Paying for Indirect Costs Directly

By: William Amt, Senior Program Manager, EDFS, NADO Research Foundation

A controversy is brewing over the cost of managing public programs. Organizations that administer federal, state, and foundation-funded programs usually rely on the indirect cost system to reimburse expenses that are not easily attributable to a particular project but are incurred for a common purpose. Such indirect costs include executive and administrative staff time, audits, utilities, insurance, generic office supplies, rent, and taxes, and, like direct costs, are necessary expenses of managing an organization that administers other agencies’ programs.

A System That Works

The Office of Management and Budget (OMB) has established guidelines designed to simplify recipient’s accounting procedures for determining indirect costs. However, some federal programs do not cover indirect costs or direct costs forcing potential recipients to reconsider applying for federal programs that could help their communities.

OMB has a series of policies for the different types of federal recipients. Circular A-87 is for governmental entities, Circular A-122 covers nonprofit organizations, and Circular A-21 pertains to educational institutions. These policies provide a cost-effective way of determining the fair assignment of costs to various funding sources. The circulars provide standards for determining direct and indirect costs that can be charged to federal awards. Direct costs are traceable to a particular project, such as compensation for staff time, materials and equipment and travel costs.

Indirect costs are not easily attributable to a single program but are integral to the management of the organization. For example, if an organization has 30 staff working on 40 projects for varying amounts of time each month, directly charging these common costs is considered by OMB to be “disproportionate to the results achieved,” and thus should be paid through an indirect cost rate.

An indirect cost rate is used to determine what share of indirect costs should be borne by projects. One common method of computing the rate is to divide total indirect costs by total direct costs. Each project’s direct salary costs are multiplied by the rate to determine the project’s indirect cost share. As a result, the more programs an organization manages, the lower each one’s share of indirect costs. Detailed information about the components of the rate is compiled in an indirect cost plan that is negotiated and approved by the recipients cognizant agency. A cognizant agency is usually the federal agency that provides the largest share of funding to the organization, and the rate it approves is generally accepted by all other agencies.

Trouble Ahead

Some federal and state programs are changing the way the government handles costs, which is a concern for recipients. Several programs have congressionally mandated statutory limits on the indirect rate or amount organizations can charge. Others prohibit grant recipients from claiming compensation for both direct and indirect costs. For instance, the Small Business Liability Relief and Brownfields Revitalization Act, signed into law January 11, 2002, prevents recipients from being reimbursed for administrative costs, which include direct costs for grant administration (such as salaries and supplies) and all indirect costs, “even if the grantee or sub-grantee is required to carry out the activity under the grant agreement,” according to the Environmental Protection Agency. The government will only reimburse programmatic costs — expenses for providing training, research, and technical assistance. As a consequence, some organizations are not applying to the program.

Prohibitions like these shift the cost burden of administering programs from the funder to the recipient. Recipients must spend additional staff time and “effort disproportionate to the results achieved,” to itemize and direct charge all expenses. According to Vernon Martin, Executive Director of the Coastal Georgia Regional Development Commission in Brunswick, “Small organizations and local governments, which already have limited staff resources and face reduced funding, feel this is another burden that is being forced on them. Many federal and state funded grants have remained constant for many years or shrunk, while the scope of work and other mandated requirements have increased.”

When even direct costs are not allowable, organizations have fewer alternatives, especially in rural areas, where resources are limited. One option is to solicit funds from foundations and local governments and organizations to pay for costs not covered, but funding from these sources is limited, especially in these times of government cutbacks. Even in the best of times, most potential sources prefer to provide funds to cover direct services to clients as opposed to paying for administrative and indirect costs. In the case of regional development organizations, local funds are mainly in the form of membership dues that are usually only sufficient to cover programs’ local match requirements.

For more information:

Visit the OMB Web site, www.whitehouse.gov/omb/circulars/index.html.

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