The following is an excerpt from "1998 U.S. Department of Education Indirect Cost Determination Guidance for State and Local Government Agencies" (Blue Book)
SECTION VI
QUESTIONS AND ANSWERS
Application of Principles:
Q. Is OMB Circular A-87 mandatory for use by both states and local governments?
A. Yes. Paragraph 3, Section A, Attachment A of the Circular states that these principles will be applied by all federal agencies in determining costs incurred by governmental units under federal grants, cost reimbursement type contracts, and cooperative agreements (including subgrants and subcontracts) except those with (1) publicly-financed educational institutions subject to OMB Circular A-21, and (2) programs administered by publicly-owned hospitals and other providers of medical care that are subject to requirements promulgated by the sponsoring federal agencies.
Q. OMB Circular A-87 states that it does not apply to grants and contracts with (1) publicly-financed educational institutions subject to OMB Circular A-21, and (2) programs administered by publicly-owned hospitals and other providers of medical care that are subject to requirements promulgated by the sponsoring federal agencies. What is the intent of this statement and how does it affect the reimbursement of costs?
A. Federal cost principles are designed to be compatible with the organizational structure, accounting systems and programs conducted by specific types of organizations which perform federal grants and contracts. OMB Circular A-87 was designed to be compatible with the type of operations conducted by state and local government. The organization and operations of colleges and universities differ markedly from that of state and local governments and, hence, there are special cost principles for them (OMB Circular A-21). These principles recognize state and local central service costs and departmental indirect costs allocable under the procedures of OMB Circular A-87.
Q. Will the indirect costs arrived at by the application of the indirect cost rate percentage be reimbursed to state and local governments?
A. The indirect costs which are determined to be associated with federal programs in accordance with the procedures in OMB Circular A-87 will be recognized as part of the total cost of the federal projects, except where restricted or prohibited by law. The extent to which such costs are reimbursed is a matter for determination between the federal awarding agency and the recipient state or local unit of government.
Federal Cognizance:
Q. Can another federal agency question the costs included in a central service cost allocation plan submitted to and approved by a cognizant agency?
A. Cognizant federal agencies will coordinate the approval of central service plans with the other federal agencies affected. Accordingly, federal agencies will accept, as part of the costs of a particular state or local government agency, those costs represented as central service costs, provided they are in accord with the amounts set out in the negotiation agreement signed by the representatives of the state or local government and the cognizant federal agency. The exception for ED would be in a restricted rate environment, adjusting Occupancy and Maintenance cost that were approved in the State Wide Cost Allocation Plan.
Q. Where can states and local governments receive additional information or clarification on the implementation of OMB Circular A-87?
A. States and local governments should contact the federal agency that has been assigned cognizance for either central service cost allocation plans or individual government department indirect cost proposals.
Definitions:
Q. To what does the expression "cost allocation plan" refer?
A. A cost allocation plan refers to a document that identifies, accumulates and distributes allowable costs to grants and contracts and identifies the procedures used in making such distribution. It refers to both the central service cost allocation plan which is used to allocate the costs of central government services to benefiting government departments and the indirect cost proposals of those departments or units performing grants and contracts.
Q. What is an indirect cost rate?
A. An indirect cost rate is the ratio of an organization??s indirect costs to some element of its direct costs, e.g., direct salaries and wages. Once determined, the rate is used to compute grantee indirect cost entitlement. The entitlement is accomplished by multiplying the indirect cost rate by the direct salaries and wages charged to a grant or contract. An indirect cost rate is the net product of an indirect cost rate proposal.
Preparation and Use of Plans:
Q. Who is responsible for the preparation of state and local central service cost allocation plans and indirect cost proposals?
A. It is the responsibility of each state and local government to prepare timely central service cost allocation plans and indirect cost proposals where indirect cost reimbursement is sought.
Q. Must the indirect cost proposal or the central service cost allocation plan be prepared centrally for each state or local department performing under federal grant programs?
A. There is no requirement that an indirect cost proposal be prepared by any designated state or local government organization. Proposals may be prepared by each of the government departments performing under federal grants or they may be prepared in a central office. However, while the state or local central service cost allocation plan need not be prepared centrally, it must be prepared as a single document.
Q. How will a central service plan be used?
A. The central service plan is used to distribute allowable central service costs to each of the individual government departments benefited, in order that they might include them in their indirect cost proposal.
Specific Items of Cost:
Q. How can a grantee distinguish between a direct cost and an indirect cost?
A. There is no universal rule for classifying costs as direct or indirect. Generally speaking, a direct cost is one that is incurred specifically for one activity. Indirect costs are of a more general nature and are incurred for the benefit of several activities. Consequently, some allocation technique must be used to distribute these indirect costs to the several direct functions benefited. Once a grantee makes an election and treats a given cost as direct or indirect it must apply that treatment consistently and may not change during the fiscal year.
Q. Some grant programs are awarded to the Office of the Governor of a state, to the Chief Executive of a political subdivision, the Count Supervisor, City Council, School Board or other similar type of body. Are these grants precluded from covering indirect costs under the Circular?
A. The general expenses required to carry out the overall responsibilities of these officers are unallowable. Attachment B, Section 23 of the Circular identifies them as general government expenses, and therefore an unallowable cost. However, if special identifiable expenses were incurred to satisfy a federal grant or contract agreement, they would be allowed if they otherwise met the standards of allowability provided in the Circular.
Q. Is it permissible to allocate costs (either directly or indirectly) on the basis of revenue or on the basis of funds available under federal grants or contracts?
A. No. The allocation of costs by either of these methods is unacceptable. Cost must be allocated on the basis of costs incurred under federal grants or contracts.
Restricted Indirect Cost Rates and Supplement not Supplant Requirements
Background
Many of the large educational entitlement programs that provide funds to state and local jurisdictions were created by legislative statute which require that the federal funds be used to "supplement and not supplant" on going educational services. This means that state and local agencies have tax revenue or other financial resources of their own to finance the education of their children. The federal government wants to help them achieve greater levels of benefits or services through financial support. Without the "supplement not supplant" provision, state "X" could simply reduce its support of educational service to the extent of the newly available federal funding. This means state "X" could release local funds for other purposes, like tax relief or non-educational projects or other programs. Looking at it another way, without the supplanting prohibition a county could substitute federal money for tax revenue already generated to fund schools. The tax revenue windfall would be available to build other state projects (e.g., sewage treatment plants) and the federal funds would never reach the classroom as intended. To place the supplanting bar in proper context, it is best to equate the education of state citizenry with other basic functions of state government (e.g., utilities like police and fire departments).
Q. What are Restricted Rates?
A. Restricted rates are special rates established to incorporate these provisions of program legislation that bar supplanting. The restricted indirect cost rate formula is described in the Education Department General Administrative Regulations (EDGAR) AT 34 CFR Parts 75.564 and in more detail at Part 76.564 (See Appendix III). The formula limits the general management costs that can be placed in the indirect cost pool (numerator) and requires a modified total direct cost (MTDC) base (denominator).
Q. What is the practical effect of the restricted indirect cost rate formula?
A. The indirect cost determination effort for federal financial participation is viewed as a "funneling process." The first step requires the state and local unit of government to segregate the accounting of costs between indirect and direct with full cost reimbursement in mind. However, there is a paring down of the full cost reimbursement concept, when Office of Management and Budget (OMB) Circular A-87 is applied to adjust the indirect cost pool and direct cost base for unallowable costs and distorting cost items that do not benefit from or generate overhead.
The restricted indirect cost rate determination further filter out costs that would be incurred by the state or local unit of government with or without federal influence. EDGAR at 34 CFR part 76.565 explains that in a restricted setting, only costs for the "direction and control" of the grantee may be considered general management costs. Conversely, costs that benefit program operations or relate to organizational units (components) are not general management costs but rather "other direct costs" for rate computation purposes.
Costs associated with activities under organizational units that are not for Department level management also are not accepted as general management costs. Therefore, in a restricted rate setting indirect costs are purged to leave just "organization-wide" general management costs at the grantee level (e.g., bookkeeping, accounting, payroll, auditing, procurement, and personnel). These Departmental level general management costs are refined again to exclude costs associated with the Chief Executive Officers, their immediate officers, and space costs. These costs are then reclassified from indirect to the MTDC base for rate computation purposes.
Q. Who are the Chief Executive Officers?
A. There are two types of Chief Executive Officers. One is the Chief Executive Officer of the grantee. This person is the individual who is the head of the executive office at the grantee who exercises overall responsibility for the operation and management of the organization. At the grantee level, the Chief Executive Officers immediate office includes any Deputies or similar office, along with the immediate support staff of these people. It is important to emphasize here that the Chief Executive Officer of the grantee is not the Governor or member of a Board of a similar elected or appointed body. Expenses for these positions are already unallowable as "costs of general and State and local government." The second type of Executive Officer is the supervisor of a component within the grantee.
Q. What are Component Costs?
A. Generally, components are organizational units for both indirect and direct functions that exist one level below the organization unit. Depending on the organization, there may be circumstances where certain direction and control indirect functions would be properly accounted for in the indirect cost pool. However, if the indirect cost functional unit is one level below the Chief Executive Officer of the grantee (or his Deputy or similar position) then the head of the indirect cost component, her/his secretary, and travel and other related office costs should be removed from the indirect cost pool and classified to the MTDC base. In effect, those costs, in that organizational setting, are considered divisional administration applicable to that component with no distinction between indirect and direct functions.
Q. What does the term organization-wide mean in the restricted indirect cost rate determination?
A. The term organization-wide should be taken to mean those Departmental level direction and control function costs that all recipients of grant funds have in common. The regulations describe accounting, payroll, personnel management as examples of organizational disciplines that every grantee or any organization must have. Often cross cutting educational activities (e.g., Curriculum Development, Pupil Data, Library Services, Evaluation Services, and School Services) are mistaken for indirect cost functions which are not for direction and control of the organization, but rather provide services to schools or students. Those cost centers are more analogous to specialized or program service functions, even if they have system-wide impact. Again, the restricted indirect cost rate determination accepts costs related to maintaining operations as a business concern, but not costs that finance the delivery of services that the state or local unit of government provides as part of its specific mission.
When making a determination as to whether a cost is organization-wide, the state and local unit of government must evaluate whether the activity is more analogous to Departmental "direction and control" overhead, versus administration of program services. The question to be answered is: "Is this cost incurred for general management purposes or does the cost further functions that are the mission of the organization?"
Q. Will the Government share in costs that are cross cutting but not for direction and control activity if they benefit federal programs?
A. Under restricted indirect cost rate programs, state and local governments are not guaranteed a dollar for dollar reimbursement of all overhead related to federal programs with supplement not supplant provisions. State and local units of government must assume the financial obligation for costs that they normally would not in a normal federal financial relationship. The restricted indirect cost determination accomplishes a marginal distribution of administrative costs required to implement federal assistance.
Q. Can costs for Divisional Administration under indirect and direct components be billed directly to federal programs?
A. Generally, such costs are the financial obligation of the state and local government. The only exception would be if the ED Grant Award official ruled the costs and the position were specifically required for federal financial participation.
Q. Space type costs are accepted in a usual indirect cost environment. How are they accounted for in the restricted indirect cost formula?
A. Occupancy and space maintenance costs as described in EDGAR at 34 CFR Part 76.568 are classified as part of the other cost denominator for the restricted indirect cost rate determination. There are two exceptions. One is if the state and local unit of government can identify that portion of space that supports allowable indirect cost personnel, then those limited costs may be included with allowable general management costs. The second exception would be if federal financial participation required the state and local government to rent additional space to carry out a government mandate.
Q. May the space costs that are reclassified to the other direct cost base be recovered through direct billings?
A. No. These space costs are the financial responsibility of the organization.
Q. When occupancy costs are part of the approved statewide costs, how are they treated for Restricted Rate purposes?
A. They are disallowed, except where allowable under 34 CFR 76.568 (b). The disallowed amount is not placed in the base, because these costs are not incurred by the recipient.
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