Ashley Larmore, CPA - July 26, 2007

At Scinto Graziano, LLP we continually strive to bring our clients and colleagues up to the minute information on tax law changes or rules and regulations that can affect you.  Recently, we have had many inquiries regarding allowable costs and cost allocation plans.  Here is some information that may be of interest to you.

Allowable Costs for Federal Programs:

Office of Management and Budget Circular A-122 “Cost Principles for Non-Profit Organizations” describes what cost may be charged to federal awards and also lists which costs are unallowable.

1.      According to A-122, allowable costs must:

a.       Be reasonable.
              i.      Ordinary and necessary.
             ii.      Obtained “at an arms length”
            iii.      Obtained with prudence. (Not excessive price)

b.      Be properly allocated to the federal program.

c.      Conform to OMB Circular A-122 or the awarded contract.

d.      Be consistent with the policies and procedures of the agency.

e.      Be consistently treated.

f.        Be determined in accordance with GAAP.

g.      Not be included in another federal program. (No “double-dipping”)

h.       Be documented. (Invoices or receipts)

The agency can request written agreement from the government on the allowance of a cost in advance.

Cost Allocations:

The organization must also document the amount to charge to federal programs. Here is where most small non-profit organizations run into serious problems. Methods most used in small organizations include:

1.      Available funding – the organization charges each grant until it is fully used up and then goes to the next grant.

2.     Management’s perception – the Executive Director or other management person makes a professional guess as to what to charge to each program.

3.      Standard timesheets – employees are instructed to write their time down according to predetermined percentages.

None of these methods are acceptable ways to charge costs to federal programs!

In order for a cost to be allocated to a federal program, OMB Circular A-122 requires that it be allocable:

A.     Specific to the award, in which case it is a direct cost. Direct costs are those which are clearly and easily attributable to a specific program.

B.   Benefits the award and other programs, in which cases it is distributable to the programs in proportion to the benefits each program derives.

C.     Benefits overall operations and not a direct relationship to any specific award or program, in which case it is an indirect cost. Indirect costs are those which are not easily identifiable with a specific program, but which are, nonetheless, necessary to the operation of the program. These costs are shared among programs and, in some cases, among functions.

Most small non-profit organizations distribute costs among A & B noted above. Indirect costs such as the president’s office, payroll department, general accounting, etc… which are found in large non-profit organizations involve the preparation of formal cost allocation plans (CAPs) or indirect cost ratio proposals (IDCRPs) in accordance with guidelines provided in OMB Circulars. These proposals are submitted to the Federal Cognizant oversight agency and are often subject to negotiation prior to approval.

The smaller the non-profit organization, the simpler the plan can be. BUT….THERE MUST BE A WRITTEN PLAN IF FEDERAL AWARDS ARE RECEIEVED! And any plan chosen must produce an equitable and rational distribution of costs.

As non-profit organizations become larger, more sophisticated cost allocation plans develop in order to assure a more equitable distribution of costs. Some suggested bases for cost distribution might be:

            Type of Service                           Suggested Bases for Allocation

    Senior Nutrition Programs                         Number of meals served

    Senior Transportation Services                  Number of rides

           Type of Service                            Suggested Bases for Allocation

Homeless Shelters                           Number of day beds    

            Health Services                                Number of employees

Methods of Cost Allocation:

Which method is best for the organization will depend on the level of federal funding, the cost/benefit rule (don’t use a method that requires an unreasonable amount of time and energy), the sophistication of the accounting system and the availability of the data (number of transactions, hours of employees, etc.)

1.                  The simplified allocation method can be used if the agency has only one major function or if all major functions benefit equally or if the federal award is not material.

a.       Separate direct and indirect costs.

b.      Divide the indirect costs by the distribution base.

2.                  The direct allocation method treats all costs as direct.

a.       General costs are allocated using a base appropriate to that cost.

b.      The base must be reasonable.

c.       The determination of the base must be documented.

3.                  The multiple allocation method can be used when indirect costs benefit major functions in varying degrees.

a.       The indirect costs are grouped in terms of the functions they benefit.

b.      Allocations are made for each group based on an allocation base which is appropriate.

4.                  Special indirect cost rates allow a separate activity to be treated by itself. A rate is established separate for each activity.

a.       The indirect costs are grouped in terms of the functions they benefit.

b.      Allocations are made for each group based on an allocation base which is appropriate.

 I hope you find this information useful.  Of course, we are available to answer any questions you may have regarding cost allocation, or any other tax, audit or accounting queries.  Please feel free to give us a call with comments or feedback if you enjoy receiving this update.  Look for more updates from us in the future!