SUBJECT: Arkansas Department of Information Systems

DECISION

The State of Arkansas appealed a determination made by the Division of Cost Allocation (DCA) of the Department of Health and Human Services (HHS). Arkansas was represented by its Department of Information Systems (DIS). The determination related to data processing and telecommunication services DIS provided to other Arkansas agencies and charged to those agencies through billing rates. Some of the charges were passed on to federal programs. DCA determined that DIS had not been following the requirements for using billing rates to allocate costs to federal programs. After numerous attempts to obtain information needed to calculate the amounts properly charged to federal funds, DCA estimated that Arkansas owed the federal government $9,439,266 for overpayments for DIS services charged to federal funds during fiscal years 1997-2000 (and associated interest). DCA asked for a cash refund. Arkansas appealed, arguing primarily that the total overcharges to federal funds should be offset by total undercharges for other DIS services.

After a lengthy period during which the parties tried to settle the dispute and then engaged in discovery, Arkansas submitted its brief and appeal file and DCA responded. DCA's response included an adjustment to the amount DCA says is due to the Federal Government, raising the amount to $18,228,612, based on information provided by DIS during the discussions. In its reply brief, Arkansas argued that DCA's amended and recalculated disallowance should be dismissed and review continue on the original disallowance. The Board denied this motion, but permitted Arkansas an opportunity to supplement its initial submission. Arkansas then sought an evidentiary hearing, primarily to present testimony in support of its allegation that there was no harm to the performance of federal programs from the overpayments. The Board ruled that this issue was irrelevant to [Page 2] whether the Board should uphold DCA's determination. The Board, however, permitted Arkansas a further opportunity to present evidence on whether the type of offsetting Arkansas advocates would result in cost-shifting, as DCA alleges, and whether the way Arkansas distributed rebates for some DIS services resulted in inconsistent treatment of costs. The Board also gave Arkansas an opportunity to explain its case in an in-person informal conference. At the informal conference, DCA agreed to an adjustment to post-disallowance interest and agreed to consider an alternative proposal for how to calculate interest as part of the disallowed amount, if Arkansas submits the necessary information within a specified time period.

The key issue before us is whether DCA acted in an arbitrary and capricious manner by refusing to permit Arkansas to offset total overcharges for DIS services against total undercharges for other DIS services in calculating the amount due. As explained below, we conclude that DCA acted reasonably, for the following reasons:

• Arkansas does not dispute that it was not reconciling DIS billing rates for data processing and telecommunications services to the actual costs of providing the services annually, as required. Arkansas was thus not submitting claims for federal funding for DIS services in accordance with an approved cost allocation methodology, as required. Rather than disallowing the entire amount charged to federal funds for DIS services, however, DCA in effect permitted some amounts to be allocated to federal funds, after estimating the federal share of overcharges resulting from billing rates that exceeded the actual cost of providing the services.



• The requirements applicable to the kind of central support services DIS provided permit some offset of overpayments against underpayments when adjusting federal funding, but those methods generally apply only when the adjustments are being made on an ongoing basis and when approved by DCA. Moreover, DCA may require a state to account for each category of service separately, even if the services are funded through the same internal service fund. DIS did make some rebates to Arkansas agencies when it had a surplus of revenues over cost in its internal service fund (and DCA gave Arkansas credit for the rebates), but DIS was not following any permitted adjustment methodology on an ongoing basis. In fact, DIS distributed the rebates in [Page 3] a way that resulted in inconsistent treatment of costs between federal and State programs.



• DCA reasonably determined that permitting retrospective offsets of total overcharges for some DIS services against total undercharges for other DIS services could result in impermissibly shifting costs from State to federal funds or from one federal program to another or in avoiding conditions on federal funding such as caps on program administrative costs or requirements for timely claims for program funds.



• Contrary to what Arkansas alleges, DCA has not affirmatively established a policy permitting this type of offset and has not treated Arkansas unfairly.



• Having determined, based on information Arkansas provided, that neither the settlement amounts previously discussed nor the amount initially disallowed would be equitable to the Federal Government, DCA appropriately sought recovery of a greater amount, since Arkansas had notice of DCA's rationale and ample opportunity to provide further information and to dispute the rationale before the Board.

We further conclude that, while Arkansas is correct that it would be more accurate to determine a disallowance amount by examining the actual charges to federal programs (rather than applying an average federal financial participation rate to the charges to State agencies), Arkansas has had numerous opportunities to come forward with documentation of the actual charges, but failed to do so. Absent such documentation, DCA reasonably relied on evidence (either provided by or not rebutted by Arkansas) about charges to State agencies, and about the average federal financial participation rates for each agency, to estimate the total excess charges to federal funds for DIS services. Moreover, despite the lengthy history of this case and the fact that Arkansas contended from an early stage that grant-specific calculations would be more accurate, Arkansas concedes that it may not even have the needed information and provides no assurance that the information, if available, would show that the disallowance amount is too high.

We also reject a number of arguments Arkansas made about how DCA calculated the amount due, such as Arkansas' arguments that DCA improperly included imputed interest and counted it twice. Since DCA indicated that it was willing to consider an alternative method for calculating the interest earned on excess federal [Page 4] funds, we have provided below for a limited opportunity for Arkansas to provide the information required for the alternative method.

Thus, we uphold the DCA determination of an amount of cash due from Arkansas, with the interest adjustment to which DCA agreed and any further adjustment to which DCA agrees as a result of information timely submitted by Arkansas consistent with our decision. Our decision does not preclude Arkansas from seeking, through an applicable process in a federal agency other than HHS, to have applied any grant-specific provision that requires a showing of harm to the performance of the program as a prerequisite for recovery of federal funds for costs that do not meet federal requirements. We have attached our ruling rejecting Arkansas' argument that DCA was required to demonstrate harm to the federal interest (beyond the harm from paying more than actual costs for some billed central services) as part of this proceeding.

Applicable Law, Regulations, and Cost Principles

The allowability of costs claimed by state governments under federal grants is governed by Office of Management and Budget (OMB) Circular A-87. 45 C.F.R. �� 74.27(a) and 92.22(b). To be allowable, a cost must, among other things, be necessary and reasonable for proper and efficient performance and administration of a federal award, conform to any limitations or exclusions in governing regulations as to types or amounts of costs, and be allocable to the award. OMB Circular (Cir.) A-87, Attachment (Att.) A, � C.1. A cost is allocable to a particular cost objective if the goods or services involved are chargeable or assignable to such cost objective in accordance with relative benefits received. OMB Cir. A-87, Att. A, � C.3.a.

This dispute concerns the disposition of federal funds that Arkansas claimed for central service costs. Central service costs are the costs of services provided by a state on a centralized basis to its various departments and agencies, which in turn may receive federal funding in those costs, to the extent they administer federally-funded programs. In this case, the central services include data processing and telecommunications services provided by DIS.

To ensure that central service costs are identified and assigned to benefitting federal programs and activities on a reasonable and consistent basis, OMB Circular A-87 establishes a process for submission and approval of a central service cost allocation plan (CAP). OMB Cir. A-87, Att. C, � A.1. A CAP is the documentation [Page 5] identifying, accumulating, and allocating (or developing billing rates based on) the allowable costs of services provided by a governmental unit on a centralized basis to its departments and agencies. OMB Cir. A-87, Att. A., � B.4. "In essence, the CAP identifies the central support services that qualify for federal financial participation and describes how central support agencies allocate the costs." Alabama v. Shalala, 124 F. Supp. 2d 1250, at 1253 (M.D. Ala. 2000). The CAP describes the method by which the costs will be distributed to different programs, as well as all costs and other data used to distribute the costs included in the plan. OMB Cir. A-87, Att. C, � A.1. The requirements for CAPs are listed in OMB Circular A-87, and in an HHS implementation guide issued pursuant to OMB Circular A-87, "A Guide for State and Local Government Agencies: Cost Principles and Procedures for Establishing Cost Allocation Plans and Indirect Cost Rates for Agreements with the Federal Government" (ASMB C-10). OMB Cir. A-87, Att. C, � A.2. ⁽¹⁾

For each year that a state claims central service costs, it must submit a CAP for review, negotiation, and approval by the cognizant federal agency. OMB Cir. A-87, Att. C., �� D.1, F.1. HHS is the cognizant federal agency for Arkansas, and DCA is the HHS component responsible for CAPs. CAPs must include all central service costs that will be claimed under federal awards. Id., Att. C, � D.1. Costs of central services omitted from the plan will not be reimbursed. Id., Att. C, � C. All costs and other data used to distribute the costs included in the plan should be supported by formal accounting and other records that will support the propriety of the costs assigned to federal awards. Id., Att. C, � A.1.

Costs of central services that are allocated to benefitted agencies on some reasonable basis (but are not billed to those agencies) are included in Section I of a CAP and are called "allocated central services" or "Section I" costs. Services that are billed to benefitted agencies and/or programs on an individual fee-for-service or similar basis are included in Section II of a CAP and are called "billed central services" or "Section II" costs. Id., Att. C, �� B.1, B.2.

The revenues that a state agency receives from other state agencies for billed central services may be accounted for through an "internal service fund" (ISF), which the state uses to finance those services. Because ISFs are typically funded [Page 6] through periodic billing cycles, charges by an ISF activity to provide for the establishment and maintenance of a reasonable level of working capital reserve are allowable since this enables the ISF to pay expenses as they arise. Except in exceptional cases, a working capital reserve as part of retained earnings is considered reasonable if it does not exceed 60 days cash expenses for normal operating purposes. Id., Att. C, � G.2. The allowance for a working capital reserve is an exception to the general policy that federal grantees may not make a profit by charging a federal award more than the cost of the services. ASMB C-10, � 1.6, Question 1-4; OMB Cir. A-87, Att. A, � A.1.

As part of the CAP, a state government must provide specific documentation about ISFs, including a fiscal year-end reconciliation schedule showing the revenues, costs, and year-end balance. OMB Cir. A-87, Att. C, �� E.3.b(1), G.4; ASMB C-10, � 4.8, Question 4-7. The cognizant agency has flexibility to request additional documentation on a case-by-case basis. OMB Cir. A-87, Att. C, � E. An ISF may cover more than one category of service provided by a central services agency, but "[e]ach billed central service activity must separately account for all revenues (including imputed revenues) generated by the service, expenses incurred to furnish the service, and profit/loss." Id., Att. C, � G.1.

With respect to revenues, OMB Circular A-87 provides:

Revenues shall consist of all revenues generated by the service, including unbilled and uncollected revenues. If some users were not billed for the services (or were not billed at the full rate for that class of users), a schedule showing the full imputed revenues associated with these users shall be provided.

Id., Att. C., � E.3.b(2). With respect to billing rates, OMB Circular A-87 provides:

Adjustments of billed central services. Billing rates used to charge Federal awards shall be based on the estimated costs of providing the services, including an estimate of the allocable central service costs. A comparison of the revenue generated by each billed service (including total revenues whether or not billed or collected) to the actual allowable costs of the service will be made at least annually, and an adjustment will be made for the difference between the revenue and the allowable costs.

[Page 7] Id., Att. C, � G.4 (emphasis added). Adjustments may be made through one of four specified methods (set out below).

Proposed CAPs must be accompanied by a certification that the costs included in the proposal are allowable and properly allocable to federal awards in accordance with federal requirements, and that similar types of costs have been accounted for consistently. OMB Cir. A-87, Att. C, � E.4., see also � E.1. This reflects basic guidelines for allowability of costs under federal awards, including that costs must be consistent with procedures that apply uniformly to both federal awards and other governmental activities and be accorded consistent treatment. Id., Att. A, � C.1.

Negotiation of central service CAPs generally results in an agreement that will be accepted and used by all federal agencies. A negotiated agreement may be reopened in some circumstances (including if the information on which the plan was negotiated is later found to be materially incomplete or inaccurate) or may be subject to adjustments or refunds for costs that are unallowable or clearly not allocable to federal awards. Id., Att. C, �� F.2., F.3. If a dispute arises in the negotiation of a plan, the dispute is resolved using the appeals procedures of the cognizant agency. Id., Att. C, � G.6.

OMB Circular A-87 was last revised in 1995. These revisions clarified some requirements for ISFs. After the revision, DCA issued ASMB C-10, pursuant to the specific provision in the Circular providing for HHS guidance. ASMB C-10 says it applies to costs claimed through state-wide CAPs for new agreements due after October 1, 1997.

While having and following an approved CAP is a prerequisite for allocating central service costs to federal programs, not all allocated costs are allowable costs for purposes of federal grants. As discussed below, federal funding may not be available for allocated costs if there are caps on federal funding, if requirements for timely filing of claims are not met, or if other restrictions on costs apply.

Board cases, based on applicable law and regulations, hold that the burden of demonstrating the allowability and allocability of costs for which funding was received under a grant rests with the grantee. See, e.g., Maryland Dept. of Human Resources, DAB No. 1886 (2003); New Jersey Dept. of Human Services, DAB No. 1797 (2001); Texas Migrant Council, Inc., DAB No. 1743 (2000) and cases cited therein; see also 45 C.F.R. �� 74.50- 74.53 (general grant documentation and record-keeping requirements) and 45 [Page 8] C.F.R. Part 92 (administrative requirements for state grants). This fundamental principle of grant law ultimately derives from the requirement that federal funds may be expended only for the purposes for which they were appropriated, and no other, absent specific legal authority otherwise. U.S.C.A. Const. Art. I � 9, cl. 7 (Appropriations Clause); 31 U.S.C.A. � 1301(a); see New York City Human Resources Administration, DAB No. 1199 (1990).

Background

The following are not in dispute:

• The Arkansas Department of Finance and Administration (DFA) is the agency authorized by the State of Arkansas to develop its state-wide cost allocation plan (SWCAP) and to negotiate with the DCA Dallas Regional Office for approval of that plan, on behalf of all State agencies, including DIS. DFA received a copy of ASMB C-10 on October 27, 1997.



• Arkansas' fiscal year (FY) ends June 30, so its SWCAP for FY 1997 was due the end of December 1997.



• DIS does not directly receive or administer any federal grants, but bills on a monthly basis and receives revenue for its data processing and telecommunications services. DIS revenues are intra-governmental transfers of funds between State agencies. DIS revenues come from federal funds only when the State agencies submit claims to the Federal Government for the costs billed by DIS.



• DIS services are considered to be "billed central services" and are included in Arkansas' SWCAPs as Section II costs. Each DIS service is billed using an individual rate. Charges are based on usage of services.



• DIS traditionally calculated the amount of a permissible reserve for the ISF it operated by calculating one sixth of its annual expenditures (a 60-day balance). DIS calculated whether it had an excess reserve by computing its total revenues less allowable costs and subtracting the amount it calculated as a 60-day balance. A DCA negotiator from the Dallas Regional Office had approved this method of calculating an excess reserve amount for FYs 1989-1996.



• [Page 9] DCA approved Arkansas' SWCAP for FY 1997 to FY 2000. DCA's approval letters indicated, however, that there were still unresolved issues, specifically, with respect to the data processing and telecommunications ISF. ⁽²⁾



• In a letter dated August 2, 2000, the DCA Director informed DFA that DCA was not able to finalize its reviews of Arkansas' SWCAPs for fiscal years ending June 30, 1997 and 1998 because of inadequate information on telecommunications and data processing costs and that, if DCA did not receive information requested in the letter prior to November, "we must remove data processing and telecommunications services provided by [DIS] as chargeable to Federally funded programs effective July 1, 2001." This request included a request for a "schedule comparing total revenues generated by each billable service to the allowable costs of each service, as defined by A-87, with an explanation of how variances will be handled." DIS Ex. 8, at 122 - 124. To respond to this request, DIS needed to calculate over- and undercharges for individual telecommunications and data processing services. ⁽³⁾



• In April 2001, DCA first received information that compared revenue to cost for each billing rate, but only for FY 1999 and FY 2000.



• In August 2001, the Dallas Regional Office sent another letter to DFA that outlined specific requests for additional information, due by October 12, 2001.



• DIS requested and received an extension until December 31, 2001, but DCA did not receive the additional information by that date.
  
  
• [Page 10] On January 24, 2002, DCA's Dallas Regional Office issued a determination that the federal share of the excess balance of the reserve for the DIS ISF was $9,439,266 (including imputed interest) and that DCA was requesting a cash payback of this amount. At the time, DCA had no information available by State user agency, so it calculated the federal overpayments only by the individual services involved.



• DIS, on behalf of Arkansas, appealed that determination on February 20, 2002.



• Pursuant to a request by Arkansas, the Board asked DCA to clarify the basis for its determination, which DCA did in its submission of March 14, 2002.



• The parties then engaged in mediation and exchanges of information. In November 2002, Arkansas submitted to DCA charts prepared by a DIS consultant showing charges to various State agencies for the individual categories of DIS services provided in FY 1997 through FY 2000. DCA requested more information and the negotiations continued until November 2003, when DCA notified the Board that it was withdrawing from mediation.



• After some discovery proceedings, Arkansas submitted its brief and appeal file, and DCA responded. In that response DCA said that it was increasing the amount of the requested refund to $18,228,612 based on the supplemental data provided to it by Arkansas in November 2002 and additional data received by DCA on July 8, 2004 regarding federal financial participation (FFP) rates.



• In reply, Arkansas asked that we dismiss DCA's revised calculation and continue review of the original disallowance. Arkansas further stated that, if required to respond to the additional issues concerning the revised disallowance, it would require additional time to prepare a response. The Board denied the request to dismiss the revised disallowance. In a ruling dated October 13, 2004, the Board explained that the basis for denying the request was the Board's longstanding practice to permit an agency to amend a disallowance, so long as a grantee has adequate notice of the reasons for the amendment and adequate opportunity to respond. The Board permitted Arkansas an opportunity to submit supplemental evidence and argument to respond to DCA's new calculation of a disallowance amount.
  
  
• [Page 11] On November 8, 2004, the Board held a teleconference to discuss Arkansas' request for a hearing, noting that DCA did not appear to dispute key factual assertions made by an Arkansas consultant with respect to DCA's practice regarding "netting" to resolve "excess reserve violations" with other States and that neither party sought to cross-examine the other's` affiants. The Board also noted that there was a threshold legal issue regarding whether a showing of harm to the federal interest, beyond an overpayment per se, is a prerequisite to recoupment, at least as to some federal programs, as Arkansas asserted. The Board gave Arkansas an opportunity to submit a supplemental statement on the legal basis for this assertion. Arkansas was also asked to identify the state agency witnesses whom it would present on this issue and to provide brief summaries of their expected testimony. DCA was given an opportunity to respond and Arkansas an opportunity to reply.



• After receiving the parties' submissions, the Board issued a ruling on May 25, 2005, holding that DCA is not required to demonstrate harm to a specific federal interest either as a prerequisite to the recovery of HHS funds or, with respect to other agencies' funds, as part of this proceeding, which applies because of the HHS role as "cognizant agency" for Arkansas. A copy of that ruling is attached to this decision and incorporated by reference into the decision.



• The Board also ruled that no evidentiary hearing was required in light of its ruling, since the testimony Arkansas proffered went to the irrelevant issue of whether the overcharges to federal programs impacted the State's ability to meet the programmatic requirements of its federal grants. The Board did, however, set the case for an informal conference, to permit oral argument on, and discussion of, the legal issues. The Board also permitted Arkansas an opportunity to support its contention that no cost shifting had occurred and "a final opportunity to submit documentary evidence of undercharges and of how those undercharges if combined with the admitted overcharges did or did not result in an excess claim for federal funds from any grant program." Ruling of May 25, 2005, at 13.



• On June 23, 2005, Arkansas made a submission that its cover letter characterized as evidence regarding the overcharges and undercharges to individual grant [Page 12] programs, but that it now acknowledges was intended to support its position that the overcharges for DIS services caused no harm to the performance of federal programs.



• The informal conference was held on July 26, 2005. Because of some problems with transcription, the tape recordings of the conference have been included in the record. ⁽⁴⁾



• DCA was permitted to file a written submission after the conference, commenting on Arkansas' June 23 evidentiary submission (to which DCA had objected on the basis that it was not responsive), and Arkansas had an opportunity to reply.
  

Discussion

1. Arkansas failed to meet the requirements of OMB Circular A-87 establishing the conditions for billing central service costs to federal programs; Arkansas had notice that it might not receive any federal reimbursement for DIS services if it did not have and follow an approved allocation methodology for those services; DCA nonetheless took an approach that permits allocation of some DIS costs to federal funds, and this context is important in considering the issues Arkansas raises about the methodology DCA used to determine the amount of federal funds owed.

While Arkansas asserted in its initial submission that DIS had been adjusting its billing rates and making rebates on an ongoing basis, DCA's response and the evidence in the record present a different picture of what occurred.

It is undisputed that, during FY 1997 through FY 2000, DIS made some adjustments to its billing rates and made some rebates to State agencies for "overrecoveries" made by DIS as a result of rates that were too high. The record shows, however, that DIS was not following the process in the Circular for setting and adjusting reimbursement rates, nor using an acceptable methodology to reimburse the Federal Government when it did determine that rates were too high.

[Page 13] Arkansas acknowledges that DIS was not adjusting its rates at least annually to reflect actual costs of providing the services. Arkansas attributes its failure to make timely adjustments to the two-year budget cycle and appropriations restrictions in Arkansas. The record indicates, however, that another factor was that Arkansas simply was not keeping its cost information in a manner that would readily enable it to determine the actual costs of each category of service. In the mid-1990's, DIS hired a consulting firm "to evaluate and revise its cost allocation and charge-back rate structure." DCA Ex. 35, at 1. This consulting firm provided a computerized system (referred to as CRIS) that would have enabled DIS to allocate the underlying costs to the service categories, but DIS did not maintain the CRIS data or update the rates on a year-to-year basis. Id.; see also DCA Ex. 23, at 47 (6/26/2002 Testimony of then DIS Director Elkins before Special Legislative Council: ". . . the rates weren't changed . . . we're to a point right now where the rates haven't been adjusted for so long that it's a reengineering"; DCA Ex 29, at 2 ("During the period in question (FY 1997-FY 2001), DIS did not have a functional general ledger . . ."). Arkansas asserts that it did change rates for some services as a result of the consulting firm's rate studies, but does not claim to have annually adjusted all of the rates as required. ⁽⁵⁾ Arkansas admits, moreover, that it did not implement the CRIS system (which, as indicated, would have enabled DIS to allocate costs among the different services, as required in order to determine the actual costs of a unit of a particular service) and was tracking costs only by budget cost center (that is, according to [Page 14] the type of underlying cost, such as personnel or supplies). AR Reply Br. at 22-24. ⁽⁶⁾

The lack of ability to determine accurately the actual costs of each of the various categories of service also affected how DIS calculated the rebate amounts when it did give rebates. ⁽⁷⁾ DIS calculated the rebates based on its view of what its "year-end surplus" was, essentially by comparing total costs to a total adjusted revenue amount. DIS then distributed rebates of the surplus amount to various State agencies using a "pro rata" calculation based on service usage. ⁽⁸⁾ The record shows that total adjusted revenue amount used by DIS also did not track federal requirements. First, DIS was not including "imputed revenue" in its revenue figures, as required by OMB Circular A-87. ⁽⁹⁾ Second, [Page 15] DIS was adjusting the revenue amount downward based on a State law that permitted it to retain a certain amount of overcharges to purchase equipment. The State law, however, does not track with the federal provisions permitting a 60-day working capital reserve. ⁽¹⁰⁾

A key reason why DCA recalculated the disallowance and why the recalculated disallowance is so much higher than the original one is that DCA determined, after analyzing figures Arkansas provided in November 2002 for charges for individual services to individual State agencies compared to actual costs, that State agencies with sizeable federal programs were usually being overcharged, and State agencies with no or minimal federal programs were usually being undercharged. DCA also determined that the distribution of the rebates did not reflect the pattern of overcharging. The effect, DCA found, violated the requirement for consistent treatment of costs since State programs were being repaid substantially all of their overpayments, but federal programs were not. This effect is illustrated in attachments to the affidavit by DCA negotiator Terry Hill. Attachment F-1 shows, for example, that for FY 1998, federally funded State agencies received rebates totaling only 43% of their overcharges ($4,121,520 in rebates on overcharges of $9,585,872), while "all other" State agencies received rebates totaling 234% of their overcharges ($2,339,470 in rebates on overcharges of $997,952). DCA Ex. 1, Att. F-1. Attachment F-2 shows that over a five-year [Page 16] period, the federally funded State agencies averaged 19% over cost, while "all other" State agencies actually paid $569,871 less than cost.

Although Arkansas offers reasons why we should find that what it did was simply a function of how its State budget and appropriation process works, rather than an intentional shifting of costs, Arkansas has presented no evidence or argument that rebuts DCA's findings regarding the effect of what DIS was doing.

Thus, the dispute here is not over whether Arkansas failed to meet federal requirements, but rather over the methodology used to calculate the amount due to the Federal Government as a result of that failure. Arkansas' chief argument is that Arkansas should be able to offset (or net) its total undercharges for DIS services against total overcharges. Arkansas disputes DCA's position that such an offset is impermissible under a previous Board decision, New Mexico General Services Dept., DAB No. 1876 (2003). In that decision, the Board upheld a determination by DCA that New Mexico could not retroactively offset alleged undercharges to federal funds against established overcharges, since the undercharges were unsubstantiated and had not gone through the federal agencies' claiming process. Arkansas disputes DCA's position that its undercharges are unsubstantiated and relies on an opinion letter from a cost allocation expert, which Arkansas says indicates that New Mexico was wrongly decided. Arkansas also relies on this letter as showing that DCA's methodology is flawed because it is based on overcharges to State agencies, rather than overcharges to individual federal awards.

Arkansas also relies on evidence that, under a methodology previously approved by a DCA negotiator for Arkansas in determining excess reserve amounts and used in negotiated settlements with other States, total overcharges for all services within the ISF are offset by total undercharges for a year when determining an excess reserve amount. According to Arkansas, DCA's failure to permit such offset here is arbitrary and capricious, inconsistent with its past interpretation, and a change in policy that was subject to notice and comment rulemaking.

Arkansas also challenges the methodology used by DCA in its revised disallowance on the grounds that this methodology shows inconsistency on DCA's part, is not a methodology that any state could reasonably be expected to apply, and is not a methodology of which Arkansas had notice during the fiscal years in question. In addition, while Arkansas concedes that DCA based its [Page 17] calculations on Arkansas' own figures and that those calculations are mathematically correct, Arkansas challenges certain aspects of the calculations, such as inclusion of "imputed interest" on the federal share of excess reserve funds.

We address all of these issues below, but wish to emphasize at the outset that Arkansas had clear notice from the Circular that a prerequisite for claiming federal funds for central services is having an approved cost allocation methodology and following that approved methodology. Thus, Arkansas had notice it might not receive any reimbursement for DIS services if it chose to use an ISF billing method and then failed to meet ISF requirements. Arguably, DCA could have taken the position that Arkansas' failure to meet ISF requirements rendered unallowable all of the billed charges related to DIS services. DCA also could also have taken the position that no amounts in excess of the billing rates actually charged were reimbursable because the proper reconciliations and adjustments were not made in a timely manner. Instead, DCA indicated it was willing to approve allocation of some charges to federal funds and to permit some offsets of over- and undercharges for the same category of service provided to the same State agency in succeeding years, so long as Arkansas repays the Federal Government for the amount DCA estimated (based on figures Arkansas provided) Arkansas owed as a result of claiming excess federal funds during FY 1997 through FY 2000. This context is important to our analysis below.

2. OMB Circular A-87 does not require DCA to permit Arkansas to have the total overcharges at issue here offset by total undercharges.

An underlying premise to Arkansas' position is that OMB Circular A-87 would have permitted Arkansas to offset profits and losses by making adjustments on an ongoing basis, so offsetting over- and undercharges would simply put Arkansas into the same position financially that it would have been had it been following the Circular.

The Circular provides for adjustments after reconciling billing rates to actual costs of providing the services, as follows:

These adjustments will be made through one of the following adjustment methods: (a) a cash refund to the Federal Government for the Federal share of the adjustment, (b) credits to the amounts charged to the individual programs, (c) adjustments to future billing rates, or (d) adjustments to allocated central service costs. Adjustments to allocated central services will [Page 18] not be permitted where the total amount of the adjustment for a particular service (Federal share and non-Federal) share exceeds $500,000.

OMB Circular A-87, Att. C, � G.4 (emphasis added).

ASMB C-10 contains additional discussion of this Circular provision in a question-and-answer format, at Question 4-12:

Attachment C, paragraph G.4 establishes four methods for adjusting internal service funds (billed central services) for profits or losses realized from operations. Alternative (b) allows credits to amounts charged to the individual programs. This method would only cover profits. If losses occur, why can't individual programs be debited? [Att. C, � G.4]

Effectively, alternative (b) is correcting billed costs in the current year, whereas alternative (c) is carrying forward the profit/loss into the next open fiscal period.

The failure of the Circular to note how losses are to be treated in alternative (b) is an editing error. For consistency purposes, both alternative (b) and (c) cover profit and loss situations. However, only one method can be used in a given fiscal year.

ASMB C-10, Part 4, � 4.8, Question 4-12 at page 4-27 (bold in original, underlining added).

While this response does show that a state could take both profits and losses into account in determining a credit amount, the profits and losses referred to are profits and losses to individual programs, not the total profits and losses across all programs being billed through the ISF. Moreover, while the carry-forward option permits offsets of profits in one year for a service against losses in another year for that same service (and vice versa) through adjustment of the rate amount, DCA has the option of disapproving this method if it is inequitable in particular circumstances. For example, if federal programs will be substantially reducing the number of units of a particular service they use in the later year due to a program change, a carry-forward adjustment to the per-unit rate for that service would not fairly compensate the federal programs for overcharges from the prior year. Here, Arkansas seeks an offset of total profits for some services against total losses for others - an offset that is outside the plain terms of the carry-forward [Page 19] provision. Moreover, since usage of the different services varied across different State agencies (some of which had no federal funds), DCA reasonably determined that the offset would be inequitable to the federal programs.

In New Mexico, the Board pointed out that ASMB C-10 highlights the time-sensitive nature of alternatives (b) and (c) (current credits or future rate changes). Here, as in New Mexico, the time frames for making those types of adjustments have long passed and the amounts involved make alternative (d) unavailable, so the only option remaining is a cash repayment. Arkansas argues, however, that ASMB C-10's response to Question 4-12 "establishes a new requirement regarding timing of adjustments and limiting how adjustment for losses can be taken" and therefore constitutes impermissible legislative rulemaking. AR Br. at 40-41. We disagree. Rather than legislating, this provision is simply interpreting the Circular. Since the adjustment methods follow the requirement for a comparison of revenue to actual costs for each service "at least annually," the ASMB C-10 interpretation is reasonable. Moreover, the Board has recognized in prior cases that the Circular gives DCA discretion in determining to seek a cash refund rather than to allow one of the alternative methods of adjustment. Colorado Dept. of Personnel and Admin., DAB No. 1872, at n.3 (2003); Michigan Dept. of Management and Budget, DAB No. 1811 (2002). Nothing in the Circular or those opinions suggests that, in determining the amount of the cash refund due, DCA must offset total overcharges for all services covered by an ISF against total undercharges for those services.

We also note that the Circular provision addresses ways for a state to correct for differences between billing rates and actual costs to avoid accruing overcharges and undercharges as Arkansas did here. What Arkansas now seeks to do is essentially retrospectively adopt the concept of balancing profit and loss after having failed to do so accurately and in a consistent way on an ongoing basis and to expand that concept to cover balancing all of its profits against all of its losses over a period of four years. That is very different and risks putting Arkansas in a far better position with respect to federal funding than if it had followed the Circular's provisions.

[Page 20] 3. DCA's application of OMB Circular A-87 is not arbitrary and capricious.

Arkansas argues that--

DCA has established an interpretation of OMB Circular A-87, Attachment C, regarding calculation of the excess reserve and has used that standard to issue disallowance determinations and in settlement negotiations with other states. This interpretation has permitted states to net over and under recoveries for individual billed central services when determining both the allowable sixty-day working capital reserve for an internal fund and calculating the Federal share of any excess billings in that reserve.

AR Br. at 3-4 (emphasis added).

The problem with this argument is that it confuses the issue of what might be an acceptable method to calculate a permissible working capital reserve (or an excess reserve amount), with the issue of how to calculate the amount of cash Arkansas owes to the Federal Government because it has not properly adjusted its billing rates on an ongoing basis and was making rebates in an inconsistent manner. There are a number of different circumstances where a state might accumulate a reserve in excess of the permitted working capital amount, even in situations where a state is properly adjusting its billing rates on an ongoing basis. For example, if a state's actual costs went down in any year (compared to the prior year's costs used to estimate the billing rates), this could result in an excess reserve.

Offsetting over- and underrecoveries in calculating a working capital reserve may constitute no more than recognizing the actual costs of providing the services covered by an ISF. Overrecoveries (or overcharges) arise from charging billing rates that are too high compared to actual costs of the services billed, whereas underrecoveries (or undercharges) arise from billing rates that are too low compared to actual costs of the services billed. Thus, offsetting them to determine a permissible working capital reserve amount (and any excess amount) does no more than recognize that the reserve amount should be based on actual costs of providing the services.

The issue here, however, is a different one. This is not a matter of merely determining what must be repaid in federal funds for a particular year because the reserve amount is in excess of a permissible working capital reserve. What is being calculated [Page 21] is the amount the Federal Government may properly seek to recover from Arkansas because of its failure over an extended period of time to follow the approved rate-setting methodology and its unequal distribution of rebates.

Of course, we would be concerned if Arkansas had shown that DCA was applying OMB Circular A-87 in an inconsistent manner to different states that were similarly situated. One of the reasons this Board was established was to ensure uniform application of the cost principles. In examining this issue, however, we must take into account that OMB Circular A-87 specifically gives the cognizant agency (here HHS) a great deal of discretion in determining whether to approve a state's allocation of central service costs. Factors such as how a state is organized, whether that organization has changed from one year to the next, how closely a state has adhered to the proper rate-setting procedures, and what is the nature of the costs allocated can determine whether a particular methodology would lead to an equitable allocation of costs. Such factors might reasonably lead to DCA approving a methodology for one state, but disapproving a similar methodology for another state because the states simply are not similarly situated. Thus, merely showing that DCA approved a particular methodology for another state, or in another year for the same state, is not enough to show either disparate treatment or adoption of a policy.

Here, the evidence Arkansas submitted does not show that DCA had a policy of always permitting offsetting at the fund level, or that other states that were similarly situated were permitted the type of offset Arkansas seeks here, or that DCA was not uniformly applying the cost principles.

We first note that Arkansas relies in part on an illustration of a reconciliation schedule in ASMB C-10 as showing use of offsetting for calculating an excess reserve amount and on DCA's acceptance of DIS's use of that schedule in prior years. This reliance is misplaced. The reconciliation schedule (Illustration 4-7) is intended to illustrate how to reconcile a retained earnings balance in an ISF to federal requirements by identifying broad categories of revenue and expenses to be included or excluded and what adjustments need to be made. The schedule states that "[i]f there is an excess balance, then the federal share should be returned to the federal gov't" but does not show how to calculate the federal share. More important, ASMB C-10 [Page 22] contains a relevant qualification on use of this schedule. Specifically, the Instructions for Illustration 4-7 state that--

for those funds which utilize multiple billing rates (e.g. ADP [automatic data processing] funds) a reconciliation schedule may be required for each billing rate. An overall/average fund balance may not be appropriate, because excess charges may occur in one billed service but undercharges may occur in other billed services. In addition, various users do not utilize each/all billed services to the same extent.

ASMB C-10 (emphasis in original). In other words, Arkansas had timely notice that, in some circumstances, DCA might require a reconciliation schedule for each billing rate, rather than for the ISF as a whole.

Arkansas' own figures show here that offsetting the total undercharges against total overcharges would result in inequity to the Federal Government because of the way Arkansas structured its billing rates and the differences in the way State agencies receiving federal funds used DIS services compared to State agencies that are exclusively or primarily State-funded. Mr. Hill's affidavit and charts analyzing the data submitted by Arkansas show how State agencies that received federal funds were consistently overcharged more and undercharged less than other States agencies (even after rebates) and how permitting the offset Arkansas seeks would result in shifting costs from State to federal programs. DCA Ex. 1, �� 22 -33, Att. F-1 to G-3.

In any event, Arkansas did not establish any general practice or policy of DCA permitting offsets of the type Arkansas seeks with respect to states similarly situated to Arkansas. Arkansas provided information about DCA negotiated settlements with five other States, specifically, Alabama, Illinois, North Carolina, Kentucky, and Wyoming. DIS Exs. 24-28. That information does show that excess reserve amounts were calculated by netting some over- and undercharges. Two of the agreements in the record specifically are limited, however, to a specific fiscal year and exclude similar overcharges for subsequent years. DIS Ex. 25, at 9 (Alabama); DIS Ex. 27, at 1 (North Carolina). Thus, they clearly were not intended to set a precedent (much less a policy) about offsetting. Moreover, not all of these States were permitted to offset all overcharges against all undercharges, as Arkansas seeks to do here. Mr. Hill pointed out, and Arkansas does not deny, that the netting permitted in four of the agreements was netting at the user or customer level, not at the fund level as Arkansas seeks to do here. DCA Ex. 1, at � 44. We [Page 23] also note that, Robert J. Cowden, an Arkansas consultant who also worked for Alabama and was involved in the Alabama negotiations, confirmed that the negotiated resolution between DCA and Alabama was limited to State agencies with significant federal funding that were also large users of the services. DIS Ex. 25, at 3. ⁽¹¹⁾ Limiting the agreement in this way would have provided some assurance that amounts undercharged to State-only programs were not being offset against overcharges to federal funds. Thus, Arkansas' reliance on Mr. Cowden's statement for support of its argument is misplaced. For Illinois, the State agency with the bulk of the overcharges was excluded from the calculations so that the overcharges to the federal program run by that agency could be separately resolved by the federal agency affected, and undercharges to State agencies with no federal funding were not offset against the net overcharges to federally funded agencies. DIS Ex. 24. Also, the Illinois determination by DCA was issued with respect to fiscal years 1994 and 1995, so this determination did not involve application of OMB Circular A-87, as revised in 1995. Id.

The information Arkansas provided does not indicate for any State, moreover, that the negotiator was aware that the State had deviated from federal rate-setting requirements to the extent Arkansas did, or that the State was distributing rebates (or similar credits or adjustments) in a way that violated consistency requirements, as Arkansas did. In fact, the Alabama settlement agreement indicates to the contrary that Alabama was adjusting its billing rates each fiscal year. DIS Ex. 25.

DCA points out that one of its concerns with respect to the "undercharges" here is that DIS may have failed to recover the actual costs of some services (such as programmers' services) because DIS did not bill out all the units of service provided (such as programmers' hours), rather than merely because it failed to adjust the rates. Rev. Tr. at 181. This concern is a reasonable one, particularly in light of the explanation Arkansas gave of the agreement between DIS and ESD, another State agency, under which ESD paid some personnel and other costs associated with the computer services it received and got periodic credits from DIS. Rev. Tr. at 133-134. Moreover, some of the undercharges to State agencies occurred because DIS rebated to them amounts in excess of their overcharges. Offsetting these [Page 24] types of undercharges goes beyond the type of ongoing adjustments contemplated as part of reconciling a fund balance to reflect the difference between the rate billed and actual costs for a unit of service.

Mr. Hill also points out that negotiated settlements "may result in various concessions, but which ultimately conserve both parties the time and resources required for litigation." DCA Ex. 1, at � 43. Arkansas argues in response that Arkansas should not be "punished" for not entering into a negotiated settlement but instead exercising its right to appeal, and that the Federal Government (which needs to be "objective") cannot have "one methodology for cooperative states and another for uncooperative states." Rev. Tr. at 100. We do not view what happened in this case as punishing Arkansas for appealing or applying a different methodology because Arkansas was not cooperative.

The nature of the cost allocation process is such that a state proposes a methodology and an allocation of costs using that methodology. Usually a negotiation ensues during which the DCA negotiator may approve the proposal, may ask for modifications, or may ask for certain types of supporting documentation. The level of documentation requested may depend on the history of negotiations with that state or on other factors, such as information from a state audit, that affect the degree of confidence the negotiator has in the state's figures. See ASMB C-10, at � 4-5. This is a matter of judgment, and, as Mr. Hill acknowledged, may depend to a certain degree on the level of the negotiator's experience. ⁽¹²⁾ Where a State is not forthcoming in providing information and/or the information provided indicates that federal requirements are not being met, it is perfectly [Page 25] appropriate for DCA to seek more information, as it did here. ⁽¹³⁾ Moreover, when analysis of the information provided indicates that an amount for which DCA may have been willing to settle at one point in time would not, in fact, be equitable to the Federal Government, it is perfectly appropriate for DCA to seek recovery of a greater amount, so long as the state has notice of the rationale and an opportunity to provide further information and to dispute the rationale.

We also disagree with Arkansas that it is irrelevant here that Arkansas was not meeting federal requirements in its rate-setting practices and should be placed in the same position as if it had. First, if a party has "unclean hands" (as Arkansas has here since it did not meet federal requirements) that is a relevant consideration in determining an "equitable" result. ⁽¹⁴⁾ Second, the system established by the Circular permits a certain degree of latitude in federal claiming because of the assurances of overall equity provided by the system itself and the fact that following the system reduces the administrative burden on all parties. Failure to follow that system undercuts the assurances and increases the burden. Third, because of Arkansas' failure, it is difficult to reconstruct what would have occurred but for that failure. Arkansas has the burden generally of documenting allowability of its costs, and cannot fairly shift the burden to DCA to prove that the unclaimed amounts are not allowable charges to federal funds.

Arkansas does not, moreover, argue that it deliberately deviated from federal requirements in reliance on DCA's using a particular methodology to calculate a disallowance amount. Even if it had, such reliance would not be reasonable since Arkansas had notice that meeting those requirements was a condition of receiving any federal funds for DIS services.

[Page 26] Finally, Arkansas argues that, since DCA's methodology for recalculating the disallowance amount permitted some offsets of undercharges against overcharges, this severely undercuts DCA's position regarding offset. DCA responds that the adjustments for underpayments used by DCA in recalculating the disallowance amount are "not comparable to the netting of one rate against another or the netting at the bottom line" Arkansas seeks. DCA letter of Nov. 6, 2004. During the informal conference, DCA explained the adjustments it made. Rev. Tr. at 44-49. Essentially, DCA determined that overpayments made by a State agency for a particular type of DIS service in one year could be offset by underpayments for the same service made by that State agency in a succeeding year (up to the total amount of overpayments in the first year). DCA reasoned that it could treat the lower rates in the succeeding year as though DIS had adjusted the rates downward in the succeeding year as a mechanism for paying back the overpayments, as permitted by the Circular.

We agree with DCA that the type of netting DCA did in calculating the amount due is not comparable to the netting of one rate against another across programs or the netting at the bottom line, which Arkansas seeks here. While DCA's calculations presume DIS was adjusting its rates in a way that would have been permissible under federal requirements (even though DIS was not in fact doing this in a systematic way based on actual costs), the result of what DCA did in making these adjustments in its recalculation was favorable to Arkansas. That DCA was willing to make this type of adjustment, however, does not mean that DCA is arbitrary and capricious in refusing to permit other types of offset. As DCA argues, offsetting all underpayments against all overpayments (at the bottom line) would result in cost-shifting and otherwise be inequitable to the Federal Government.

DCA also provides a satisfactory reason why it did not offset underpayments by a State agency in one service category against overpayments by that agency in another category. According to DCA, different programs run by a State agency may have different patterns of usage of different services, so permitting offset among service categories might result in cost-shifting among programs run by that agency. Arkansas does not really dispute the assertion that cost-shifting could result, merely arguing that, without knowing which programs used the services that generated the over- and undercharges, one cannot know what the [Page 27] cost-shifting might be. This is true, but insufficient as a reason for permitting the offset. ⁽¹⁵⁾

Arkansas argues, however, that at the very least offsetting among service categories should be permitted with respect to its Office of Child Support Enforcement because that agency runs only one program - the federally funded child support enforcement program. The affidavit Arkansas presented regarding this program, however, identifies the program as the "primary federal grant" administered by DFA and as constituting 95% of DFA's federal funding, rather than as the only federal program run by DFA. DIS Ex. 34, � 3. Moreover, while the affidavit says that the program is operated by DFA's Office of Child Support Enforcement, the DIS consultants' analysis shows two apparently related agency accounts, one for "DFA Child Support Enforcement" and one for "DFA Rev - Div of Child Support." The record does not clearly show how the organizational structure relates to the two accounts. More important, nothing in the record establishes that all of the activities of DFA's Office of Child Support Enforcement are federally reimbursable. In sum, Arkansas did not establish that permitting offset at the user agency level would not result in shifting costs between federal programs or from State to federal funds. Moreover, the federal child support enforcement program (under title IV-D of the Social Security Act) is one of the programs subject to a two-year filing limit for claims. See 42 C.F.R. Part 95, subpart A. DCA argues that Arkansas should not be permitted to circumvent the time limit and obtain through an offset federal funds that it might not be able to obtain by submitting a claim. We agree.

Arkansas also raises an argument about the fairness of not permitting the offset it seeks, and cites the basic premise in OMB Circular A-87 that "Federal awards should bear their fair share of costs recognized under the principles, except where restricted or prohibited by law." AR Br. at 23, citing OMB Cir. A-87, Att. A, � 1. Arkansas's fairness argument overlooks [Page 28] several important points. First, the reason that Arkansas is unable to recover undercharges in some rate categories is that DIS did not follow OMB Circular A-87 requirements that would have permitted such recovery. Second, the costs of which OMB Circular A-87 speaks in saying that the federal programs should bear a fair share are expressly limited to those "recognized under these principles." Third, the offsetting Arkansas advocates could result in Arkansas circumventing appropriations and other restrictions established by law.

In sum, DCA did not apply the Circular here in a way that is inconsistent with how it has been applied to other States, inconsistent with DCA policy, or otherwise arbitrary and capricious.

4. The asserted undercharges were not properly substantiated and claimed.

Arkansas says it "fundamentally disagrees with the notion that 'substantiation' has any relation to determination of the Federal share of an adjustment, or that the undercharges are unallowable." AR Br. at 26. According to Arkansas, review of the costs for allowability and allocability has already been completed. In support, Arkansas cites the report of its consultants who examined DIS costs to allocate them to different service categories. This argument confuses the issue of determining what were the allowable underlying costs to DIS of providing the services to the State agencies, with the issue of what are allowable charges to federal awards.

Arkansas suggests that since DCA used costs from its consultants' report to determine the overcharge amounts, that same consultants' report must be considered satisfactory substantiation of what the undercharges were. While superficially appealing, the attempted parallel does not hold.

As DCA argued, submitting information to DCA as part of its review of central services billing rates is not equivalent to submitting claims to the federal grantor agencies. The costs of providing the services at issue here were not claimed directly by DIS under any federal award, but instead the services were billed at the billing rates to various State agencies that receive federal funds. The amounts now asserted to be undercharges were amounts that were not billed to the State agencies (or passed on to federal awards).

DCA has a legitimate concern that the undercharges Arkansas seeks to substitute for amounts admittedly overcharged to federal [Page 29] programs may not meet the requirements to be recognized as allowable claims for federal funds. Permitting the offsets Arkansas seeks here could result in impermissibly shifting costs from one federal program to another or in avoiding federal provisions capping program administrative costs, requiring timely claims for program funds, or imposing other funding limits.

An important factor here is that Arkansas seeks to offset overcharges for some types of DIS data processing or telecommunications services against undercharges for other types of data processing or telecommunications services. Yet, not all state agencies (and therefore not all federal programs) were necessarily using the undercharged services as much as they were using the overcharged services. For example, in FY 2000, non-federally funded agencies (shown as "all other" on DCA's charts) were undercharged $593,833 for "800 service," but some federally funded agencies were not using the "800 service" at all (as evidenced by the fact that the revenue from those agencies for that service is listed as 0). DCA Ex. 1, at 28. Thus, permitting offset of this $593,833 in undercharges against overcharges to these federally funded agencies would effectively shift costs to programs that did not benefit from the services to which those costs pertain. Such cost shifting violates federal appropriation restrictions and OMB Circular A-87.

Another reason for DCA not agreeing to the offset is that some of the federal programs have funding restrictions, such as a cap on the total amount of costs or a cap on the amount that may be claimed for administrative costs. Retroactively offsetting overpayments to account for amounts a grantee could have, but did not claim, risks paying out federal funds in excess of such a funding restriction. For example, the record shows that Arkansas received federal funding for a program that had a 10% limit on federal funding for administrative costs. Arkansas did not show that DCA's concern is not a legitimate one. We see no inequity in DCA denying an offset that could result in circumventing such funding restrictions.

Similarly, such an offset could result in Arkansas circumventing requirements for timeliness of claims applicable to some of its programs. For example, section 1132 of the Social Security Act requires states operating programs like Medicaid, Foster Care, and Child Support Enforcement to submit their claims (in the [Page 30] manner and format specified) within two years of the end of the quarter in which the expenditure was incurred. ⁽¹⁶⁾

We also note that, while DCA may be willing to accept the DIS consultants' reconstruction of DIS's books to allocate costs to various service categories in determining a minimum amount due to the Federal Government, this does not necessarily require DCA to accept their calculations of undercharged amounts or to accept them as allocable to federal funds. Moreover, the record shows that, in calculating amounts they identified as over- or underrecoveries, the DIS consultants grouped the services by "service level," rather than using the individual "service codes" that were used for purposes of rate-setting, because DIS did not track revenue by service codes. DIS Ex. 31, �� 20 -23; DIS Ex. 8, at 82-91. The units of service for the service codes within a service level were not always the same, moreover. Thus, the consultants' calculations do not show, for each unit of service that was in fact billed, how the billing rate compared to the actual cost of providing that unit of service.

Finally, we note that Arkansas is not the only state that has been denied approval for an offset proposal. DCA cites an Illinois case in 1982, as well as the case leading to the Board's New Mexico decision (cited above).

5. Arkansas has not shown that the Board's New Mexico decision was wrongly decided or distinguishable.

Arkansas argues that the Board's New Mexico decision is "due no deference in this dispute" for the following reasons:

Even assuming the factual circumstances of the two cases were identical, the decision was fundamentally flawed because New Mexico failed to articulate significant issues for the Board's consideration. DIS retained an expert consultant, Mr. Hank Kirschenmann, formerly of the U.S. Department of Health and Human Services and a principal architect of OMB Circular A-87, to address issues that were not properly considered in the New Mexico dispute. DIS Ex. 3. Had the Board been able to consider all material issues and review pertinent facts [Page 31] before reaching its conclusions, DIS believes the outcome would have produced a radically different result.

AR Br. at 4-5.

We disagree. Arkansas claims that the Board's reasoning in New Mexico is flawed because in that decision the Board did not consider the well-established principle that retroactive approval may be given for transactions that would have been approved had the grantee requested approval in advance. AR Br. at 35, citing Arizona Affiliated Tribes, Inc., DAB No. 1500 (1994); New York State Dept. of Social Services, DAB No. 1394, at 33 (1993). Arkansas' reliance on this principle is misplaced, however. First, we are not dealing here with a prior approval requirement of the type at issue in the cases Arkansas cites. Second, those decisions recognized that, while retroactive approval may be granted in some situations where prior approval was required but not obtained, nothing requires that retroactive approval must be given in every such situation.

Arkansas also claims that the U.S. Department of Education has allowed grantees to offset state funds that could have been charged to federal funds many years after the close of the relevant fiscal years. AR Br. at 35, citing Tangipahoa v. U.S. Dept. of Education, 821 F.2d 1022 (5^th Cir. 1987). What Arkansas fails to recognize is, regardless of whether some federal programs may in fact permit retroactive claiming, here the issue is whether, in the absence of Arkansas having timely adjusted its rates, Arkansas should be permitted in effect to recover federal funds for amounts it has not claimed from specific programs through the proper channels, merely because Arkansas overcharged federal funds for some services. In denying such an offset, DCA reasonably considered the fact that such retroactive claiming may not be permitted in some of the affected federal programs. This is particularly so since the public assistance programs operated by HHS in which there are time limits on claims (for example, Medicaid and Foster Care) are likely to constitute a significant part of a state's budget. ⁽¹⁷⁾

[Page 32] Finally, while we recognize Mr. Kirschenmann's expertise, his opinion submitted by Arkansas here does not cause us to reconsider our analysis in New Mexico (or to reach a different result here), for the following reasons:

• Mr. Kirschenmann's letter was issued based on review of a limited number of documents made available to him that did not include DCA's recalculations based on the information DIS later provided. ⁽¹⁸⁾



• Mr. Kirschenmann's letter recognizes that OMB Circular A-87 requires an annual comparison of the revenue generated by each service to the actual allowable costs of the service. DIS Ex. 3, at 4. His opinion is based on the erroneous assumption that DIS followed this process. Thus, he states that it "was, and is, DIS practice to periodically review its billing rates and provide partial rebates to those users which were over charged and to carry forward the year end balances of each service into the following year regardless of whether the balance constituted a profit or loss for the service." DIS Ex. 3, at 2. He further states that "DIS adjusts its rates through rebates of excessive billings, adjustments to future billing rates, and the carry over of balances from one year to the next." DIS Ex. 3, at 4. He apparently bases this assumption on the "marked differences in the profit/loss percentages of the individual services over the years and the aggregate of all the percentages," which he says is "indicative of a responsible costing/charging process." Id. The record before us shows, however, that DIS not only was not making annual adjustments to each of its rates, but that DIS was not maintaining its records in a way that would permit it to determine accurately the actual costs of individual services on an ongoing basis. Moreover, in making partial rebates, DIS favored state-only agencies, treating the costs of State and federal programs inconsistently. There is no indication in Mr. [Page 33] Kirschenmann's opinion letter that he was aware of this discrepancy in how rebates were distributed. Since Mr. Kirschenmann's opinion is based on erroneous assumptions and incomplete information, we cannot give it any weight. Nor can we agree with him that DCA's disallowance interrupts a process that, over its course, would otherwise have resulted in appropriate charges to federal programs.



• Mr. Kirschenmann states that, in many respects, OMB Circular A-87 treats ISFs as "a single entity and a going concern" (for example, by referring to a balance sheet for each "fund" rather than each individual service within a fund). He points out that "the identification of the individual services provided by a fund that is to be costed and billed is largely at the discretion of the service provider (DIS), a decision largely driven by practicality and cost benefit" and that, had the categories of services "been defined differently the amount of the over/under charges would have been different." Thus, he concludes, the argument for offsetting is "among other things, recognition of the mutability and adaptability of the costing process." DIS Ex. 3, at 3. While this may be true to a certain extent, it simply does not preclude a well-founded determination by DCA that DIS set up its individual services in such a way that retrospective adjustments offsetting overcharges in one category against undercharges in another category would not be equitable to the Federal Government. Moreover, having set up its individual services in a particular way, DIS was obliged to use billing rates for each of those services that were adjusted at least annually to actual costs of providing the services, but did not do so. While it is true that the result may have been different if DIS had set up its service categories differently, that fact should not allow DIS to ignore the applicable requirements and then expect to be in the same (or a better) position, despite the effects of its failures.



• Mr. Kirschenmann further posits that, even though the term "cost" is defined in several sections of OMB Circular A-87, the concept of "cost" in the context of an ISF is not so clear cut, where an entity is established to provide numerous services to numerous users and must remain viable as a business entity. He states that "logic suggests that the writers of A-87 had the going concern concept in mind when they wrote the [Page 34] internal service fund provisions" and allowed "for a reasoned approach that looks to the equity of a charging practice in a broader sense" while striving to "assure that Federal awards are not abused through questionable accounting practices." He further states that, in his experience, "grantee organizations commonly perceive service funds in the ongoing concern context and adjust their billings accordingly." He then gives the example of over- or undercharges for different makes or years of automobiles as amounts that are commonly netted. DIS Ex. 3, at 3-4. ⁽¹⁹⁾ We agree that OMB Circular A-87, by permitting adjustments to a future year's rates as one method for accounting for differences between rates billed and actual costs of services, permits treating an ISF as an ongoing concern (where DCA approves this method as part of a CAP and a state in fact applies it on a consistent basis). We also recognize that the approach in OMB Circular A-87 permits DCA to approve allocation of costs using a method determined to be equitable, even if that method is not as accurate as other, more burdensome methods. We further agree that there may be some kinds of offsets that are equitable and permissible. We do not, however, think it necessarily follows that DCA must approve every type of offset that a state proposes or that the particular offset proposed here is an equitable one.

• Mr. Kirschenmann's discussion of the Board's New Mexico decision is also based on erroneous assumptions about what Arkansas did, including the assumption that DIS was making appropriate annual adjustments to its billing rates based on actual costs of individual services, and adjusting its claims for the difference between billed rates and actual costs.



• Mr. Kirschenmann also tries to distinguish Arkansas from New Mexico on grounds that either are irrelevant or misconstrue our decision. For example:



• In New Mexico, the Board noted that the Circular provides generally for the federal programs to bear their fair share of costs "recognized under these [Page 35] principles." Mr. Kirschenmann comments that there is no suggestion in the DCA disallowance that any of the costs making up the billing rates were not allocable and allowable under A-87. DIS Ex. 3, at 6. This is not entirely accurate, but, in any event, the Board's point was that the principles establishing when billed amounts for central services will be recognized as costs to federal programs include requirements for how billing rates are established and adjusted, as well as principles that govern what types of underlying costs are allowable in setting the rates.



• In New Mexico, the Board pointed out that the "amounts asserted to be undercharges were amounts that were not billed to the State agencies but which New Mexico now calculates could have been billed." At 7. Mr. Kirschenmann states: "In the instant case, the services were billed to the user state agencies and as stated above would have been billed to federal grant programs." DIS Ex. 3, at 6. The fact that DIS billed for its services does not distinguish this case, however, since the undercharges occurred because DIS billed for some services at rates that were too low. There is no evidence that any State agency ever increased its federal claims to adjust for these undercharges. Moreover, some of the undercharges are for services that were provided to State agencies with no federal funding and, therefore, were not billed to federal programs.



• In New Mexico, the Board pointed out that requiring New Mexico to go through the claims process would permit the federal programs to review the claims, whereas offsetting would not. Mr. Kirschenmann asserts that, here, there "has been no issue on the part of the grantor agencies regarding the acceptability (or the cost, for that matter) of the services provided by DIS." DIS Ex. 3, at 7. The grantor agencies may have reviewed the DIS services that were billed to them and accepted the amount billed as within any program cap or other limit. They have not, however, been in a position to determine whether increasing the amount charged for services (billed to them at a lower rate) to account for undercharges would result in exceeding a cap or other limit. Moreover, offsetting the overcharges for services that were billed to a federal program [Page 36] with undercharges for different types of services, even if those services (or those units of service) were not provided to or billed to that program would result in allocating costs to that program that did not benefit it, contrary to what Mr. Kirschenmann suggests.
  

Arkansas also argues that it did not have timely notice of the Board's New Mexico decision regarding offsetting and that the decision should not be applied retroactively to uphold DCA's determination here. While our rationale here is similar to our rationale in the New Mexico decision, we are not "applying" that decision as though it were a rule, nor even binding precedent. Instead, we are applying the provisions of OMB Circular A-87, as in effect during the entire period at issue here.

Arkansas further questions the Board's decision in New Mexico on the grounds that the statutory provision at 31 U.S.C. 1552 (part of the CMIA) provides for a five-year period for liquidating obligations and that the key date for measuring the five years under that provision is the date of the obligation or activity. Arkansas suggests that the Board should have taken this into account since, even if there is only a two-year period to obligate funds, there would be five years to liquidate the obligations. This argument confuses the Social Security Act provision setting a two-year period for states to file claims under certain programs and the general requirement that federal agencies must obligate funds from a fixed appropriation account within a particular time period and then timely liquidate those obligations. ⁽²⁰⁾ These are distinct requirements, imposed on different parties and with different purposes. Arkansas cites no support for reading the cited CMIA provision as somehow [Page 37] superseding the timely claims requirement under the Social Security Act (or any other similar statute).

Arkansas asserts, however, that some claims adjustments (particularly for U.S. Department of Education programs) might still be considered timely. According to Arkansas, "by following the New Mexico precedent, the Board would effectively prevent DIS and its state agency clients from making these adjustments and 'substantiating' undercharges." AR Br. at 36. What prevents DIS from making these adjustments, however, are the requirements of OMB Circular A-87 and DIS's failure to meet those requirements and to make adjustments on an ongoing basis, as permitted by the Circular.

6. DCA reasonably calculated the disallowance amount using DIS charges to Arkansas departments or agencies, rather than charges to particular federal grants.

Arkansas also relies on the opinion of Mr. Kirschenmann to support its argument that DCA inappropriately calculated the disallowance amount by looking at charges to Arkansas departments or agencies for DIS services and applying an average rate of FFP for each of those departments or agencies. Mr. Kirschenmann states that the disallowance improperly assumes that "DIS charges to the State departments that use its services equates to charges to the State's Federal grants" but "[t]hey do not." DIS Ex. 3, at 1.

DCA did not, however, make such an assumption. DCA was unable to track the billing for various services to the grant level because the documentation Arkansas produced did not do so. Thus, DCA reasonably estimated the amount overcharged to federal funds using information provided by Arkansas about the charges to each State agency for each type of service and the average rate of FFP for each State agency for each fiscal year. ⁽²¹⁾

[Page 38] Arkansas says that it was not remiss in not providing grant-specific information since DCA never specifically asked DIS to provide that information. Rev. Tr. at 22. From the beginning of this case, however, Arkansas has argued that we should not accept the calculations at the State agency level since calculations at the grant level would be more accurate. That argument would have merit only if calculations at the grant level showed that Arkansas owes less than what DCA determined. Yet, Arkansas made no attempt to make such a showing, even though it is the party with the burden of documenting that costs charged to federal funds are allowable, and it is the party that has the documentation regarding amounts charged to individual grants for various DIS services (if it still exists). ⁽²²⁾

In addition, as DCA points out, the Board had in its May 27, 2005 ruling specifically permitted Arkansas an opportunity to submit documentary evidence on undercharges and how those undercharges, if combined with the admitted overcharges, did or did not result in any excess claim for federal funds from any grant program. The material Arkansas submitted is wholly inadequate to provide any assurance that giving Arkansas even more time to show actual charges at the grant level would be productive. AR Submission of June 23, 2005, including Exs. 34-40. Indeed, Arkansas admits that the documents do not deal with the issue of the undercharges. Rev. Tr. at 195. Instead, Arkansas used the opportunity primarily to provide affidavits to support its argument that the overcharges did not affect program performance - an issue that the Board had found irrelevant to our review of DCA's determination. The material provides only very general information about specific claims under specific grants. No information provided actually shows that Arkansas still has [Page 39] documentation that would enable it to trace all of the charges for DIS services in various service code categories to the individual grant level.

In support of its argument that grant-specific information should be used, Arkansas points to limits on administrative costs in some of the federal programs, arguing that any overcharges for DIS services in excess of the limit would not have been charged to federal funds, but would have been paid with State funds. Rev. Tr. at 111. According to Arkansas, given the caps on administrative costs for some programs, "it's simply not realistic based on the way these programs operate to assume that these costs were 100 percent charged to the Federal grant." Rev. Tr. at 109. This argument assumes that caps were exceeded, without pointing to any support in the record. We note, however, that affidavits Arkansas provided assert, for at least some of the programs with administrative caps, that the limits were not exceeded. DIS Ex. 35, at � 12; DIS Ex. 36, at � 7. In any event, DCA's calculation does not assume that all of the overcharges were 100 percent charged to federal grants. DCA used FFP rates for each State agency that reflect the extent to which federal funds were used to pay total costs for any year for that agency (rather than the applicable FFP rate for any specific program or category of cost). This method takes into account any shifting to State funds of program administrative costs in excess of a limit. ⁽²³⁾

While use of an average FFP rate could have skewed the calculation in favor of the Federal Government for some State agencies or DIS services, it also could have skewed the calculation in favor of Arkansas for other agencies or other [Page 40] services. ⁽²⁴⁾ With one exception, DCA used the same FFP rates that the DIS consultant used, and for that rate (for the Department of Health Services), DCA used an FFP rate it obtained from Arkansas in discovery. DCA Ex. 1, � 35, Att. S. DCA indicated it was using those rates in the absence of additional documentation from Arkansas, but Arkansas has not presented any information to show a different FFP rate, either for all State agency administrative costs or for DIS costs specifically. We therefore consider use of an average to be reasonable.

The Board asked DCA to address in the informal conference whether it would be willing to consider adjusting the disallowance amount if Arkansas could produce reliable information about what charges for DIS services were actually claimed at the level of specific grant programs. Rev. Tr. at 8-14. DCA expressed skepticism about whether Arkansas had that information available. Rev. Tr. at 11. The Board asked Arkansas whether it in fact had information for FY 1997 through FY 2000 that would allow it to trace the billings to the different State agencies through to the federal grants to which they were charged. Rev. Tr. at 14-15. The DIS Director indicated that DIS had worked with Arkansas' DFA on this issue, but that, given that the record retention period had passed, Arkansas would need some time to be able to verify that the information exists at different levels. Rev. Tr. at 16. ⁽²⁵⁾ She suggested that DIS hire an independent verification source, such as a forensic accountant, acceptable to DCA. Id.

While such a process might lead to a more accurate determination of the amount of overcharges to federal funds, it would not necessarily lead to a determination in Arkansas' favor, would take a considerable amount of time, and would place an additional burden on DCA and federal agencies to examine the information. Given that Arkansas has had ample opportunity to provide grant-[Page 41] specific information since Mr. Kirschenmann first raised the issue in his January 14, 2004 letter (about two years ago), we see no need for the Federal Government to wait for such a process before recovering the amount it has reasonably determined is owed, based on the information Arkansas has made available.

7. Arkansas was not entitled to advance notice about the methodology DCA would use to calculate a disallowance amount.

Arkansas also argues that the method used to calculate the $18 million amount was set out for the first time in the Hill Affidavit and is inconsistent with the method DCA used to calculate the $9 million originally disallowed. According to Arkansas, not only was the methodology not published in the Federal Register, but it bears no relationship either to OMB Circular A-87 or to the guidance in ASMB C-10. Arkansas asserts that the methodology would be confusing even to DCA negotiators around the country. According to Arkansas, there is something "fundamentally wrong" about using this methodology to calculate the liability of Arkansas, without providing any notice that this is the methodology that the Federal Government is going to consistently use against all states. Rev. Tr. at 28-29.

This argument has no merit. Arkansas had notice regarding the requirements for having and following an approved cost allocation methodology in order to charge central service costs to federal funds, as well as notice of the requirements for billing rates and ISFs and the prohibitions on cost-shifting and inconsistent treatment of costs. These requirements are government-wide, uniform conditions for claiming federal funds. Despite Arkansas' failure to follow those requirements, DCA is nonetheless willing to approve allocation of DIS costs to federal funds to the extent there is reasonable assurance of allowability and allocability. DCA reasonably determined to use Arkansas' own figures (with a few adjustments) to estimate the amount charged to federal funds in excess of actual costs for which there was such assurance. That DCA had to develop a unique methodology for calculating the amount owed by Arkansas is largely due to the fact that analysis of the individual services provided by DIS (and the rebates made) showed that offsetting would not provide reasonable assurance of allowability and allocability of costs charged to federal funds because of differences in the use of various categories of DIS services by State agencies that were receiving federal funds and those that were not.

As discussed above, part of the reason for the CAP approval process is that an allocation method used by one state may lead [Page 42] to inequitable results if used by another state, given differences in organization, service category definitions, and use of services. The need to accommodate such differences is reflected in the Circular and the Guidance in ASMB C-10 in various ways, including the provision that in some instances, reconciliation of fund balances may need to be done at the service level, rather than at the fund level.

We see nothing fundamentally wrong with applying a methodology to determine a disallowance amount, even if Arkansas did not have advance notice of what specific methodology would be used. Contrary to what Arkansas suggests, this is not a methodology that Arkansas would be "expected to adhere to." Rev. Tr. at 76. With respect to how it operates its ISF, Arkansas is expected only to adhere to the requirements of OMB-Circular A-87, as interpreted in ASMB C-10. Those requirements permit Arkansas a great deal of flexibility, but advise Arkansas that the methods it chooses are subject to approval by DCA. The methodology DCA employed does not establish a rule for future conduct. Rather, it is DCA's determination of an amount owed by Arkansas under the particular circumstances here, based on information provided by Arkansas to DCA, and is subject to review by the Board based on the record before us.

Arkansas does not, moreover, allege that it was somehow prejudiced by lack of notice about how DCA would calculate what amounts it would require Arkansas to repay for overcharges to federal funds. One could hardly say that Arkansas reasonably failed to meet the federal requirements in reliance on any particular method being used to calculate the extent to which its failure resulted in overcharges to federal funds. While Arkansas points to the offset method for determining an excess balance in an ISF reserve as the method used in Arkansas in the past, Arkansas does not claim that it somehow relied on this method in determining not to follow federal requirements. Nor does Arkansas claim that it would not have accepted the federal grants if it had known that a disallowance might be calculated using this methodology.

We also note that DCA indicated, when issuing its original disallowance, that it was still not satisfied with the information it had received from Arkansas, which at that point had been unresponsive to DCA's requests for several years. As DCA also points out, the methodology Mr. Hill employed in recalculating the disallowance was partly in response to criticism by Arkansas and its experts of the original methodology DCA used (calculating the overpayment amount according to service category), and uses information by customer agency (provided by [Page 43] Arkansas in November 2002), which DCA says provides a more accurate result.

There are a few aspects of the methodology with respect to which Arkansas raises questions (which we address below), but none of these questions undercuts the reasonableness of the basic approach used by DCA, given the information available.

8. DCA did not improperly charge Arkansas for interest that was not in fact earned on excess federal funds.

Arkansas raises a number of challenges to how DCA's calculations treated interest on reserve funds. Based on the Kirschenmann letter and several past Board decisions, Arkansas argues that the disallowance includes "imputed interest," that there is no authority for assessing that interest, and that, in the absence of express authority, a federal agency may not recover interest on federal funds that could have been earned but was not. AR Br. at 29, citing Colorado Department of Personnel & Administration, DAB No. 1872 (2003); Oklahoma Office of State Finance, DAB No. 1668 (1998); Alabama Department of Finance, DAB No. 1635 (1997). Arkansas also argues, in the alternative, that DCA's method counted imputed interest twice and that DCA was improperly charging interest on interest.

These arguments have no merit. The Kirschenmann letter gives three reasons for his opinion that assessment of interest is improper. First, he says: "I know of no authority" for assessing "imputed interest on the working capital reserve balances in excess of the 60 day cash expense standard . . . ." DIS Ex. 3, at 1. He explains that, although imputed interest and the assessment of interest are cited in ASMB C-10, "implementation of the citations would constitute a substantive rule and, since that document did not go though the rule making process, implementation is improper." Id. at 5.

Mr. Kirschenmann appears to be unaware that OMB Circular A-87, which did go through notice and comment rulemaking, treats the interest earned by an ISF as revenue to the ISF. Specifically, for each ISF with an operating budget of $5 million or more, the plan must include, among other things, "a revenue statement with revenues broken out by source, e.g., regular billings, interest earned, etc." OMB Cir. A-87, Att. C, � E.3.b.(1). The Circular also provides that [e]ach billed central service activity must separately account for all revenues (including imputed revenues) generated by the service, expenses incurred to furnish the service, and profit/loss." Id., Att. C., � G.1.

[Page 44] As was pointed out in the comments on the proposal that led to the 1995 revisions, generally accepted accounting principles for states do not require states to account for and report internal service activities in proprietary accounts. 60 Fed. Reg. at 26,488. In other words, states may commingle ISF funds with their other funds, so long as the ISF is recognized in the government's comprehensive annual financial report. See ASMB C-10 at � 4-10. Moreover, even if a state has a proprietary account, a state may have transferred money out of that account into its general treasury. Rev. Tr. at 58. Thus, a state may have difficulty in determining an exact amount of interest earned on ISF funds. Rev. Tr. at 56. ASMB C-10 merely recognizes this and provides an alternative method of calculating and reporting the actual interest earned. Specifically, ASMB C-10 interprets the Circular provision regarding accounting for all revenues to mean that earnings on ISF cash balances "are to be treated as applicable credits" and provides an alternative to reporting actual interest earned, by providing that "earnings may be imputed by applying the government's, e.g., State Treasurer, Average Rate of Return on the average monthly balance for a given fund." ASMB C-10, at � 4-11. This is a reasonable interpretation of the Circular provisions on ISFs, is consistent with the Circular provision on applicable credits, and is consistent with past Board decisions. ⁽²⁶⁾ This interpretation also makes sense because otherwise states would have an incentive to deliberately overcharge federal programs for central service costs in order to earn interest on the overcharges between the time when federal funds are drawn down based on the billings and [Page 45] when the overcharges are paid back. ⁽²⁷⁾ Arkansas had timely notice of this interpretation and of the definition of applicable credit.

Moreover, DCA asked Arkansas in April of 2002 to provide information about the "actual annual interest rate earned by the DIS internal service funds for FYEs June 30, 1997, 1998, and 1999" and had previously requested this information in an August 6, 2001 letter. DCA Ex. 22, at 2. Arkansas does not allege that it provided that information to DCA, and Arkansas did not submit that information to us.

We note that the term "imputed interest" in the context of an ISF merely means that the precise amount of the interest actually earned is unknown (for example, because the state commingled funds), but is presumed to be at the average rate for the relevant fund. This is different from a federal agency presuming that a grantee invested funds and earned interest when the grantee can show that in fact it earned no interest. Moreover, DCA provided information that DIS pools cash in the State Treasury, where it is invested and earns interest, and Arkansas does not deny this. DCA Ex. 1, � 40, citing Atts. P-1997 and P-2000 (DCA Ex. 1, at 70, 73); see also Rev. Tr. at 74. Thus, the Board decisions on "imputed interest" that Arkansas cites are inapposite here.

Mr. Kirschenmann also faults the DCA original calculation on the basis that it "assumes that the over recoveries and prior year adjusted balances upon which they were calculated represent actual cash draw downs of monies through federal grants and that the timing of the draw downs were made proportionately throughout the fiscal year." DIS Ex. 3, at 5. According to Mr. Kirschenmann these assumptions are without foundation because the "billing of charges by DIS is not a draw down of cash against Federal grants." Id. Mr. Kirschenmann is correct that billing by DIS is not a drawdown of federal cash. But cash drawdowns may [Page 46] occur based on the actual cash requirements of a state in carrying out the purposes of a project or program. See, e.g., 31 C.F.R. Part 205; 45 C.F.R. �� 74.22, 92.22. Thus, it is not unreasonable to assume that the drawdown would occur shortly after the billed amounts were recorded (or even at the time the usage of DIS services was recorded), if not immediately thereafter. The consultants Arkansas hired to reconstruct its DIS costs appear to have made the same assumption as DCA in this regard.

Mr. Kirschenmann further states that the assessment of interest is inconsistent with the CMIA, which, he says, "assesses and nets interest on the aggregate federal under and overpayments to states based on the timing of actual draw downs." Id. We see no inconsistency between the OMB Circular A-87 provision on interest earned on ISF reserves and the interest provisions of the CMIA. The CMIA addresses interest that a state earns on federal cash between the time the cash is drawn down (generally under a letter of credit) into a state's account and the time the cash is paid out by the state to redeem checks or warrants or to make payments by other means for program purposes. 31 U.S.C. � 6503(c)(1). If a state "disburses its own funds for program purposes in accordance with Federal law," the CMIA also entitles a state to interest "from the time the State's funds are paid out to redeem checks or warrants, or make payments by other means, until the Federal funds are deposited to the States' bank account." 31 U.S.C. � 6503(d)(1). What we are addressing here is interest earned on excess federal cash that state agencies drew down based on billed amounts and disbursed to DIS. DIS effectively held these excess amounts in an ISF reserve over a period of years; some amounts were part of a permissible working capital reserve, but some amounts were held because DIS did not fully and timely credit the Federal Government for the differences between the billed amounts and the lower, actual costs of providing the services. Arkansas provided no evidence that it had already accounted for the interest earned on the federal share of these funds as part of the accounting it does under the CMIA.

While presumably Arkansas covered some of the undercharges for DIS services for which the billing rates were too low to cover actual costs of services, Arkansas has not established the extent, if any, to which those amounts could be considered to be "disbursed for program purposes in accordance with Federal law" within the meaning of the CMIA, much less that any loss of interest would qualify for an interest offset under the CMIA.

Contrary to what Arkansas argues, moreover, DCA's calculations do not count twice the amount of imputed interest treated as revenue [Page 47] to the ISF reserve. As DCA explained in the informal conference, DCA included imputed interest amounts from the Arkansas consultant's calculations that represented interest earned on federal funds in the reserve during a fiscal year that overcharges were made, and then calculated interest earned in later years on the federal funds in the reserve (including the federal share of the interest), remaining after rebates were made. This does not duplicate interest, nor is it improper.

We also note that the interest that the ISF reserves earned, if properly accounted for, could have been applied to ISF expenses and, ultimately, used to reduce the billing rates. Thus, the interest calculation is simply trying to place the Federal Government in the position it would have been in but for Arkansas' failure to properly credit it for the interest earned and for the overpayments it made.

Finally, we note that DCA indicated a willingness to consider an alternative calculation of interest if Arkansas provides supporting information, such as an average monthly balance in the fund. Rev. Tr. at 203-204. Thus, our decision gives Arkansas an opportunity to show to DCA, within 60 days of the date it receives our decision, that the actual interest earned was less than what DCA determined. Absent such a timely, supportable showing, DCA's determination of the interest amount is upheld.

9. Arkansas' other arguments have no merit.

In this section, we address a number of miscellaneous arguments that Arkansas made and explain why we conclude that none of those arguments has merit.

One of the adjustments that DCA made to the figures provided by DIS was to adjust revenues upward to account for amounts that would have been billed to one State agency (ESD) for usage of DIS data processing services, but was not so billed because of a "fixed price agreement" between DIS and ESD. As noted above, OMB Circular A-87 requires treating such amounts as imputed revenue. Arkansas does not appear to challenge DCA's treatment of these amounts as imputed revenue (and such treatment is consistent with the Circular). Rev. Tr. at 138. Arkansas does, however, raise a question about DCA assuming in its calculations that ESD charged the full billing rate amount to federal funds (and therefore was overcharged to the extent the billing rates exceeded actual costs), even though ESD was being charged by DIS only for the fixed amount. Id. Theoretically, this may be a concern, but the problem is that Arkansas did not provide information sufficient [Page 48] to demonstrate it is a legitimate concern or to permit us to calculate a corresponding adjustment to the disallowed amount.

First, just because ESD was not paying DIS more than a fixed price amount, this does not necessarily mean that ESD was not using the billing rate to charge the federal programs. Arkansas was keeping track of ESD's usage of DIS services, and obviously knew what the billing rate was for each service. At the hearing, Arkansas explained that, although it used the term "fixed price agreement" for the memorandum of understanding between DIS and ESD, what was really occurring was that DIS gave periodic credits to ESD to recognize that ESD had transferred equipment to DIS and was paying personnel and some overhead costs related to the services treated as DIS services. Rev. Tr. at 133-134. Second, although Arkansas provided an affidavit from a program official in ESD, nothing in that affidavit addresses the issue of the rates in fact used to charge federal programs for DIS services. DIS Ex. 35. Total expenditures are given for some object classes that appear to relate to DIS services, but units of service are not given and the expenditure account categories do not track with either the service codes or service level codes used by DIS. See, e.g., DIS Ex. 35, Att. A, 4^th page. Thus, the information provided is insufficient to calculate an adjustment, even if one should be made. Third, DCA gave Arkansas credit for rebates to ESD. See, e.g., DCA Ex. 1, at 53. Yet, the expenditure reports for ESD programs included with DIS Exhibit 35 do not show any entry under the line for "Refunds, rebates, etc." Thus, we would be reluctant to require DCA to make any adjustment to the disallowance amount associated with ESD, absent a full accounting of charges to federal funds for DIS services and how, if at all, ESD credited federal funds for the rebates given.

Arkansas also argues that DCA improperly included $3,899,934 (which Arkansas says is the ISF's retained earnings as of the end of FY 1996) in calculating the total debt for the federal share of the ISF fund for 1997. We disagree. First, the $3,899,934 is only the federal share of the 1996 ending balance. DCA Ex. 1, at 61. DCA explained how it calculated this federal share, at the informal conference. Rev. Tr. at 49-51. Second, Arkansas needs to account for any interest earned on federal funds in a reserve, even if they are properly part of a working capital reserve carried over from one year to the next. Third, since the DIS ISF is an ongoing entity, the retained earnings at the end of FY 1996 are properly taken into account in determining what funds the ISF had in excess of a permissible working capital reserve in later years and what the federal share of that excess is.

[Page 49] Arkansas raises another issue concerning DCA's treatment, in its recalculation, of the "A-87 balance" - the amount in the ISF reserve at the beginning of FY 1997. Arkansas suggests that DCA should have split the balance among the individual service categories, rather than using an aggregate amount, as it did for Alabama and Illinois. AR Supp. Reply Br. at 20-21. The record indicates, however, that the consultants Arkansas hired had viewed splitting the A-87 balance among the services as arbitrary, since "the balances were derived from a different mix of services in the past that may or may not even exist today." DCA Ex. 42; see also DCA Ex. 41. Thus, Arkansas itself, in a letter dated March 29, 2001 said that "the concept of allocating the report's beginning A-87 balance to particular services is questionable since there is no exact way to determine which past services might have generated the balance." DIS Ex. 16, at 1. In light of this, DCA's treatment of the balance was reasonable.

During the informal conference, the Board pointed out that, despite its criticisms of what DCA did in its revised calculations, Arkansas does not offer any reasonable, alternative methodology, supported by reliable information, that would show that Arkansas owes less than what DCA determined. Arkansas suggested in response that the Board could accept the methodology proposed by its consultants. Under that methodology, the amount owed by Arkansas for FY 1997 through FY 2000 would be $6,091,793. Conf. Ex. 4; DCA Ex. 29, at 4; DCA Ex. 1, at 17, 21, 25, and 29. The main problems with this calculation are that it credits undercharges against overcharges in a way that could result in impermissible cost-shifting, and uses an FFP rate that is too low. Arkansas also suggested use of its proposal to return $241,669, with netting at the bottom line, but this proposal not only would result in even more cost-shifting, but it is significantly flawed in other respects, such as in its failure to take into account imputed revenue, consistent with ISF requirements.

Finally, we reject the attempt by Arkansas to shift blame to DCA for its failure to follow a methodology under which DIS recovered for undercharges on an ongoing basis. Arkansas says that the DCA Dallas Regional Office "was aware of and had accepted DIS' rebate methodology for the entire period in question" and "accepted that rebates were provided for over recoveries but that no further adjustments were made to credit individual programs or individual services for losses." AR Br. at 37, citing DIS Ex. 7, 8, 12, 13. The exhibits cited do not support Arkansas' assertions. Instead, they show that, for fiscal years beginning with 1997, DCA raised questions about DIS central services, excluding them from SWCAP approval.

[Page 50] Even assuming that the DCA negotiator had, for some years, been aware of and accepted DIS making rebates for overrecoveries, but not adjusting for losses, that would not somehow bind DCA to now accept the kind of offset Arkansas proposes. From a federal negotiator's standpoint, a state's choice to credit programs that have been overcharged, but not to recoup its losses from undercharges, would be acceptable, so long as the credits reasonably compensate federal programs for any overcharges. ⁽²⁸⁾ There is no evidence, moreover, that the DCA Dallas Regional Office was aware at the time that rebates were being distributed in a manner that constituted inconsistent treatment, aware that the rebates were insufficient to cover the overcharges to federal funds, or aware that Arkansas was not following federal requirements for tracking actual costs of each billed service.

Conclusion

For the reasons stated above, we uphold DCA's revised determination that Arkansas must repay the Federal Government $18,228,612 in federal funds, with the interest adjustment to which DCA agreed and any further adjustment to which DCA agrees as a result of information about the interest actually earned on federal funds submitted by Arkansas within 60 days of the date it receives our decision.

Our decision does not preclude Arkansas from asserting in an appeals process of a federal agency other than HHS its position that a prerequisite for recovery of the federal funds claimed under that agency's awards is a showing of specific harm to the federal interest (beyond the fact that federal programs overpaid Arkansas for DIS services). Regarding HHS funds, we have already ruled that such a showing is not a prerequisite to recovery of HHS funds, and our decision is the final agency action on the matter. Since Arkansas has not yet obtained a favorable ruling [Page 51] on this issue from any other federal agency (and has not established what the overcharges and undercharges were to any particular federal program), nothing in our decision should be read as preventing the Federal Government from collecting the full amount DCA determined was due (as adjusted for interest pursuant to our decision) and later repaying Arkansas if another federal agency rules that an amount associated with its programs was inappropriately recovered from Arkansas.

Cecilia Sparks Ford

Donald F. Garrett

Judith A. Ballard
Presiding Board Member

1. ASMB C-10 replaced "A Guide for State and Local Government Agencies," OASC-10 (Dec. 1976).

2. We note that Arkansas' submissions mention that its SWCAPs for the years in question had been approved. The DCA letters, however, clearly indicate that this approval did not extend to the DIS data processing and telecommunications funds at issue here. DIS Exs. 12, 14, 15. Arkansas does not deny that the approvals were qualified.

3. DIS suggests that somehow it was being treated unfairly by DCA because it was asked to provide this information. But the Circular requires this information to be submitted routinely as part of a CAP for each ISF with an operating budget of $5 million or more. OMB Cir. A-87, Att. C. � E.3.b.(1).

4. Below, we cite to the revised transcript of the informal conference as "Rev. Tr."

5. We note that, while Arkansas submitted an affidavit and documents to support its assertions about adjusting some rates "pursuant to the recommendations" of the consulting firm, the documents show only that some rates were adjusted and do not tie the adjustments to any cost analysis done by the consultant. DIS Ex. 31. Moreover, the adjustment amounts raise a question about their basis. For example, for Central Processor services (Service Code 001), the rate was $2150.00 per hour on June 30, 1997, was adjusted downward by $475 to $1675.00 on October 6, 1997, and was adjusted downward by another $475 to $1200 per hour on February 27, 1998. Similarly, the rate for CPU Nighttime (Service Code 008) was adjusted downward by $220 in both October 1997 and February 1998. Yet, it seems highly unlikely that reductions to reflect actual costs would involve the exact same amount for two different periods.

6. Arkansas asserts that DCA was aware of this fact. AR Reply Br. at 24, citing DIS Exs. 5, 6, and 31. The cited exhibits do not support this assertion, however. Instead, they merely show that the format in which the cost data was presented to DCA was at the fund level and that the DCA negotiator had accepted the data in that format, with adjustments based on State audit information, for years prior to FY 1997.

7. The evidence submitted by Arkansas indicates that rebates to State agencies were made for FY 1997 on January 31, 1998, for FY 1998 on December 31, 1998, and for FY 1999 on February 18, 2000. DIS Ex. 11. No rebates were made for FY 2000.

8. It is not clear from the record how DIS took "service usage" into account if the actual costs per unit of service were not being determined. Some services were billed by the hour, others using other units, such as pages printed. Moreover, just using total units of service would not account for differences among the costs of the services, which were substantial. Nor is it clear how the State agencies determined how to credit any federal programs for the rebates. For purposes of its calculation, DCA assumed that the Federal Government received a share of the rebates (even though Arkansas submitted no evidence to show that in fact any refund was made for overcharges to federal funds).

9. DIS was providing services to some State agencies under contract and charging them a contract amount lower than the billing rate (or not charging them for some services), yet DIS was including only amounts paid to it (through intergovernmental transfer) as revenue to the ISF. These arrangements clearly resulted in the need for DIS to treat as "imputed revenue" the differences between what these State agencies in fact paid and what they would have paid if charged the full rates, like other agencies. Arkansas originally raised questions about adjustments to revenue DCA made to account for this imputed revenue, but did not before us deny that it had such imputed revenue, nor challenge DCA's calculation of the amounts of imputed revenues for each year.

10. The State law authorized DIS to accumulate a reserve for equipment acquisition in an amount not to exceed 5% of gross billings for services per fiscal year and to exclude this amount from calculation of the fiscal-year surplus. DIS Ex. 9. The working capital reserve permitted under OMB Circular A-87 is limited to operating expenses for 60 days. Reserves, for purposes of federal recognition, may include only allowable cash disbursements, so depreciation, principal payments, and capital expenditures are not allowable (although interest payments are allowable). ASMB C-10, � 4-10.

11. Mr. Hill also points out in his affidavit that the Alabama settlements were handled by the Mid-Atlantic Office of DCA, not the Dallas Regional Office, and Arkansas concedes this point. DCA Ex. 1, � 42; Board Letter of Nov. 10, 2004, at 2.

12. Arkansas says that Mr. Hill's statement about experience shows that the methodology used may depend on arbitrary factors, such who the negotiator was. That a more experienced negotiator might ask for more information before accepting a proposed methodology for resolving an issue that a less experienced negotiator would accept does not render the result an arbitrary one, however. Moreover, as discussed above, OMB Circular A-87 recognizes that there may be a need to request additional documentation to support a CAP in some circumstances. Certainly, one of those circumstances is when a negotiator learns that a state is not meeting the ISF requirements. Yet, experience can affect whether a negotiator knows to ask certain questions of a state and picks up on any discrepancies in the figures a state provides.

13. Apparently, DCA's requests were prompted in part by newspaper articles suggesting that DIS was manipulating the ISF to fund a state project with federal funds. We do not make any finding here that this was in fact the case, but merely note that DCA is reasonable in seeking additional information when such allegations are made.

14. The new Director of DIS suggests that her staff felt that it had never received guidance that what it was doing was wrong. The terms of the Circular are clear, however, and the Arkansas DFA had the responsibility within the State of Arkansas of ensuring that any State agency providing central services and operating an ISF understood and was following the requirements.

15. Arkansas also says that there "has been no dispute that those undercharges stemmed from services that . . . Federal Government programs enjoyed" and that they "used the services" and "were not charged the full amount for those services." Rev. Tr. at 84-85. This statement is misleading. The analysis DCA provided shows that the services that were undercharged were more heavily used by State agencies that had no federal funding than by those that did, and that some categories of service in which there were undercharges were not used at all by some of the State agencies that had federal funding.

16. For discussion of the kinds of timely claims issues that might be implicated, see generally New York State Department of Health, DAB No. 1867 (2003) (Medicaid); Minnesota Department of Human Services, DAB No. 1791 (2001)(Medicaid); Florida Department of Children and Families, DAB No. 1777 (2001) (foster care).

17. Arkansas says it would not be going back and trying to claim FFP for the undercharges, but is simply asking DCA to take them into account in the context of a methodology to arrive at a "reasonable federal share," and there is a difference between those two activities. Rev. Tr. at 124. The effect of taking the undercharges into account by offsetting them against the overcharges, as Arkansas proposes, however, would be to provide federal funds for the amounts undercharged, as though they had been claimed and found allocable and allowable to federal programs. That is the problem.

18. Arkansas did not propose to present Mr. Kirschenmann at a hearing to supplement or explain his opinion.

19. We note that Mr. Kirschenmann's opinion on this point is not based on knowledge he gained as a participant in developing OMB Circular A-87, but instead on what logic suggests and what certain grantees do.

20. The cited CMIA section provides:

On September 30th of the 5th fiscal year after the period of availability for obligation of a fixed appropriation account ends, the account shall be closed and any remaining balance (whether obligated or unobligated) in the account shall be canceled and thereafter shall not be available for obligation or expenditure for any purpose.

31 U.S.C. 1552. For a general discussion of requirements for timely obligation of funds from a fixed appropriation account, see Principles of Federal Appropriation Law, 2d Ed., Vol. I, published by the General Accounting Office (now the Government Accountability Office).

21. We note that the record is unclear whether the FFP rate was determined based on total DIS billings to a State agency compared to the federal share of those billings or on total costs of the State agency compared to the federal share of the total costs. We also note that, although Arkansas provided information on the amount of rebates credited to its State agencies for some individual services, it did not provide information to show that credits were in fact given to the federal programs for these amounts, to the extent the related excess billing amounts were charged to federal funds. DCA, however, assumed that the rebates were credited to federal programs and that the credit would be proportional to the State agency level FFP rate for the period.

22. Arkansas suggests that the Federal Government should have records that would enable it to determine the amounts charged to individual grants. However, the records the Federal Government would have of State claims for federal funds would show aggregate amounts, not the individual expenditure items that would be needed to determine exactly what DIS services were billed to federal funds and at what amounts. Moreover, for some State agencies, DIS services may not have been charged as direct costs, but may have been used to calculate indirect cost rates, that would then be applied to total direct costs of an individual grant program to determine the amount claimed for indirect costs.

23. For example, if a federal grant for 50% FFP in allowable costs supports a program with total non-administrative costs of $1,000,000, a limit on total administrative costs of $10,000, and actual administrative costs of $20,000, the federal government would have paid 50% of $1,010,000, or $505,000 and the State $515,000, making the average FFP rate less than 50% of total costs. To the extent administrative costs exceeded the limit, in other words, the overcharges would have been included in the amount used as the State's share of total costs, not in the amount used as the federal share. Thus, DCA's calculation does not assume that all of the overcharges were paid with 100% federal funds, as Arkansas alleges.

24. We note in particular that it appears that DIS data processing services, for which it was substantially overcharging, may have been claimed at enhanced rates available under some federal programs for operation of computerized information systems, rather than the usual 50% rate for administrative costs. See, e.g., DIS Ex. 32, Atts.

25. Grantees are required to retain records pertinent to an award or cost allocation plan for a period of three years, except that records must be retained for a longer period if any claim, negotiation, financial management review, or audit involving the record has been started before the end of the three-year period and not finally resolved. See, e.g., 45 C.F.R. �� 74.53, 92.42.

26. The 1993 proposed revision to OMB Circular A-87 gave "earnings or imputed earnings on reserves" as one of the examples of "applicable credits." 58 Fed. Reg. 55,212, 55,216 (Aug. 19, 1993). While this example does not appear in the final version published in 1995 (which lists fewer examples), the definition of "applicable credits" was substantially unchanged. Interest income falls within the plain meaning of the definition of "applicable credit" since earnings derived from federal funds are clearly receipts which offset grant costs, and the Board has held in a variety of contexts that interest is an applicable credit within the meaning of OMB Circular A-87. See, e.g., Oklahoma Office of State Finance, DAB No. 1668 (1998); West Virginia Dept. of Administration, DAB No. 1465 (1994); Pennsylvania Office of the Budget, DAB No. 1234 (1991), aff'd, 996 F.2d 1505 (3rd Cir. 1993), cert. denied, 510 U.S. 1010 (1993).

27. The requirements for additional documentation regarding the financial condition and operations of ISFs were "in response to audit findings that the Federal Government was inappropriately charged when governmental units accumulated excessive retained earnings or transferred excess cash balances from internal service and self insurance funds to general funds." 58 Fed. Reg. 55,212 (Aug. 19, 1993). A reasonable approach to this problem is to require states to account for any interest earned and thus remove any incentive to states to accumulate and retain excess federal funds.

28. We also note that a 1997 amendment to State law required DIS to credit other State agencies for any surplus of receipts over expenditures (less the reserve for equipment acquisition) related to a particular service, but does not provide for other State agencies to credit DIS where receipts are inadequate to cover expenses for a particular service. DCA Ex. 30, at 8, AR St. � 25-4-124. What Arkansas did with respect to rebates (although not entirely clear) does not seem consistent with either the State law or the credit option in OMB Circular A-87 (which permits, but does not require, offset of profits and losses for an individual program if credits are given on a current basis and meet other Circular requirements).