Understanding Indirect Cost
Rates: A Primer for Auditors
Performing Single Audits
A Governmental Audit Quality Center Web Event
September 25, 2012
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Presenters
Kim McCormick, CPA
Partner
Grant Thornton LLP
&
Alex Weekes, CPA
Principal
ML Weekes & Co., PC
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What we will cover
Single Audit Objectives
Overview of Regulations
Rate Proposals and Indirect Rate Example
Factors Affecting Allowable Costs
Types of Rates
General Risk Areas for Indirect Costs
Rate Agreements
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Single Audit
Objectives
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Single Audit Objectives
Part 3 of OMB A-133 Compliance Supplement
(Allowable Costs/Cost Principles)
 Compliance
 Internal Controls over Compliance
State, Local and Indian Tribal Governments
Educational Institutions
Non-Profit Organizations
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Single Audit Objectives
Compliance:
 Indirect rates are applied consistent with rate agreement AND
agency/program limitations
- Need to understand current agreement and program-specific cost
limitations
 Indirect rates are applied consistent with appropriate base (e.g.,
MTDC)
 Actual billings reflect approved rate
 Indirect costs pools reflect allowable costs
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Single Audit Objectives
Internal Controls over Compliance:
 Look to Part 6 of Compliance Supplement
 Control Objectives- To provide reasonable assurance that Federal
awards are expended only for allowable activities and that the costs of
goods and services charged to Federal awards are allowable and in
accordance with the applicable cost principles.
 5 COSO buckets
 Control activity examples
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Overview of Regulations
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Cost Principles
Federal Rules & Cost Principles
 Not-For-Profits (OMB A-122 now 2 CFR Part 230)
 Hospitals (OASC-3)
 Colleges and Universities (OMB A-21 now 2 CFR Part 220)
 State and Local Governments (OMB A-87 now 2 CFR Part 225)
 Commercial Entities (Federal Acquisition Regulations – FAR Part
31)
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Administrative and Audit
Federal Rules & Cost Principles


Administrative Requirement (OMB Circular A-110 now 2 CFR
Part 215) Applies to All Entities
OMB Circular A-133 – Audit Requirements
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OMB Circular A-87
“…establishes Principles and standards for
determining costs for federal awards carried out
through grants, cost reimbursement contracts, and
other agreements with state and local governments
and federally-recognized Indian tribal governments”
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OMB Circular A-122
“This circular establishes Principles for
determining cost of grants, contracts, and
other agreements with non-profit
organizations ……the principles are
designed to provide that the federal
government bear its fair share of costs
except where restricted or prohibited by
law”
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Applicability
“Shall be used by all federal agencies in
determining costs of work performed ….
under grants, cooperative agreements,
cost reimbursement contracts, and other
contracts in which costs are used in
pricing, administration, or settlement.”
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Rate Proposals and
Indirect Rate Example
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What is Cost Allocation?
Accomplished through an annual cost allocation
plan
 Concept recognizing operating programs should pay for the
general fund support received – Causal and beneficial
relationship between cost incurred and benefits received
 Document identifying and distributing State and Local indirect
(administrative, support, overhead) costs to benefiting
departments/divisions/programs/final cost objectives
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Types of Cost Allocation Plans
A-87
 Used to recover costs from federal grants and programs
 Prepared in accordance with OMB Circular A-87
Full Cost
 Used to allocate indirect costs to enterprise operations,
departments and final cost objectives
 Can be used to recover indirect costs in non-federally funded
programs and departments
 Unallowable costs per A-87 are not considered
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OMB Circular A-122
Section C – “Indirect Costs”
Direct Allocation Method:
“Joint Costs, such as depreciation, rental costs,
operation & maintenance of facilities, telephone
expenses, and the like are pro-rated individually as
direct costs to each category and to each award or
other activity using a base most appropriate to the
particular cost being pro-rated.”
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Cost Allocation Plans
Directly Allocated Costs
Common Allocation Bases

Sq. ft. of programs

Cost of programs

Sq. ft. of programs

Cost of property per dept.
Professional Liability Ins.

# of staff with prof. degrees
Information Technology

# computers

# personnel

Hours spent per dept.
Occupancy
Property Insurance
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Cost Allocation Plans (cont’d)
Directly Allocated Costs
Human Resources
Internal Audit
Maintenance Services
Grant & Contract Adm.
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Common Allocation Bases

# of employees

Payroll dollars

# of employees

Hours worked per dept.

Sq. ft. of programs

Actual charges

Revenue of grants & K’s

Cost of programs

% of salary charged direct
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Cost Allocation Goals
Try to keep it as simple as possible
Measurements should be based on relative benefits
received
Be able to replicate the process
Your accounting system structure and capabilities
should be considered
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Direct Costs
Costs that can be specifically identified with a
particular cost objective
 Program Salaries
 Materials specific to award
 Travel
 Equipment
 Other minor direct items
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Indirect Costs Terms
Indirect Costs
 Overhead, Administrative and Facilities
Overhead Costs (are directly associated with
programs)
 Facilities, Program Supervision, Equipment
Administrative Costs (benefit the entire
organization)
 Accounting, Finance, IT, Facilities for Administration
Facilities and Administrative Costs (F&A)
 All of the above
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Indirect Costs Terms
Cost Objective
“A function, organizational subdivision, contract,
grant, or other activity for which cost data are
needed and for which costs are incurred”
Indirect costs are allocated to “Final Cost
Objectives” and Final Cost Objectives will incur
direct costs and be allocated indirect costs (i.e.
grants and contracts)
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Indirect Costs
“Indirect Costs are costs that are incurred for
common or joint objectives, and therefore cannot be
readily and specifically identified with a particular
project or activity.”
Indirect costs generally include:
•
•
•
•
Operations and Maintenance
Depreciation and Use Allowance
Administration Costs
Legal, Accounting, Finance, HR, IT - Administrative
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Simplified Method – Indirect Cost Rate
Expressed as a percentage
Ratio between indirect and direct costs
Simply stated if the indirect cost rate is 40%:
For every $1.00 spent on sponsored activities (direct)
40 cents of indirect costs are incurred
Establishes a fair and equitable way to
allocate costs to projects, grants, contracts,
etc.
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How Do We Get a Rate?
Indirect Cost Rate Proposal is submitted to
Cognizant Federal Agency (generally agency
with most funding)
Proposal & documentation are reviewed
Negotiated Indirect Cost Rate Agreement
(NICRA) is executed
Outlined in Appendix E of OMB Circular A-87
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Allocation Methods
Simple Method – Used when major functions
benefit from indirect costs in the same degree
Multiple Allocation Base Method – When
organization has several major functions which
benefit from its indirect costs in varying degrees
(e.g. clinical vs. research, instruction, other
sponsored activity)
Direct Allocation Method – When programs are
charged for all costs directly
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Simplified Method
Modified Total Direct Cost
Salary & Wage
Pro’s & Con’s to both


S&W (higher rate, but not recovery)
MTDC (most organizations use this base)
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Indirect Cost Rate Example
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Modified Total Direct Cost
Includes S&W, Benefits, Materials, Supplies,
Services, Travel
Excludes (typically)
Subcontract Costs (usually over $25k)
Capital Equipment Purchases
Other Distorting Items
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MTDC Example
Simple example of one project’s MTDC:
Total Direct Costs in our budget:
Salaries/benefits:
Supplies:
Subcontract:
Capital Equipment:
$ 210,000
$ 95,000
$
5,000
$ 100,000
$ 10,000
Modified Total Direct Costs:
= $210,000 - $10,000 - $75,000 (subcontract)
= $125,000 MTDC (apply IDC)
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Factors Affecting Allowable Costs
Allowable, Allocable and Reasonable
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Determining Chargeable Costs
REASONABLE
Ordinary and necessary
Support operation
Contribute to performance
ALLOCABLE
Tied to cost objective, contract,
service
Proportional to benefits
ALLOWABLE
Allowability determined by OMB
guidelines & grant provisions
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Factors Affecting Allowability
General Criteria:
 Be reasonable for the performance of the award and be allocable
thereto under these principles;
 Conform to any limitations or exclusions set forth in these principles or
in the award as to the types or amount of cost items;
 Be consistent with policies and procedures that apply uniformly to both
federally financed and other activities of the organization;
 Be accorded consistent treatment;
 Be determined in accordance with generally accepted accounting
principles (GAAP);
 Not be included as a cost or used to meet cost sharing or matching
requirements of any other federally financed program in either the
current or a prior period; and
 Be adequately documented.
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Unallowable Costs
Entertainment
Contributions to Reserve Funds
Cost of Elected Officials
Donations & Contributions
Investment Management Fees
Lobbying
Bad Debt Expense
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Types of Rates
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Types of Indirect Rates
Types of Rates



Provisional
Fixed Rates with Carry-Forward
Predetermined
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Rate Types
Provisional Rate
“A provisional indirect cost rate is a temporary
rate established for a given period of time to
permit funding and reporting of indirect costs
pending establishment of a final rate for that
period.”
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Provisional Rate
The following rules apply when a provisional
indirect cost rate or a rate applicable to an earlier
period is used to calculate the reimbursement of
indirect costs on a financial status report.
 Such indirect costs must be adjusted downward, if appropriate,
when a new lower permanent rate (i.e., final or predetermined)
is established.
 They may also be adjusted upward (based on a higher rate) at
the grantee's request, but not to exceed the unobligated
balance of the grant.
 If the grantee fails to establish a permanent rate, any indirect
costs previously reimbursed based on the provisional or earlier
permanent rate shall be disallowed.”
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Rate Types
Predetermined Rate
“A predetermined indirect cost rate is a
permanent rate established for a specific future
period based on an estimate of the costs for that
period. Except under very unusual
circumstances, this type of rate is not subject to
adjustment…”
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Rate Types
Predetermined Rates - Continued
“Predetermined rates are established when there is a
reasonable assurance, based on experience and a
reliable estimate of the organizations costs, that the
predetermined rate will approximate the
organization’s actual rate.”
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Rate Types
Predetermined Rates - Continued
“Predetermined rates can be used only when an
organization conducts activities solely under grants.
It cannot be used if an organization performs work
only on contracts or performs under both grants and
contracts.”
This applies to direct federal contracts only.
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Rate Types
Fixed Rates
“an indirect cost rate which has the same
characteristics as a predetermined rate, except that
the difference between the estimated costs and the
actual costs of the period covered by the rate is
carried forward as an adjustment to the rate
computation of a subsequent period.”
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Carry-forward
Carry-forward provision
Negotiated Fixed Rate - 2012
40%
Direct Cost Base – 2012
$10,000,000
Actual indirect Costs - 2012
$ 4,200,000
Indirect Cost Recovery – 2012
$ 4,000,000
Actual Rate - 2012
Under-recovery
42%
$
200,000*
*Carry-forward is 2 years forward (2014 in this scenario).
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Carry-forward
Carry-forward
Actual Indirect Costs - 2014
$ 4,500,000
Carry-Forward from - 2012
$
Indirect Costs - 2014
$ 4,700,000
Direct Cost Base - 2014
$10,000,000
Rate with Carry-forward
47%
Rate without Carry-forward
45%
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200,000
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General Risk Areas
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General Risk Areas
Key areas of Risk include:
 Predetermined and fixed rates carry lowest compliance risk
- Rates cannot change; therefore program costs for prior years not
subject to adjustment
- For fixed rates must determine if current year indirect costs and
carry-forward are correctly identified
 Provisional rates carry risk that changes in base or pool may
have material impact on programmatic costs
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General Risk Areas
Key areas of Audit Risk include (cont’d):
 Consistency in applying rate to correct base
 Consistent treatment of costs (no “double dipping”)
 Inadequate documentation / Unsupported costs
 Timeliness of preparing and submitting rate proposals (6 months
after year end)
 Expired Rate Agreements
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Rate Agreement
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Rate
Agreement Predetermined
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Rate Agreement - Provisional
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Rate Agreement – Fixed CF Provision
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