Ins and Outs of Indirect Costs

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Ins and Outs of Indirect Costs
CAPLAW National Training Conference
Presented by Carr, Riggs Ingram, LLC William H.
Carr, CPA J. Michael Maddox, CPA,
CFE www.cricpa.com

• June 21 , 2007

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AGENDA

• Welcome and Introductions
• What is Indirect Cost
• Types of Rates
• Selecting the appropriate base
• Preparing IDC Proposal
• Common Pitfalls
• Barriers to Full Recovery
• FAQs
• Questions

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• What is
• Indirect Cost???

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• Applicable Standards
• OMB Circular A-122
• Cost Principles for Non-Profit Organizations
• OMB Circular A-110
• Uniform Administrative Requirements
• OMB Circular A-133
• Audits of States, Local Governments and
  Non-Profit Organizations

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• Two types of costs
• Direct Costs
• Costs that can be identified specifically with a
  particular project relatively easily and with a
  high degree of accuracy
• Indirect Costs
• Costs that are incurred for common or joint
  objectives
• a.k.a. Facilities and Administrative Costs

Both can be programmatic or administrative
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Characteristics of Two Types of Costs

• Direct Costs
• Easily identified to a cost objective
• Head Start teacher salaries
• LIHEAP client benefits
• CACFP Food Costs
• Typically benefit one program
• Can be charged directly to applicable cost
  objective
• Indirect Costs
• Not easily identified to a particular cost
  objective
• Fiscal officer salaries
• Cost of IT systems
• Facilities costs
• Typically benefit more than one program
• Must be allocated to various benefiting programs

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Direct Costs
Indirect Costs
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• Challenge becomes
• How do we equitably recover our indirect costs?

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• OMB Circular A-122 Cost Principles for
  Non-Profit Organizations
• Requires equitable allocation to benefiting cost
  objectives
• Sets forth two methods to allocate indirect cost
• Simplified allocation method
• Used when major functions benefit to
  approximately same degree
• Utilizes single rate
• Multiple allocation base method
• Used when major functions benefit in varying
  degrees
• Utilizes multiple pools and rates
• Utilizes multiple bases
• Square footage for space
• Modified Total Direct Cost for GA

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• Direct Allocation Method as option to indirect
  cost allocation
• Treats all costs as Direct Costs except GA and
  general expenses
• Joint Costs (depreciation, rental costs,
  telephone expense, facilities, etc.)
• Prorated individually as direct costs using most
  appropriate base
• Acceptable method as long as base
• Accurately measures benefits provided to each
  award/activity
• Are established in accordance with reasonable
  criteria
• Are supported by current data

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Recovery of Indirect Cost

• Negotiate IDC Rate(s)
• Identify Indirect Costs
• Accumulate in IDC Pool(s)
• Allocate to Programs via approved Indirect Cost
  Rate

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Steps to Negotiating Your Rate

• Determine type of Rate desired
• Determine most appropriate base
• Prepare and Submit IDC Proposal
• Negotiate Rate with Cognizant Agency
• Formalized written agreement

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Types of Indirect Cost Rates

• Provisional Rate
• Temporary Rate
• Established for a prospective period of time
• Based on estimated costs
• Later revised to Final Rate based on operating
  experience
• Final Rate
• Established after actual costs for period are
  known
• Replaces Provisional Rate
• Based on audited financial statements

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Types of Indirect Cost Rates (cont.)

• Predetermined Rate
• Effective for a specified period of time (i.e.
  fiscal year)
• Based on estimate of costs to be incurred during
  the period
• Not subject to adjustment
• Fixed Rate
• Same characteristics as Predetermined Rate
• Subject to prospective adjustment
• Actual vs. Estimated costs carried forward as
  adjustment to rate of subsequent period

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Types of Indirect Cost Rates (cont.)

• Special Rate
• Developed to deal with unique situations
• Often used by colleges/universities when IDCs are
  different for on-campus and off-campus activities
• Multiple Indirect Cost Rates
• Utilized where organization-wide rate not
  appropriate
• Consider when departments, divisions or programs
  use services of IDC pool disproportionately

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Step Two

• Determining
• Appropriate
• Base

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• Typical IDC Bases
• Modified Total Direct Costs (MTDC)
• Excludes Capital Expenditures, flow through funds
  and subcontracts
• Direct Salaries and Wages
• Direct Salaries and Wages, including fringe
  benefits

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Sample Rate Calculation

• Total IDC Pool - 500,000
• Total Direct Cost - 5,000,000
• Resulting IDC Rate 10
• (500,000/5,000,000)
• Total Salaries and Wages - 2,000,000
• Resulting IDC Rate 25
• (500,000/2,000,000)

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Factors Affecting Base Selection

• Types of Direct Costs Incurred
• Are some programs more labor intensive than
  others?
• Do some programs benefit from pooled costs
  disproportionately to their direct costs?
• Restrictions on Admin/IDC Costs within Grants
• Some programs are more restrictive
• Over-Arching Principle
• Base utilized must result in equitable allocation
  with respect to benefits derived

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Steps to Determining Your Rate

• Determine type of Rate desired
• Determine most appropriate base
• Prepare and Submit IDC Proposal
• Negotiate Rate with Cognizant Agency
• Formalized written agreement

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Elements of Indirect Cost Proposal

• Narrative
• Introduction describing entity, types of programs
  and period covered
• Cost allocation methodology
• How agency identifies direct vs. indirect costs
• Nature of proposal (seeking indirect rate,
  multiple rates, special rate, etc.)
• Definition of Direct and Indirect costs and how
  captured
• Description of cost pool and base for
  distribution
• Reconciliation to audited financial statements
• List of Salaries by position and Fringe costs
  included in indirect pool
• Salaries listed must identify percentage charged
  to pool if not 100

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Elements of Indirect Cost Proposal

• Schedule of Total Direct Cost
• Subtotal for labor costs
• Columnar format broken down by programs
• Schedule of Indirect Cost Pool
• Can include with Direct Cost in Schedule of
  Functional Expenditures
• Exclude unallowable costs
• Exclude capital expenditures
• Include depreciation and use allowance on
  indirect portion of faciliites
• Calculation of Proposed Rate
• Indirect Costs divided by Applicable Base
• Lobbying Cost Certificate
• Certifies compliance with OMB A-122 re lobbying
  costs
• IDC Proposal Checklist

http//rates.psc.gov/fms/dca/np_exall.pdf
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• Your proposal is just that.a Proposal

• Must be negotiated with your cognizant agency
• Cognizant Agency
• Typically largest funding source
• HHS Division of Cost Allocation (DCA)
• Role is to maximize cost savings
• Cost Savings defined as negotiating plan or rate
  that is less than proposal
• Cost Savings for FYE 6/30/03
• Total 717,637,000 (2,044 plans)
• Includes over 73,000,000 in cash refunds
• NPOs 47,303,000 (1,012 plans)
• 46,700 per NPO plan

Source http//www.ncura.edu/data/conferences/45/
handouts/CognizantAgencies_Talesnik.pdf
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Negotiation Process

• Cognizant Agency Review and Negotiation
• Review for required documentation
• Review prior negotiation work papers
• Reconcile proposal to financial statements
• Review proposed base for equitable distribution
• Perform trend analysis
• Review costs for allowability, consistency and
  treatment of costs
• Concluding steps and rate negotiations

Source DCA Review Guide for NPO Indirect Cost
Proposals
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• Review for Required Documentation
• Cognizant Agency (CA) will be looking for
• Proposal itself
• Audited financial statement
• For period of proposal
• Reconciliation between Proposal and Audited
  Financials
• Notice of Grant Award or Financial Assistance
  Award Document
• Evidence that NPO has current award that is
  eligible to receive IDC
• Information specifically requested by CA in prior
  correspondence or advance agreements established
  in previous negotiations

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• RECONCILIATION TO FINANCIAL STATEMENTS
• Cognizant Agency (CA) will be looking for
• Incorporation of prior corrections or adjustments
  into current proposal
• Existence of Special Rates
• For period of proposal
• Did prior agreement contain conditions and did
  NPO comply?
• Proper Carryforward in Fixed Rate Agreements
• Over-recovery in prior year will reduce rate in
  current year
• Need for site visit
• Usually associated with multiple rates
• Perform math check

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• REVIEW PRIOR NEGOTIATED WORK PAPERS
• Cognizant Agency (CA) will be looking to
• Reconcile total of Direct and Indirect Costs to
  expenses reflected in financial statements
• Analyze adjustments for unallowable and
  extraneous costs that should be excluded
• Analyze and verify accuracy and necessity for
  adjustments and reclassifications
• Adjustments may include known changes in
  circumstances for upcoming periods

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• REVIEW FOR ACCEPTABLE BASE
• Cognizant Agency (CA) will be looking to
• Determine that proposed base results in most
  equitable distribution of indirect costs
• Verify that base is consistent with base used in
  previous submissions and rates
• i.e. Use of Total Direct Salaries and Fringe in
  past and exclusion of fringe in current proposal
• Base change can be negotiated must prove to be
  more equitable

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• TREND ANALYSIS
• Cognizant Agency (CA) will perform detailed trend
  analysis of indirect costs, rates and allocation
  base for last three years, including proposal
  year
• Be prepared to explain unusual increases in
  indirect cost in comparison to increase in Base
• i.e. Base increases 5 and indirect travel
  increases 40.
• Reviewer will want substantiation of increase in
  indirect travel

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• ALLOWABILITY, CONSISTENCY AND TREATMENT OF COSTS
• Cognizant Agency (CA) will be looking to
• Determine whether proposed costs benefit federal
  awardsa
• Determine that types of costs in IDC pool are
  consistently treated as indirect costs
• Review proposal and financial statements for
  unallowable costs
• Schedule of Findings and Questioned Costs
• Financial Statement Disclosures
• Alcoholic beverages, bad debts, contingencies,
  contributions and donations, fines and penalties,
  fund raising, lobbying, etc.
• Review financial statements for any applicable
  offsets
• Income generated by activites in indirect cost
  pool
• i.e. Rents generated from facilities costs
  charged to pool

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• CONCLUDING STEPS AND RATE NEGOTIATIONS
• Cognizant Agency (CA) will
• Look for anticipated significant changes in level
  of NPOs activities
• Rates typically based on most recent years
  actual costs
• Adjustments may be made for anticipated changes
• Determine whether advance agreements should be
  established
• May be needed to preclude future
  disputes/problems
• May be related to changes/refinements in base
• May be in reference to agreed upon treatment of
  certain types of costs
• Negotiate appropriate type of rate
• Provisional negotiator has little confidence in
  consistency of costs, organization has plans for
  significant operational changes, accuracy of
  rates contingent on occurrence of future events
• Predetermined only if high probability that
  recovery will approximate proposed costs
• Fixed May be used unless unlikely to have
  future awards, erratic mix of federal vs.
  non-federal funds from year to year, operating
  activities unstable, etc.

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• Understanding How Pools Function and Potential
  Pitfalls

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Pitfalls

• Predetermined Rate
• Cant loseright?
• What if indirect Costs Pool grows faster than
  base?
• Base Year Base 1,000,000
• Pool 100,000
• Rate 10
• Year 1 Base 1,100,000
• Pool 105,000
• Recover - 110,000 (5,000 excess)
• Year 2 Base 1,250,000
• Pool 150,000
• Recover 125,000 (25,000 unrecovered IDC)
• Management of Indirect Budget in proportion to
  Budgeted Base is critical with this type of
  rate

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Pitfalls

• Provisional/Final Rate
• Base grows faster than pool costs
• Base Year Base 1,000,000
• Pool 100,000
• Rate 10
• Year 1 Base 1,100,000
• Pool 105,000
• Final Rate 9.55
• Recovered - 110,000
• 5,000 excess (must be repaid)
• Management of Base Costs in proportion to
  Budgeted Pool is critical with this type of rate
• Rememberthis type of rate is subject to
  adjustment

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Pitfalls

• Fixed Rate with carryforward
• Base grows faster than pool costs
• Base Year Base 1,000,000
• Pool 100,000
• Rate 10
• Year 1 Base 1,100,000
• Pool 105,000
• Recovered - 110,000
• 5,000 excess
• Year 2 Rate Computation
• Year 1 Actual excess/Year 1 base
• New Rate (105-5/1100) 9.091
• Year 2 Base 1,100,000
• Pool 105,000
• Recovered - 100,000
• 5,000 unrecovered cost

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• Other Barriers to Full IDC Recovery

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• Other Barriers/Pittfalls
• Failure to Properly Identify Indirect Costs
• Charged as direct charges to non-federal programs
• Misclassified on general ledger as unallowable
  type of cost
• Failure to include Depreciation/Use allowance for
  indirect facilities costs
• Administrative/IDC limits on Specific Grants
• Certain grants/programs limit Admin costs to 10
  - 15
• Certain grants/programs allow no indirect costs
• Costs allocable to these programs must be
  absorbed by non-federal funds
• Cannot be used as match without prior approval
  (OMB A-110 sub-part B, section 23(b))

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Helpful Hints

• INDIRECT vs. ADMINSTRATIVE
• Indirect does not necessarily mean administrative
• Example Facilities Cost
• Remote office housing intake staff for three
  grants
• Common space is programmatic in nature but may
  not be directly allocable
• Example Exec. Director Salaries
• May have programmatic and administrative duties

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• EXAMPLE
• Assumptions
• Grant of 600,000
• Admin Limit 10
• Indirect Costs to be charged to grant total
  65,000
• Did we exceed admin limit????

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• Pool of Indirect Costs
• Accounting System Admin
• Travel Admin
• Director Salary Prog/Admin
• Facilities Prog/Admin
• Supplies Admin
• Telephone Admin
• Assume this calculates to 65 Admin and 35
  program

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• Resulting Calculations
• Total IDC 65,000 65 admin portion 42,250
  administrative IDC
• Admin Limit 60,000
• Leaves room for 17,750 Direct Admin Costs
• Important to understand the true nature of costs
  within IDC Pool

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Common Indirect Cost Problems

• Timekeeping Systems
• To be allowable, labor costs, whether direct or
  indirect must be based on accurate time sheets
  reflecting actual activities of all employees.

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Common Indirect Cost Problems

• Cost of Unallowable Activities
• Must not be charged to indirect cost pool
• Must be treated as direct costs (charged to
  separate final cost objectives) and allocated an
  equitable portion of indirect cost. (OMB A-122,
  Attachment A, paragraphs B.3 and B.4)

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Common Indirect Cost Problems

• Credits
• Failure to reduce total costs incurred (both
  direct costs of a specific program or indirect
  costs) by credits applicable to those costs.
• Fees for conferences
• Building rental programs
• Insurance credits or adustments
• Data processing and office services performed for
  others

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Common Indirect Cost Problems

• Inter-Organizational Transfers and Related-Party
  Transactions
• Supplies and services acquired from affiliates,
  related parties and organizations under common
  control must be based on the supplying
  organizations actual costs
• Cannot include profit
• Applies to rental of buildings owned by related
  parties

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Common Indirect Cost Problems

• Unsupported Costs
• To be allowable, all direct and indirect costs
  must be adequately supported by source
  documentation
• Cancelled checks and credit card receipts not
  sufficient
• Must meet purpose and circumstance test

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FAQs

• What do we do if some grants/contracts provide
  for no indirect costs or rates lower than our
  approved indirect rate?
• All indirect costs must be allocated using the
  approved indirect rate. Any allocated cost that
  exceeds approved rates or ceiling under a
  specific project may not be shifted to other
  Federal grants/contracts, unless specifically
  authorized by legislation. Non-federal sources
  must be used to pay for these un-recovered costs.

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FAQs

• Can our indirect cost rate be based on Federal
  funds only since they only represent 15 of our
  total revenue?
• No. Your indirect cost rate proposal must be
  accompanied by a schedule of costs incurred for
  all projects, Federal and non-Federal, and the
  amount of the proposed allocation base must
  tie-in with the applicable direct cost base for
  all projects.

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FAQs

• What is the difference between bid and proposal
  costs and fund raising costs and how should
  they be treated in our indirect cost proposal
• Bid and proposal costs represent salaries,
  consultant fees, printing, postage, travel etc.
  associated with proposals and applications to
  perform specific tasks for renumeration under
  Federal and non-federal grants/contracts. Treat
  as allowable indirect costs subject to any
  limitations imposed by cognizant agency.
• Fund raising costs represent these types of costs
  associated with seeking donation of funds for
  non-specific purposes from private institutions
  or individuals. Unallowable for Federal
  reimbursement purposes. Must be included in
  direct costs and allocated an appropriate share
  of indirect.

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FAQs

• Can audit costs under OMB Circular A-133 be
  recovered?
• A-133 allows audit costs to be recovered as
  either direct or indirect costs in accordance
  with applicable cost principles. However, there
  is no specific appropriation for audit costs.
  Must be built into specific grant/contract
  document (if direct) or into the indirect cost
  proposal (if indirect).

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FAQs

• What is the relationship of OMB A-122, Cost
  Principles for Non-Profit Organizations and OMB
  Circular A-133, Audits of States, Local
  Governmentes and Non-Profit Organizations in
  regard to indirect costs?
• The compliance supplement for OMB Circular A-133
  incorporates OMB Circular A-122 and requires the
  auditor to audit direct and indirect costs to
  determine whether costs claimed are in compliance
  with OMB Circular A-122.

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FAQs

• Can transactions with an affiliate affect
  allowable costs
• Yes. The cost of goods and services delivered
  from an affiliate must exclude any profit
  component. (OMB Circular A-122)
• This works in reverse also. If the non-profit
  provides goods or services to an affiliate, a
  credit must be applied to the appropriate cost
  center, whether direct or indirect.

FAQs obtained from www.dol.gov/oasam/programs/boc/
costdeterminationguide/sec4/htm
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FAQs

• Is the cost of accrued annual leave allowable
  under OMB Circular A-122?
• In most instances, yes.
• Under A-122, cost charged to grants/contracts
  must be determined in accordance with GAAP. (OMB
  Circular A-122, Attachment A, Part A., paragraph
  2.e.
• GAAP requires recording of accrued leave if
• Employers obligation relating to employees
  rights to receive compensation for future
  absences is attributable to employees services
  already rendered
• The obligation relates to rights that vest or
  accumulate
• Payment of the compensation is probable
• The amount can be reasonably estimated
• Does not result in increased costs, but allows
  for recognition of costs in the proper accounting
  period

FAQs obtained from www.dol.gov/oasam/programs/boc/
costdeterminationguide/sec4/htm
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OMB Circular A-122, Cost Principles for
Non-Profit Organizations, http//www.whitehouse.
gov/omb/circulars/a122/a122.html
OMB Circular A-110, Uniform Administrative
Requirements for Grants and Agreements with
Institutions of Higher Education, Hospitals and
Other Non-Profit Organizations http//www.whiteh
ouse.gov/omb/circulars/a110/a110.html
OMB Circular A-133, Audits of States, Local
Governments and Non-Profit Organizations http/
/www.whitehouse.gov/omb/circulars/a133/a133.html
HHS Division of Cost Allocation http//rates.psc.
gov/
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QUESTIONS???