Allowable Cost

Deciphering "Allowable Cost" in the Oil & Gas Industry

In the complex world of oil and gas contracts, understanding terminology is crucial. One frequently encountered term is "allowable cost." While seemingly straightforward, it encompasses a set of specific criteria that determine which expenses can be charged to a project.

Allowable costs represent expenses deemed legitimate and eligible for reimbursement under a contract. These costs must meet specific tests, ensuring transparency and fairness in the financial dealings between contractors and clients.

Here's a breakdown of the key criteria for establishing allowable costs:

1. Reasonableness:

• Costs must be justified and supported by proper documentation. This includes invoices, receipts, and detailed explanations of the expenditure.
• The cost should be in line with industry standards and comparable to similar expenses. Avoid excessive or extravagant spending.
• The cost-benefit analysis should be clear, demonstrating the value and necessity of the expenditure.

2. Relevance to the Contract:

• Costs must be directly connected to the scope of work outlined in the contract. This means avoiding unrelated expenses or activities that fall outside the agreed-upon project parameters.
• The contract's specific clauses should be carefully reviewed to determine allowable expenses. This includes any limitations, exclusions, or specific cost caps defined within the agreement.

3. Accounting Standards:

• If applicable, Cost Accounting Standards Board (CASB) standards must be adhered to. These standards ensure consistency and uniformity in cost accounting practices.
• In the absence of CASB standards, generally accepted accounting principles (GAAP) and industry best practices, relevant to the specific project and its circumstances, should be followed. This ensures that the accounting treatment of costs is sound and transparent.

4. Contract Terms:

• The contract itself serves as the ultimate guide for determining allowable costs. It should clearly outline the specific types of costs that are eligible for reimbursement, as well as any limitations or exceptions.
• Careful review and understanding of the contract are essential to avoid disputes or disagreements over allowable costs.

Understanding the "Allowable Cost" concept is vital for both contractors and clients in the oil and gas industry. It ensures transparency, fairness, and adherence to agreed-upon financial parameters. By adhering to these criteria, both parties can establish clear and accountable cost management practices, fostering a robust and collaborative working relationship.

Beyond this basic understanding, several factors can influence the determination of allowable costs, including:

• Project type and location: Offshore projects often have different cost structures compared to onshore projects.
• Contract structure: Different contract types, like lump sum or cost-reimbursable, will have distinct allowable cost definitions.
• Market conditions: Fluctuations in material costs and labor rates can influence the definition of reasonable costs.

Conclusion: The "allowable cost" concept is a fundamental element of oil and gas contracts. By understanding and adhering to the criteria outlined above, both parties can ensure fair and transparent financial management throughout the project lifecycle. This contributes to successful project outcomes and healthy relationships between contractors and clients.