Washington Department of Social and Health Services, DAB No. 1245 (1991)

Department of Health and Human Services

DEPARTMENTAL APPEALS BOARD

Appellate Division

SUBJECT: Washington Department of  Social and Health Services

DATE: April 23, 1991
Docket No. 90-207
Decision No. 1245

DECISION

The Washington Department of Social and Health Services (State) appealed
a decision of the Division of Cost Allocation, Department of Health and
Human Services, Region X (Agency), disallowing $283,659.48 in federal
financial participation (FFP) for design and development costs
associated with the acquisition of automated data processing (ADP)
services.  The State charged federal programs with an allocated share of
project development costs for the period May 1, 1987 through November
30, 1990. 1/  The Agency determined that claims for FFP for the
Financial Reporting Module (FRM) of the State's Accounting Systems
Project (ASP) were unallowable because prior federal approval for the
acquisition of automatic data processing services for design and
development of the system had not been obtained pursuant to Subpart F of
45 C.F.R. Part 95.

For the reasons stated below, we uphold the Division of Cost
Allocation's disallowance of $283,659.48.

I.  Regulatory Authority

Department regulations at Subpart F of 45 C.F.R. Part 95 describe the
conditions under which the Department will approve FFP at the applicable
rates for the costs of ADP equipment and services under an approved
State plan under Titles I, IV-A, IV-B, IV-D, IV-E, X, XIV, XVI, and XIX
of the Social Security Act.  45 C.F.R. 95.601. 2/

The regulations define "automatic data processing services" as:

 (b) Services provided by . . . State and local organizations
 other than the State agency to perform such tasks as feasibility
 studies, system studies, system design efforts, development of
 system specifications, system analysis, programming and system
 implementation.

45 C.F.R. 95.605 (1987).

The provision in Subpart F concerning the conditions for prior approval
states:

 95.611  Prior approval conditions.

 (a) General-Acquisition requirement.  A state shall obtain prior
 written approval from the Department, as specified in paragraph
 (b) of this section, when it plans to acquire ADP equipment or
 services with proposed FFP at the regular matching rate that it
 anticipates will have total acquisition costs of $200,000 or
 more in Federal and State funds over a twelve-month period, or
 $300,000 or more in Federal and State funds for the total
 acquisition. . . .

 (b) Specific prior approval requirements.  The State agency
 shall obtain written approval of the Department: (1) For the
  advance planning document or any change of the advance
  planning document prior to entering into contractual
  agreements or making any other commitment for
  acquisition of ADP equipment or ADP services . . . .

45 C.F.R. 95.611(a) and (b). 3/

The regulations further provide that the conditions of Subpart F (which
would include the prior approval requirements of section 95.611) apply
notwithstanding the existence of an approved cost allocation plan.  45
C.F.R. 95.631.

II.  Factual Background

The State initially submitted an advance planning document (APD) to the
Agency in September, 1986 in order to "seek [HHS] approval for federal
financial participation" for the design and development costs of ADP
equipment and services for the ASP.  Agency Exhibit (Ex.) A, p. 1.  The
object of the ASP was to "develop a systems design which will integrate
the data and processing functions of the various accounting processes."
Agency Ex. B, p. 3.  No action was taken on this APD by the Agency since
the State did not respond to questions posed by the Agency about the
project.  Agency Ex. C.  The State instead proceeded with the ASP design
efforts without federal approval.  Agency Ex. D, p. A-1.

The subject of the present dispute involves the development of a
component of the ASP, entitled the "Financial Reporting Module" (FRM).
The APD stated that the ASP is "a total replacement of the ADP functions
as they relate to the DSHS accounting systems."  Agency Ex. D, p. B-1.
The FRM is the first module of the ASP to be implemented.  The basic
purpose of the FRM is to replace the current system's reporting routines
with new formats, improved access, and the ability for users to design
unique reports without major disruption in the present system's data
entry, accumulation, and manipulation functions.  Agency Ex. D, p. B-4.

The design and development phase of the FRM began on May 1, 1987, and
the FRM was targeted to become operational on October 1, 1989.  Agency
Ex. D, pp. E-5, G-3.  However, the APD for this project was not
submitted to HHS until April 25, 1989.  Agency Ex. D.  The State's
transmittal letter stated that the APD was submitted in accordance with
45 C.F.R. Part 95, for approval of the APD for the operational costs of
the FRM.  The transmittal also stated that "this APD is submitted for
FFP on only the operational costs of the new system commencing on
October 1, 1989."  The State transmittal further indicated that the
submission of the APD for operational costs was not a change in the
State's position that the "federal government has no authority, under 45
C.F.R Part 95, to mandate APDs for systems used in general
administrative functions,"  but the APD was submitted to safeguard
operational FFP.  State Ex. F.  The APD for operational costs of the FRM
was approved on July 7, 1989.  State Ex. G.

The ASP/FRM APD indicated that the State had not received prior approval
for the developmental costs and that the FRM was developed without
federal funds.  Agency Ex. D, p. A-1.  However, in reviewing the ASP/FRM
APD for operational costs, the Agency discovered that despite the
statement in the APD, the State in fact had been charging federal
programs for design and development costs of the FRM since the inception
of the project.  State Ex. G.  The Agency informed the State that the
claims for the developmental costs for the FRM must be withdrawn because
the State had not requested and obtained prior approval for an APD and,
therefore, had not received the necessary prior approval from the Agency
for the developmental costs.

On February 15, 1990, the Region X Division of Cost Allocation Director
disallowed all the ASP/FRM developmental costs charged to federal
programs.  State Ex. J.  The State requested reconsideration by the
Regional Director.  The Regional Director affirmed the disallowance and
the State appealed the disallowance to the Board.

III.  Discussion

 A.  The applicable regulations require specific prior approval
 of the advance planning document for the ASP/FRM in order to
 receive FFP for ADP services.


There is no dispute that the State proceeded with the ASP/FRM project
without the prior written approval by HHS of the APD for the ADP
services necessary for the design and development of the FRM.  Moreover,
there is no dispute that the total acquisition cost of the ADP services
allocable to the public assistance programs exceeded $300,000 in federal
and state funds.  The State,  however, argued that the provisions of
Subpart F of 45 C.F.R. Part 95 are not applicable to the system design
and development costs of the ASP/FRM because the ASP/FRM is a general
administrative accounting system for the State agency, which renders
financial reporting for the operation of all the departmental programs.
The State contended that under the provisions of Office of Management
and Budget (OMB) Circular A-87, Attachment B, Part B, section 1, which
was incorporated into HHS regulations at 45 C.F.R. 74.171, the costs of
establishing and maintaining accounting and other information systems
required for the management of grant programs are allowable without the
specific prior approval of the grantor. 4/  The State argued that since
the ASP/FRM was an accounting system, these costs were allowable without
prior approval under the OMB Circular. 5/

The State argued, in effect, that the OMB Circular A-87 provision
regarding the allowability of costs for accounting systems should govern
here instead of the Department regulations at Subpart F of 45 C.F.R.
Part 95.  The State's arguments, however, ignore the regulation that
determines when the cost principles in 45 C.F.R. Part 74 should apply.
That regulation, 45 C.F.R. 74.4(a), provides that Part 74 (which
necessarily would include all cost principles made applicable by Part
74) "applies:"

 Except where inconsistent with Federal statutes, regulations, or
 other terms of a grant . . . .

This provision therefore recognizes that a particular provision of the
cost principles in OMB Circular A-87, incorporated into Part 74 at 45
C.F.R. 74.171, will not apply where there is an inconsistency with
applicable statutes and regulations.

In this instance, the specific costs in question are for automatic data
processing services for designing and developing an automatic data
processing system capable of performing the necessary accounting tasks
for the State agency.  Agency's Ex. B, p. 3.  The APD for the ASP/FRM
clearly describes the development of an automatic data processing system
including the creation of data elements, the design of the subsystem and
general system, and the development of the programs.  Agency Ex. D, p.
G-3.  The APD indicated that the State plans to:

 Develop and implement a hybrid system of front-end subsidiary
 applications coupled with an enhanced version of AFRS/TAS
 (Agency Financial Reporting System/Treasury Accounting System) .
 . . .

Agency Ex. D, p. C-3.  The APD further explains the functional
requirements of the system as:

 The systems must be capable of operating in a real-time, on-line
 input/output mode . . .

 The systems must be capable of full integration and be
 compatible with existing and planned DSHS ADP systems and
 hardware. . . .

Agency Ex. D, p. D-1.  The APD, thus, confirms that the primary tasks
involved in developing the ASP/FRM involve the design, development and
modification of automatic data processing programs.

Under the regulations at 45 C.F.R. 95.611, a state must obtain specific
prior approval in writing from the Agency for acquisition of ADP
services or equipment meeting the applicable threshold in acquisition
costs.  Clearly, the services described in the APD fit the definition of
ADP services in 45 C.F.R. 95.605, and, indeed, the State did not dispute
that it was contracting with the State central data processing center to
perform system studies, systems design efforts, and development of
system specifications as well as system programming and implementation.
Thus, we conclude that based on explicit requirements stated in Subpart
F of 45 C.F.R. Part 95, the State was required to obtain prior approval
of an APD for its ASP/FRM and that even if a provision of OMB Circular
A-87 were inconsistent with this requirement, it would not apply. 6/

The State cited prior Board decisions as support for its position that
the OMB Circular provisions should apply here in lieu of Subpart F of 45
C.F.R. Part 95.  The State has clearly misinterpreted these decisions,
however, which in fact support the Agency's position.  In South Carolina
Dept. of Social Services, DAB No. 256 (1982), the Board concluded on
page 5 that the "costs of development and implementation of the MMIS
[Medicaid Management Information System] required prior approval, even
if part of the system was an accounting system."  This decision in any
event could not support the State's position since it relied on
requirements that predated the promulgation of Subpart F of 45 C.F.R.
Part 95.  Second, in South Carolina Dept. of Social Services, DAB No.
303 (1982), the Board specifically determined that 45 C.F.R. 95.611,
which had come into effect just prior to the time period involved in
that dispute, required prior approval for a contract for ADP services
even though a system might have attributes of an accounting system. 7/
Contrary to the State's argument, the Board did not construe the
provisions of 45 C.F.R. 95.611 to favor OMB Circular A-87, Attachment B,
Part B, section 1.  Rather, the Board merely explained as a subsidiary
matter that, if 45 C.F.R. 95.611 had not been promulgated, the contract
would still require prior approval as automatic data processing costs
under OMB Circular A-87, Attachment B, Part C, section 1, as was found
in the first South Carolina case.

Thus, we find that this disallowance was properly based on the prior
approval requirements of Subpart F of 45 C.F.R. Part 95.

 B. Subsection (f) of the definition of "service agreement" at 45
 C.F.R. 95.605 does not obviate the need for prior approval here.

The State also argued that subsection (f) of the definition of "service
agreement" in 45 C.F.R. 95.605 obviates the requirement for prior
approval under section 95.611(a) for the ADP services at issue here.
Subsection (f) is one of several subsections detailing the contents of a
service agreement between the State or local central data processing
facility (the provider) and the state agency administering a state plan
under various titles of the Social Security Act.  Specifically,
subsection (f) provides that a service agreement must require that the
provider obtain prior approval under section 95.611(a) whenever it
acquires ADP equipment or services from commercial sources primarily to
support the Social Security Act programs.  It then goes on to provide
that equipment or services primarily support the public assistance
programs when the programs may reasonably be expected to be billed 50
percent of the total charges made to all users or to be directly charged
the total cost.

The State argued that since the services at issue were provided under a
service agreement and since the Social Security Act programs were not
expected to be billed 50 percent of the total charges for the services
acquired by provider, neither the provider nor the State agency needed
to obtain prior approval under section 95.611(a).

The State here clearly misconstrued the effect of subsection (f) and its
relationship to the prior approval requirements in section 95.611(a).
Subsection (f) sets out the circumstances where the provider will have
to obtain prior approval for ADP equipment and services that it obtains
from commercial sources when the provider in turn will be providing that
equipment and services to the state agency administering public
assistance programs through a service agreement.  This requirement is a
separate, additional requirement imposed on the provider and in no way
obviates the requirement that the state agency obtain prior approval
under section 95.611(a) when the state agency acquires ADP services or
equipment that meet the threshold requirements.

Thus, even if the provider does not have to obtain prior approval under
subsection (f) for the acquisition of ADP services from commercial
sources, the state agency still must do so under section 95.611(a) when
it obtains ADP services from the provider and the threshold requirements
in section 95.611(a) apply.  The regulations essentially are addressing
two different acquisitions where different considerations may apply in
determining whether prior approval is justified.  Under the State's
interpretation of subsection (f) of the definition of "service
agreement," a state could avoid the prior approval requirement for
acquisitions that greatly exceed the thresholds in section 95.611 merely
because the equipment and services were acquired as part of a service
agreement and the public assistance programs were expected to be charged
less than 50 percent of the costs.  As we have indicated previously,
section 95.611(a) sets out the rules for prior approval for the
acquisition of ADP equipment and services, and these rules apply to the
State through its State agency whenever threshold acquisition amounts
apply.

 C.  Prior approval of the State agency's cost allocation plan
 does not constitute prior approval of the ADP services costs.

The State also argued that it obtained prior approval of the ADP costs
pursuant to approval provisions in 45 C.F.R. 74.177 because the design
and development costs for the ASP/FRM were included in the State
agency's 1985-1987 cost allocation plan, which had been approved by HHS.

We do not agree.  The regulation at 45 C.F.R. 95.631  provides that the
conditions of Subpart F apply notwithstanding the existence of an
approved cost allocation plan.  Consequently, any approval of a cost
allocation plan could not substitute for the prior approval requirements
of Subpart F, and the provisions of 45 C.F.R. 74.177 would not apply.
Moreover, section 74.177 discusses specifically the approval
requirements arising out of the cost principles and does not address
(and, consequently, does not preclude the application of) the
requirements in Subpart F for prior approval of an APD for the
acquisition of ADP services.  Finally, to the extent that any provision
in Part 74 concerning approval of costs were inconsistent with Subpart F
of 45 C.F.R. Part 95, that provision would not apply under 45 C.F.R.
74.4(a).

In any event, the cost allocation provisions submitted by the State for
the period 1985 through 1987 do not specifically identify, assign and
distribute the development costs of the ASP/FRM as required by 45 C.F.R.
95.631.  In fact, the provisions of the 1985-1987 cost allocation plan
submitted do not even reference the ASP/FRM project, nor are development
costs of this project specifically mentioned.  State Ex. B.  The
regulation at 45 C.F.R. 95.631(a) requires the state agency to
specifically identify what items of costs constitute development costs,
assign these costs to specific cost centers and distribute these costs
to funding sources based on the specific identification, assignment and
distribution outlined in the APD.  Thus, even if the State had an
approved 1985-1987 cost allocation plan, the development costs were not
assigned and claimed in accordance with 45 C.F.R. 95.631(a).

With respect to the period 1987 through 1989, the Division of Cost
Allocation advised the State on October 19, 1989 that it was withholding
approval of the revision of the DSHS Administrative Cost Allocation Plan
which addresses various schedules of DSHS' 1987-1989 cost allocation
plan which were in need of clarification or modification.  The Division
of Cost Allocation specifically advised the State that the proposed
allocation basis for the ASP was in error, stating that since the
project had not received HHS prior approval, the federal programs cannot
participate in such costs and the costs must be identified as "State
Only" costs in the cost allocation plan.  State Ex. N.

 D.  The Agency's interpretation of Subpart F of 45 C.F.R. Part
 95 is not unreasonable, arbitrary, or capricious, and the State
 had notice of the interpretation by virtue of the explicit
 requirements of the regulations.

The State argued that the Agency position to impose prior approval upon
general administrative accounting systems was unreasonable, particularly
where the amount claimed represented a mere 20 percent federal share for
the total project costs.  The State also argued that its documentation
burden generally should be lessened if it is not seeking an enhanced
rate of FFP.  Finally, the State argued that the Agency position of
giving priority to the prior approval requirements of section 95.611(a)
over any inconsistent rules in OMB Circular A-87 required prior actual
notice before it could be applied to the State here.

As we have discussed throughout this decision, the State had actual
notice of the Agency's position by reason of the regulatory provisions
then in effect.  Under the explicit requirements of 45 C.F.R. 95.611(a),
a state must obtain prior approval when it plans to acquire automatic
data processing services meeting the threshold requirements.  There is
no dispute in the present case that the threshold requirements have been
met for the portion of the total costs of the ADP services that are
allocable to the Social Security Act programs.  Thus, even though the
federal share of the total project costs may only have been 20 percent,
the threshold requirements of the regulations were clearly met, and the
State had notice of those requirements.  Moreover, the regulation makes
no distinction based on the intended purpose or function of the ADP
services within the public assistance programs.  The State merely must
intend to fund the services with proposed federal funding from the
public assistance programs.  Thus, it is irrelevant whether the ADP
services are intended for a general administrative accounting system
used in the programs or for the actual operation of the programs.

Moreover, the State was clearly wrong when it argued that its burden
here related to whether it was seeking funding at the regular matching
rate or an enhanced matching rate.  While this Board has frequently held
that a state has an additional documentation burden to show that an
enhanced matching rate is available, the issue here is not whether the
state met documentation requirements but whether it met prior approval
requirements.  Moreover, section 95.611(a) specifically provides that
the prior approval requirements apply when the State intends to acquire
ADP services with proposed federal fundings "at the regular matching
rate."

In response to an Agency argument that retroactive "prior" approval was
precluded under the regulations, the State argued in its reply brief (p.
19) that retroactive approval would be appropriate because of "ongoing
Agency vacillation on the matter" and the vagueness of the regulations
on the effective date for FFP in ADP approvals.  However, section
95.611(a) expressly requires a "prior" approval as specified in section
95.611(b).  Section 95.611(b) clearly places the State on notice as to
specific nature of the prior approval requirements, which if not met,
would preclude FFP for particular acquisition costs that followed.
Moreover, section 95.611(a) requires states in their requests to
indicate clearly the Social Security Act titles under which funding is
requested, the estimated cost for the total acquisition, and the
estimated amount or percent that is requested for each title.  Thus, a
state would be on notice, by virtue of its own request, of the amount of
FFP that is in jeopardy.

Finally, the Agency argued that section 95.623 sets out the only
circumstance where the prior approval requirements may be waived and
that circumstance would not apply here.  The State here did not
demonstrate otherwise.  Further, the preamble discussion of the purpose
and effect of section 95.623 makes it clear that the Department would
not approve any requests for retroactive approval that were not covered
by that section.  51 Fed. Reg. 3337-3338 (Jan. 27, 1986).

Conclusion

For the reasons discussed above, we sustain the Agency's decision to
disallow $283,659.48 in FFP for ADP services costs related to design and
development of the State's ASP/FRM for which the State failed to receive
prior approval as required by 45 C.F.R. Part 95, Subpart F.

 


 _____________________________ Judith A. Ballard

 

 _____________________________ Cecilia Sparks Ford

 

 _____________________________ Donald F. Garrett Presiding Board
 Member


1.     The disallowance was originally $481,750, but was subsequently
reduced to the current amount by the parties' joint decision.

2.     Since the State is seeking reimbursement for the design and
development costs from the inception of the ASP/FRM project in May 1987,
we will cite to the provisions applicable as of May 1, 1987.

3.     45 C.F.R. 95.611(a) was amended February 7, 1990 to increase the
threshold acquisition costs from $200,000 in federal and state funds
over a twelve month period or $300,000 in federal and state funds for
the total acquisition costs to a threshold of $500,000 or more in
federal and state funds for the total acquisition costs.  45 C.F.R.
95.611 (1990).  In any event, the ASP/FRM development costs at issue
here were in excess of even this revised threshold.  The amended
regulation also continues to require specific written prior approval by
the Agency of the APD where the State is requesting FFP at the regular
administrative matching rate of 50 percent.

4.     OMB Circular A-87 establishes uniform principles for determining
costs applicable to grants and contracts with states and local
governments.

5.     The State argued that OMB Circular A-90, entitled "Cooperating
with State and local governments to coordinate and improve information
systems," expressly delineated the difference between data processing
system's cost for federal program support and for administrative or
other purposes incidental to the conduct of the program.  OMB Circular
A-90, Transmittal Memo. No. 1, 41 Fed. Reg. 38832 (September 13, 1976).
This Circular, however, was rescinded in 1985 with the publication of
OMB Circular A-130, entitled "Management of Federal Information
Systems."  50 Fed. Reg. 52730 (December 24, 1985).  Therefore, this
Circular is not applicable to the dispute at issue.  Even if it were,
however, the issue it discusses is at best peripheral to the underlying
issue raised here.

6.     In reaching this conclusion, we do not mean to imply that the
prior approval requirements of Subpart F are in fact inconsistent with
any of the principles in OMB Circular A-87, such as those pertaining to
accounting systems.  Arguably, the Subpart F requirements provide
additional approval requirements for a specialized subcategory of costs:
automated data processing equipment or services that exceed specific
cost thresholds.  In any event, we do not need to reach the question of
whether Subpart F is in fact inconsistent with any of the cost principle
provisions, since, under section 74.4(a), a cost principle provision
would not apply if inconsistent with Subpart F.

7.     In the first South Carolina case, the Board explained that even
though the system may have attributes which were within the parameters
of an accounting system, the majority of the tasks involved in
developing the system were closely related to development and
implementation of computer programs (ADP).  Therefore, the Board used a
weighing test to determine which of the Circular provisions
applied--whether the systems were more properly characterized as an
accounting system which does not require prior approval under OMB
Circular A-87, Attachment B, Part B, section 1, or as an ADP system, the
acquisition of which required prior approval under OMB Circular A-87,
Attachment B, Part C, section