1. A Governmental Audit Quality Center Web Event September 25, 2012
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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5. Presenters
Kim McCormick, CPA Partner Grant Thornton LLP & Alex Weekes, CPA Principal ML Weekes & Co., PC

6. 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

7. Single Audit Objectives

8. 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

9. 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
Verify against billings and cost reporting forms
Was most current applicable rate used
Could lead to over recovery or duplicate recovery

10. 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
Accountability provided for charges and costs between Federal and non-Federal activities.
• Process in place for timely updating of procedures for changes in activities allowed and cost principles.
• Computations checked for accuracy.
• Supporting documentation compared to list of allowable and unallowable expenditures.
• Adjustments to unallowable costs made where appropriate and follow-up action taken to determine the cause.
• Adequate segregation of duties in review and authorization of costs.
• Accountability for authorization is fixed in an individual who is knowledgeable of the requirements

11. Overview of Regulations

12. 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)

13. 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

14. 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”

15. 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”

16. 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.”

17. Rate Proposals and Indirect Rate Example

18. 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

19. Types of Cost Allocation Plans
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

20. 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.”

21. Directly Allocated Costs Common Allocation Bases
Cost Allocation Plans
Directly Allocated Costs
Common Allocation Bases
Occupancy
Sq. ft. of programs
Cost of programs
Property Insurance
Cost of property per dept.
Professional Liability Ins.
# of staff with prof. degrees
Information Technology
# computers
# personnel
Hours spent per dept.

22. Cost Allocation Plans (cont’d)
Directly Allocated Costs
Common Allocation Bases
Human Resources
# of employees
Payroll dollars
Internal Audit
Hours worked per dept.
Maintenance Services
Sq. ft. of programs
Actual charges
Grant & Contract Adm.
Revenue of grants & K’s
Cost of programs
% of salary charged direct

23. 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

24. 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

25. 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

26. 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)

27. 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

28. 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.

29. 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

30. 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

31. 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)

32. Indirect Cost Rate Example

33. 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

34. MTDC Example Simple example of one project’s MTDC:
Total Direct Costs in our budget: $ 210,000
Salaries/benefits: $ ,000
Supplies: $ ,000
Subcontract: $ 100,000
Capital Equipment: $ ,000
Modified Total Direct Costs:
= $210,000 - $10,000 - $75,000 (subcontract)
= $125,000 MTDC (apply IDC)

35. Factors Affecting Allowable Costs Allowable, Allocable and Reasonable

36. Determining Chargeable Costs
Ordinary and necessary
Support operation
Contribute to performance
Tied to cost objective, contract, service
Proportional to benefits
Allowability determined by OMB guidelines & grant provisions
REASONABLE
ALLOCABLE
ALLOWABLE

37. 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.

38. Unallowable Costs Entertainment Contributions to Reserve Funds
Cost of Elected Officials
Donations & Contributions
Investment Management Fees
Lobbying
Bad Debt Expense

39. Types of Rates

40. Types of Indirect Rates
Types of Rates
Provisional
Fixed Rates with Carry-Forward
Predetermined

41. 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.”

42. 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.”

43. 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…”

44. Predetermined Rates - Continued
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.”

45. Predetermined Rates - Continued
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.

46. 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.”

47. Carry-forward Carry-forward provision Negotiated Fixed Rate - 2012 40%
Direct Cost Base – $10,000,000
Actual indirect Costs $ 4,200,000
Indirect Cost Recovery – $ 4,000,000
Actual Rate %
Under-recovery $ ,000*
*Carry-forward is 2 years forward (2014 in this scenario).

48. Carry-forward Carry-forward Actual Indirect Costs - 2014 $ 4,500,000
Carry-Forward from $ ,000
Indirect Costs $ 4,700,000
Direct Cost Base $10,000,000
Rate with Carry-forward %
Rate without Carry-forward %

49. General Risk Areas

50. 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

51. 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

52. Rate Agreement

53. Rate Agreement - Predetermined

54. Rate Agreement - Provisional

55. Rate Agreement – Fixed CF Provision

56. Questions ????? 56

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