That which is not direct—that is about as clear a definition of indirect costs as many people will find in their quest to understand the difference between direct and indirect costs. Indirect costs are one of the most confusing, misunderstood and controversial concepts in nonprofit financial management. Terms like “administrative costs,” “overhead” and “indirect” are often used interchangeably when they can represent very different things. Show
Let’s look at the definitions of these often confusing terms:
200.56 – .56-1 Indirect Costs v. Administrative Costs
Assume that you are the executive director of a small nonprofit organization that has recently received funding to add an after-school activity program for troubled teens to the counseling services that you already provide. You hire a part-time staff person to coach a weekly basketball clinic and a consultant to teach a weekly course on scrap booking. You rent the high school gym for two hours a week. The gym contains a small room located next to the basketball court that you can use for the crafts activities. Let’s look at how to categorize the costs related to these new programs. Line ItemDirect Cost – 100%Shared Direct CostIndirect CostAdministrative CostOverhead CostSalary – Part-time basketball coachXCrafting consultantXGym rentalXXSalary -counseling program manager (Manages after school programs and provides direct service to clients.)XXBasketballs for clinicXScrapbooking suppliesXSalary – accountantXXXFringe benefitsXXXXOffice rent and utilitiesXXXXCorporate insuranceXXXCell phones (all staff have one)XXXXPostageXXXXFundraising event expensesX
COST ALLOCATIONIf your organization provides one service to the community and is funded by one grant award, your tracking needs are simple. All of your expenses benefit that one funding source and that one program so they would all be charged directly. As soon as you add another program and/or funding source, you will have to determine which costs are direct, which costs are shared direct and which costs are indirect as well as how to charge each of these programs and funding sources for the expenses that occur. You could always have a separate accountant, corporate liability insurance, audit, board meeting, fidelity bond, and D&O insurance policy for each of your funding sources/programs! Obviously, this would not be cost effective or practical but it would certainly provide each funding source an accurate accounting of the cost of these expenses for each one. Short of the above scenario, how is an organization to prorate and charge its funding sources for all of the shared costs, both direct and indirect, associated with running the organization? “We charge everything directly” is a response I often hear. That’s great, but how do you decide how much each program or funding source will pay “directly” for all the costs that are shared? These shared costs may include office supplies, rent, audit, telephone, printing and copying, utilities and salaries as well as all of the indirect costs for the organization. It all comes down to fair and equitable allocation of these essential costs, which should be documented in a written, approved cost allocation plan that outlines your organization’s methodology for allocating these costs. THE COST ALLOCATION PROCESSAllocation of shared costs (direct and indirect) to appropriate funding sources is a multiple-step process:
Let’s look at what this would mean for the organization described above:
The table below lists common shared costs and some typical cost bases that are used to allocate them. Note that this is not a complete list. You may choose any cost base that results in an equitable and consistent allocation of costs. Line Item/PoolCost Base(s)SalariesTime sheets showing actual time charged to programsFringe benefitsSalariesBoard travel% of revenue OR % of salariesSupplies% of salariesRentSquare footageUtilitiesSquare footageTelephone (basic)# of instrumentsPostagePostage meter OR % of salariesCopyingCopy log OR % of salaries OR # of full time equivalents (FTE’s)Accounting/audit# of transactionsIndirect poolDirect salary and fringe OR Total or Total Modified direct costs So what base should we choose for our indirect costs? The most common cost bases used to calculate and allocate indirect cost rates are modified total direct costs and total direct salaries (with or without fringe benefits associated with those salaries). You should choose the base that would result in the fairest and most equitable allocation of indirect costs across your funding sources. For example, if you have one program that has no salaries or fringe benefits charged to it but benefits from the organizational costs charged to the indirect pool, you should not use salaries and fringes as the base. It would not result in an equitable allocation because the program that has no salaries and fringe charged to it would receive no share of the indirect costs.Each cost base you choose must meet the following guidelines:
Several years ago, the Office of Inspector General (OIG) of the Department of Labor reviewed the cost allocation practices of federally funded organizations and found a number of common problems. The most common problem involved the lack of documentation of salary costs. Many organizations used timesheets as documentation for payroll expenses, but the timesheets only reflected the number of hours each employee worked, and not the allocation of those hours across various funding sources. Time sheets serve as the base for allocating salaries and wages and must reflect the distribution of labor costs among multiple funding sources. Hours charged to funding sources on timesheets must match the way in which those hours were charged to the organization’s funding sources or those expenses can be disallowed. The issue of undocumented expenses came up as well when OIG reviewed travel expenses. If an organization is going to charge a funding source for travel-related costs, those costs must be documented to show how the travel was related to the program. Travel documentation should include forms that show authorization to travel prior to the date of the trip. Organizations should also use specific travel reimbursement forms to which receipts for travel costs are attached once the trip has been completed. OIG also discovered that organizations were including unallowable items in the cost pools that were allocated across all funding sources including federal grants. In one instance, board meeting snacks and lunches were recorded as indirect costs and included in the indirect pool. These costs were later disallowed and had to be repaid. Another common allocation mistake many organizations make is the way they treat credits received on overpaid bills. If you receive a refund from an overpayment of an expense and the expense was originally expensed at least in part to a federal grant, the federal government expects that it will receive its fair share of the refund. Many organizations make the mistake of recording this refund as unrestricted revenue but it should instead be used to reduce the current year’s expense. There is no time like the present to re-examine your organization’s cost allocation policies. Don’t make the mistake of using unrestricted funds or general funds for allowable costs that should really be borne by the grants that fund your operations. Make sure that all of your sources of funds and programs are paying their fair share of the costs that are necessary to continue to serve your clients. Save those hard earned unrestricted funds to pay for new programs, capital expenditures or federally unallowable costs! Part II: Indirect costs and the uniform guidance—what’s new?Does your organization struggle to get your federal grants to cover any overhead costs directly or indirectly? Does your organization have a negotiated indirect cost rate that has to be renegotiated every fiscal year? The new Uniform Guidance has some good news for you—there are new ways to recover indirect costs from your federal awards! Title 2 CFR 200 was implemented by all federal agencies on December 19, 2014. The new regulations consolidated eight OMB Circulars, including the Circulars that governed direct and indirect costs (A-122 and A-87), into one location in the Code of Federal Regulations (www.ecfr.gov). These streamlined and revised regulations include some changes to the calculation and application of indirect costs to federal awards. (See Section 200.414 of Subpart E – Cost Principles):
USING THE DE MINIMIS RATEAs mentioned above, if your organization has never negotiated an indirect cost rate (NICRA) with a cognizant agency, you may elect to use the 10 percent of Modified Total Direct Cost (MTDC) de minimis indirect rate to recover indirect costs as part of your federal grant budgets.
The term “Modified” refers to certain exclusions of costs that must be removed from the total direct costs before the 10 percent indirect rate is applied to each funding source. According to the Uniform Guidance, the costs to exclude are equipment, capital expenditures, charges for patient care, rental costs, tuition remission, scholarships and fellowships, participant support costs and the portion of each subaward in excess of $25,000. Other items may only be excluded when necessary to avoid a serious inequity in the distribution of indirect costs, and with the approval of the cognizant agency for indirect costs.
.414-12 Providing Proof of Indirect Costs for De Minimis Rate Does a non-federal entity that uses the 10 percent de minimis indirect cost rate need to provide documentation to prove that its indirect costs are at least 10 percent of its organization’s modified total direct costs? No. A non-federal entity that has never received a negotiated indirect cost rate and that uses the 10 percent de minimis rate does not need to provide proof of its indirect costs. The 10 percent de minimis rate was designed to reduce burden for small non-federal entities (See also .414-11 above). The non-federal entity has to report in its SEFA whether it has elected to use the 10 percent de minimis rate for its federal programs (see §200.510(b)(6)).
According to the July 2017 COFAR FAQs, any limitation or statutory cap on administrative costs applies to the combined claims for indirect costs and direct administration costs. (See 200.56-1 Indirect Costs v. Administrative Costs) As a result, your organization may not be able to collect the full 10 percent de minimis indirect charge from the award. The first step is to calculate the two amounts since the cap applies to the full grant amount while the 10 percent de minimis is applied only to the MTDC. For example, if an organization receives a $100,000 federal grant with a 5 percent admin cap, there would be $5,000 available for direct and indirect admin. However, the 10 percent de minimis indirect charge to that grant (assuming there were no exclusions to make from the direct costs) would be $9,091 ($100,000 divided by 1.1 x 10 percent), not $10,000 (10 percent of the $100,000). Obviously the grant would not pay its full share of the 10 percent but the difference would be a little less than the difference between $10,000 and $5,000. If your organization decides to accept this grant with its administrative cap, the full amount of the de minimis indirect rate should be calculated and charged to the grant internally so that management will know the true cost of the program even though your organization will not be able to draw the full cost down from the grant.
The Supplement also includes suggested compliance audit procedures for the de minimis indirect cost rate which apply to any non-federal entity using a de minimis indirect cost rate, whether as a recipient or subrecipient. The auditor should determine that the non-federal entity has not previously claimed indirect costs on the basis of a negotiated rate for the 3 fiscal years immediately prior to the current audit period. In addition, the auditor should test a sample of transactions for conformance with 2 CFR section 200.414(f). This would include a sample of claims for reimbursement of indirect costs and verify that the de minimis rate was used consistently, the rate was applied to the appropriate base, and the amounts claimed were the product of applying the rate to a modified total direct costs base. Finally, for a non-federal entity conducting a single function, which is predominately funded by federal awards, the auditor should determine whether the use of the de minimis indirect cost rate resulted in the non-federal entity double-charging or inconsistently charging costs as both direct and indirect. Which allocation method's is are used to allocate indirect departmental costs to products?Fixed cost classification is the simplest way to allocate indirect costs. This method works with costs such as depreciation and labor that can be classified as fixed. Fixed costs are allocated as a fixed charge to a specific business asset or department within the business.
Which costing system will trace the most costs as direct costs?ABC systems trace more costs as direct costs. ABC systems create homogeneous cost pools linked to different activities. For each activity cost pool, ABC systems seek a cost allocation base that has a cause-and-effect relationship with costs in the cost pool.
What is the name of the system used to allocate costs to cost objects?A costing system accumulates costs and then assigns these costs to cost objects.
How are direct and indirect costs allocated?You can allocate indirect costs by taking your total indirect expenses and dividing them by some sort of allocation measure, like direct labor expenses, direct machine costs, or direct material costs.
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