categories are allowable under 2 CFR 200 but only with specific documentation, prior approval, or under defined circumstances. These generate the most questions during cost reviews:
Meals. Allowable when they are incidental to a bona fide meeting, training, or programmatic event — not for routine staff lunches or departmental gatherings. Documentation should include the meeting agenda, attendee list showing their program-related roles, and a brief description of the programmatic purpose. Per diem meals during approved travel follow the applicable GSA or agency per diem rate regardless of actual cost.
Memberships (§ 200.454). Membership in professional organizations is allowable if the membership benefits the federal program — a public health nonprofit's membership in APHA is potentially allowable. Memberships in civic or community organizations, country clubs, dining clubs, or social organizations are expressly unallowable. Memberships in organizations that engage in lobbying are specifically restricted to the portion of dues that does not support lobbying activities.
Compensation above published pay scales. Salaries of key personnel that exceed NIH salary caps (currently $225,700 for CY 2024), or that significantly exceed comparable positions at peer organizations, must be justified. Compensation includes all forms of pay: base salary, bonuses, commissions, and deferred compensation. The "reasonableness" standard requires that pay be consistent with the organization's written compensation policies and comparable positions in comparable organizations.