Introduction

Depending on organization and function, an entity may use a cost allocation plan, indirect cost rate, or both to identify and assign indirect costs to benefiting cost objectives. This chapter compiles the applicable federal, state and agency requirements that apply to indirect cost rates. In the event of conflict between these standards and federal statute or regulation, federal statute or regulation will apply.

Requirements pertaining to cost allocation plans are addressed in Chapter 11 of this manual while underlying cost principles for the general allowability and treatment of costs are discussed in Chapter 8 of this manual.

Record retention and access requirements that apply to cost allocation plans are provided in Appendix K to this manual. All financial and programmatic records, supporting documents, statistical records, and other records pertaining to an award of federal or state funds must be retained and made available to authorized entities or their representatives in accordance with applicable administrative requirements.

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Simplified Method

The simplified method is appropriate when an entity has only one major function, where its level of federal funding is relatively small, or where all of its major functions benefit from its indirect costs to approximately the same degree.

When using an indirect cost rate, an organization’s indirect costs are generally distributed using one of three basic methods: 1) the simplified method, which is discussed in this section, 2) the multiple rate method (Section 12.2), or 3) the direct allocation method (Section 12.3).

Under the simplified method, indirect costs are distributed to individual awards by applying the same single indirect cost rate to an equitable distribution base for each award. Governmental entities, educational institutions that receive less than $10 million in federal funding of direct costs in a fiscal year, and non-profit organizations may use the simplified method. The general guidelines for calculating the indirect cost rate under the simplified method follows.

  • Identify the organization’s total costs regardless of the source of funds.
  • Classify the total costs for the base period as direct or indirect costs. Exclude the following direct costs and indirect costs from the classification:
  • Pool indirect costs and select an equitable distribution base.

    Once the distribution base is selected, any unallowable costs that are the same type as those included in the distribution base, but were excluded from direct costs, should be included in the distribution base if they generate overhead or benefit from indirect costs. For example, if direct salaries and wages for an unallowable activity were excluded from direct costs and the distribution base for allocating indirect costs is direct salaries and wages, the unallowable direct salaries and wages costs should be included in the distribution base. However, if the distribution base is one that does not include direct salaries and wages, then unallowable direct salaries and wages should not be included in the base.

    While the unallowable costs should be included in the distribution base for purposes of calculating the indirect cost rate, neither the unallowable cost nor the indirect cost associated with it may be recovered and/or reimbursed.

  • Divide the total allowable indirect costs (net of applicable credits) by the distribution base to arrive at the overall indirect cost rate (expressed as a percentage). For non-profit organizations that receive more than $10 million in federal funding of direct costs in a fiscal year and for educational institutions, the indirect cost rate must also be calculated in terms of the organization’s “Facilities” and “Administration” (F&A) indirect cost categories. To calculate the F&A rates, divide the total costs in each of the two indirect cost categories by the distribution base and express the resulting rate as a percentage of the base.
  • Apply the indirect cost rate to the distribution base for each award to identify the portion of indirect costs that are allocable to it.The same distribution base is used for each award.

A Sample Indirect Cost Rate Proposal using the Simplified Method is shown in Illustration 6-1 of ASMB C-10PDF, which is the implementation guide for Office of Management and Budget (OMB) Circular A-87 that was issued by the Assistant Secretary for Management and Budget (ASMB) for the U.S. Department of Health and Human Services.

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Multiple Rate Method

The multiple rate method is appropriate when an entity has several major functions that benefit from its indirect costs in varying degrees.

When using an indirect cost rate, an organization’s indirect costs are generally distributed using one of three basic methods: 1) the simplified method (Section 12.1 of this manual), 2) the multiple rate method which is discussed in this section, or 3) the direct allocation method (Section 12.3 of this manual).

Under the multiple rate method, each award is assigned to one of the organization’s major functions. A separate indirect cost rate is developed for each function and applied to all awards within that function. Governmental entities, non-profit organizations, and educational institutions may use the multiple rate method. General guidelines for calculating the indirect cost rates under the multiple rate method follow.

  • Identify the organization’s total costs regardless of funding source.
  • Classify total costs for the base period as direct or indirect costs. Exclude the following direct costs and indirect costs from the classification:
  • Pool indirect costs into separate cost groupings (cost pools). Each cost grouping should consist of a pool of costs that are similar in terms of the major functions that they benefit, and that are measurable by the same distribution base. The number and type of these cost groupings should be kept within practical limits.

    Non-profit organizations that receive more than $10 million in federal funding of direct costs in a fiscal year and educational institutions must categorize cost groupings between two indirect cost categories: “Facilities” and “Administration” (F&A). These cost groupings are more specifically defined in Appendices H-1 to this manual (for non-profit organizations) and H-2 to this manual (for educational institutions), respectively.

  • Select an equitable distribution base for each cost grouping, taking actual conditions into account. The distribution bases for non-profit organizations and educational institutions are more specifically defined (see Appendices H-1 and H-2 to this manual). Consideration should be given to whether the base is best suited for: assigning costs to cost objectives in accordance with benefits derived; a traceable cause and effect relationship; or logic and reason (where neither benefit nor cause and effect relationship can be determined).

    Governmental entities may use any appropriate and acceptable cost element or related factor associated with the organization’s activities provided that:

    Once the distribution base is selected, any unallowable costs that are the same type as those included in the distribution base, but were excluded from direct costs should be included in the distribution base if they generate overhead or benefit from indirect costs. For example, if direct salaries and wages for an unallowable activity were excluded from direct costs and the distribution base for allocating indirect costs is direct salaries and wages, the unallowable direct salaries and wages costs should be included in the distribution base. However, if the distribution base is one that does not include direct salaries and wages, the unallowable direct salaries and wages would not be included in the base.

    While the unallowable costs should be included in the distribution base for purposes of calculating the indirect cost rate, neither the unallowable cost nor the indirect cost associated with it may be recovered and/or reimbursed.

  • Identify the organization’s major functions, and create a separate indirect cost pool for each function. Allocate the cost groupings to each function using the selected distribution bases. Allocate the cost groupings of non-profit and educational institutions to the major functions in the order prescribed by the applicable Office of Management and Budget (OMB) Circulars (see Appendices H-1 and H-2 to this manual). Aggregate the allocated indirect costs for each function in their respective indirect cost pool.
  • Identify an equitable distribution base that will be used to distribute the functions’ indirect cost pools to the respective awards within each function.
  • Establish a separate indirect cost rate for each major function by dividing the indirect costs in each indirect cost pool by the distribution base. Non-profit organizations and educational institutions must also express the indirect cost rate in terms of “Facilities” and “Administration” indirect cost categories (see Appendices H-1 and H-2 to this manual). The rate must be expressed as a percentage of the respective distribution base
  • Apply the indirect cost rate established for each function to all awards within that function.

A Sample Indirect Cost Rate Proposal using the Multiple Rate Method is shown in Illustration 6-3 of ASMB C-10PDF, which is the implementation guide for OMB Circular A-87 that was issued by the Assistant Secretary for Management and Budget (ASMB) for the U.S. Department of Health and Human Services.

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Direct Allocation Method

The direct allocation method is appropriate for use by non-profit organizations provided that each indirect cost is prorated using a base that accurately measures the benefits provided to each award or other activity.

When using an indirect cost rate, an organization’s indirect costs are generally distributed using one of three basic methods: 1) the simplified method (Section 12.1 of this manual), 2) the multiple rate method (Section 12.2 of this manual), or 3) the direct allocation method, which is discussed in this section.

Under the direct allocation method, organizations generally separate costs into three categories: (i) general administration and general expenses, (ii) fundraising, or (iii) other direct functions (including projects performed under federal awards). Only general administration and general expenses are treated as indirect costs and are distributed in the same manner used for the simplified method (Section 12.1 of this manual). All other costs are charged directly to the benefiting cost objective. Any joint costs are individually prorated to the benefiting cost objectives using bases that: accurately measure the benefits provided to each award; are established in accordance with reasonable criteria; and are supported by current data.

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Special Indirect Cost Rates

It is appropriate to make provisions for a separate indirect cost rate that is only applicable to a specific award when that particular award is carried out in an environment that appears to generate a significantly different level of indirect costs.

A special indirect cost rate should be established when additional factors exist that substantially affect the distribution of indirect costs to an award. Such factors include:

  • Physical location of the work
  • The level of administrative support required
  • The nature of the facilities or other resources employed
  • The organizational arrangements used
  • Any combination thereof

When these factors exist, a separate indirect cost pool and indirect cost rate should be established and used for the affected award provided that:

  • The special rate differs significantly from the rate that would have been developed under the simplified or multiple rate methods
  • The award to which the rate applies is material in amount

When a special indirect cost rate is developed, that rate is only used to distribute costs to the particular award to which it relates. The rates developed under the simplified, multiple rate, or direct allocation methods are used to allocate indirect costs to all other awards.

Restricted Rates. A restricted rate is a special rate needed when federal or state statutes restrict the reimbursement of certain indirect costs. It is developed using the same methods as are used for developing non-restricted rates, except that the prohibited costs are eliminated from the indirect cost pool. Like other rates, a restricted rate should be developed during the course of the regular allocation process. OMB Circulars A-122 and A-21 do not discuss restricted rates.

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Negotiation

All entities desiring to claim indirect costs under federal or state awards using an indirect cost rate must either have an approved indirect cost rate, or maintain the indirect cost proposal and supporting documentation for review, as required.

An entity, such as a governmental entity, Indian tribal government, educational institution, or non-profit organization that intends to claim indirect costs under federal awards or subawards must negotiate an indirect cost rate with its cognizant agency as required by that agency. If the cognizant agency does not require the entity to negotiate its rate, the entity must prepare an indirect cost rate proposal in accordance with the requirements of this chapter and retain the proposal and supporting documentation for audit purposes. A governmental entity whose indirect cost rate is not approved by the cognizant agency may be required, at the discretion of the entity’s designated State Single Audit Coordinating Agency (SSACA), to negotiate an indirect cost rate with that SSACA prior to claiming indirect costs under state awards or subawards. If the entity is a local government and only receives federal or state funds as a subrecipient, the primary recipient must negotiate and/or monitor the subrecipient's indirect cost rate plan.

Submission Deadlines. Submission deadlines vary according to the type of entity, and in some cases, type of indirect cost rate proposal being submitted. When a governmental entity is required to negotiate its indirect cost rate with its cognizant agency or SSACA, the entity must submit its indirect cost rate proposal to the agency within six months after the close of the entity’s fiscal year. Non-profit organizations that have previously established an indirect cost rate must comply with the same six-month deadline. However, if the non-profit organization has not previously established an indirect cost rate, the entity must submit its initial proposal to the cognizant agency immediately upon being advised that an award will be made, and no later than three months after the effective date of the award. Office of Management and Budget (OMB) Circular A-21 does not establish submission deadlines for educational institutions.

Types of Rates. An entity may claim indirect costs using a predetermined, fixed, or provisional with final rate. Educational institutions may also claim indirect costs under a negotiated lump sum amount, but must still comply with administrative limitations provided in OMB Circular A-21 (See Entity Specific Considerations – Educational Institutions at the end of this section).

Agreement. When an indirect cost rate is negotiated between a governmental entity or non-profit organization, and a cognizant agency or SSACA, the results are formalized in a written agreement. The cognizant agency for educational institutions formalizes all determinations or agreements and provides copies to other interested agencies.

Rate Changes. If the period of performance for an award extends beyond the applicability of the approved rate and the entity is a governmental entity, it must apply the rate to the expenditures incurred during the applicable fiscal year. Consistent accounting treatment should be maintained in accordance to the organization’s normal procedures of expenditure recognition. If the entity is an educational institution; however, it must use the rate in effect at the time of the initial award for the life of the award.

Entity Specific Considerations:

Non-Profit Organizations. A fixed rate must not be negotiated if: 1) all or a substantial portion of the organization's awards are expected to expire before the carry-forward adjustment can be made; 2) the mix of federal and non-federal work at the organization is too erratic to permit an equitable carry-forward adjustment; or 3) the organization's operations fluctuate significantly from year to year.

Educational Institutions. Additional provisions relating to a lump sum for indirect costs, administrative limitations, and fixed allowances for administration costs follow.

Lump Sum. A lump sum amount may be negotiated in lieu of an indirect cost rate when the indirect costs are associated with self-contained, off-campus, or primarily subcontracted activities where the benefit cannot be directly determined. The costs will be treated as an offset before allocation to applicable institutional activities. The base on which the remaining expenses are allocated should be appropriately adjusted.

Administrative Limitations. Indirect costs must be classified within two categories: “Facilities” and “Administration,” and the indirect cost rate must be expressed in terms of each component. The amount of the “Administration” category may not exceed 26% of modified total direct costs.

Fixed Allowance. A fixed allowance for “Administration” costs may be claimed in lieu of developing a separate “Administration” indirect cost rate. The allowance may be the lesser of 24% of the modified total direct costs, or a percentage equal to 95% of the most recently negotiated fixed or predetermined rate for the cost pools included under the “Administration” category. If the fixed allowance is used no additional “Administration” charges may be claimed under the award. When a fixed allowance is used, a detailed analysis of administrative costs is not required. However, the indirect cost proposal must be reconciled with the entity’s financial statements in order to compute the “Facilities” component of its indirect cost rate.

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Documentation

Adequate documentation, including the indirect cost rate proposal, subsidiary worksheets, and other relevant data must be maintained and made available upon request.

Documentation and certification must be submitted to the governmental entity’s cognizant agency or State Single Audit Coordinating Agency (SSACA) (see Section 12.5 of this manual) in support of its indirect cost proposal. If the entity is not required to obtain an approved indirect cost rate, the documentation and certification must be maintained on file for review. The following documentation is required:

  • The rates proposed, including subsidiary work sheets and other relevant data, cross referenced and reconciled to the financial data required by the following bullet. Allocated costs will be supported by the summary table included in the approved cost allocation plan. The summary table is not required if the cost allocation plan for the same fiscal year has been approved by the cognizant agency that is negotiating the indirect cost rate, and is available to the funding agency.
  • A copy of the financial data (financial statements, comprehensive annual financial report, executive budgets, accounting reports, etc.) upon which the rate is based. Adjustments resulting from the use of unaudited data will be recognized, where appropriate, by the federal cognizant agency in a subsequent proposal.
  • The approximate amount of direct base costs incurred under federal awards. These costs should be broken out between salaries and wages and other direct costs.
  • A chart showing the organizational structure of the agency during the period for which the proposal applies, along with a functional statement(s) noting the duties and/or responsibilities of all units that comprise the agency. (Once this is submitted, only revisions need be submitted with subsequent proposals.)

Each indirect cost rate proposal shall be accompanied by a certification of indirect costs. For entities subject to the Uniform Grant Management Standards (UGMS), the certification must be signed by the entity’s chief financial officer (or equivalent) and the entity’s chief administrative officer. Otherwise, only one signature is required.

A sample certification follows:

This is to certify that I have reviewed the indirect cost rate proposal submitted herewith and to the best of my knowledge and belief:

  • All costs included in this proposal ___ [identify date] to establish billing or final indirect cost rates for ___ [identify period covered by rate] are allowable costs in accordance with the requirements of the federal award(s) to which they apply, and OMB Circular A-87, “Cost Principles for State, Local, and Indian Tribal Governments” (or OMB Circular A-122, “Cost Principles for Non-Profit Organizations” or OMB Circular A-21 “Cost Principles for Educational Institutions”). Unallowable costs have been adjusted for in allocating costs as indicated in the cost allocation plan.
  • All costs included in this proposal are properly allocable to federal awards on the basis of a beneficial or causal relationship between the expenses incurred and the agreements to which they are allocated in accordance with applicable requirements.

    Further, the same costs that have been treated as indirect costs have not been claimed as direct costs. Similar types of costs have been accounted for consistently and the federal government will be notified of any accounting changes that would affect the predetermined rate.

I declare that the foregoing is true and correct:

Governmental Unit: _____________________________________________
Signature: _____________________________________________
Name of Official: _____________________________________________
Title: _____________________________________________
Date of Execution:: _____________________________________________

 

Entity Specific Considerations:

 

Educational Institutions and Non-Profit Organizations. OMB Circulars A-21 and A-122, respectively, do not impose specific documentation or certification requirements for indirect cost rate proposals.

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Refunds

Unallowable and over recovered indirect costs must be refunded or returned to the Agency through an indirect cost rate adjustment.

Regardless of the type of rate that was negotiated, a refund (including interest chargeable in accordance with applicable federal agency regulations) may be due to the Agency if the proposal is found to include unallowable costs or if there was an over recovery of indirect costs that cannot be carried forward. Costs may be found unallowable: 1) as specified by law or regulation; 2) as identified in Office of Management and Budget (OMB) Circulars; 3) by the terms and conditions of federal awards; or 4) because they are clearly not allocable to federal awards.

Entity Specific Considerations:

Non-profit Organizations. OMB Circular A-122 does not address refunds relating to an entity’s indirect cost rate.

Educational Institutions. The amount or proportion of unallowable costs included in each year’s rate will be assumed to be the same as the amount or proportion of unallowable costs included in the base year proposal used to establish the rate. An adjustment or refund may be used to recoup unallowable indirect costs depending on the period of time covered by the indirect cost rate.

  • Future fiscal year – the unallowable costs will be removed from the indirect cost pools and the rates adjusted.
  • Past period – the federal share of the unallowable costs will be computed and recouped by a cash refund (including interest). Provisional or fixed rates will be adjusted when finalized to avoid duplicate recovery of by the federal government.
  • Current period – a rate adjustment or a refund will be required at the cognizant agency’s discretion.

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