Allocating Direct And Indirect Costs . - Accounting Services

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Allocating Direct and IndirectCosts for NonprofitsCarol Barnard April 18, 2018 Aronson LLC aronsonllc.com

Agenda Allocating Indirect Cost– Why allocating costs is important tononprofits– Identifying indirect costs– Different methods for allocating Joint Cost– What qualifies as a joint cost– Meeting the 3-part test– Ratios and charity watch groups Negotiated Indirect Cost RateAgreement (NICRA)– Allowable/unallowable costs– Modified Total Direct Costs vs Labor– Applying for a NICRA Aronson LLC aronsonllc.com

Learning ObjectivesAfter attending this live webinar you will be able to: Identify indirect costs to allocate and understand methods forallocating them. Explain joint cost allocation and the steps required to pass the jointallocation test. Recognize unallowable costs. Understand how to apply for a negotiated indirect rate for a Federalaward. Aronson LLC aronsonllc.com3

Polling Question 1How confident are you with your organization’s method to allocateindirect costs? Very confidentConfidentNot sureNot confidentHelp! Aronson LLC aronsonllc.com4

Why Allocating Costs Is Important for Nonprofits What is the true cost of conducting a program? It’s obvious thatthere’s more than the total spent directly on the program. There areexpenses that typically benefit multiple cost objectives that need tobe captured. As defined by the Code of Federal Regulations (CFR) Section200.56: “Indirect costs mean those costs incurred for a common orjoint purpose benefitting more than one cost objective, and notreadily assignable to the cost objectives specifically benefitted,without effort disproportionate to the results achieved.” Aronson LLC aronsonllc.com5

Definitions– Cost Objective – a function, organizational subdivision, contract,federal award or other work unit to which cost data are desired and forwhich provision is made to accumulate and measure the cost ofprocesses, projects, jobs, and capitalized projects. Aronson LLC aronsonllc.com6

Definitions (cont.) Direct Costs: Expenses incurred specifically to further the grantprogram objective. These include items specified in the approvedgrant budget line items. Indirect Costs: Expenses that have been incurred for common orshared objectives and cannot be readily identified with a particularfinal cost objective. Example: Administrative and overhead areindirect costs. Indirect Cost Rate: A rate used to uniformly allocate administrativeand overhead costs across programs. Either specified in the awarddocument or a Negotiated Indirect Cost Rate Agreement (NICRA)from the cognizant agency. Aronson LLC aronsonllc.com7

Identifying Indirect Costs Examples of indirect costs include: Utilities and rent expense, healthinsurance, equipment depreciation, officer salaries, humanresources, accounting and legal fees, office and cleaning supplies. Essentially these are the labor and other costs that aren’t specificallygenerated as a result of the organization’s primary operations andthat keep the day-to-day operations running. Aronson LLC aronsonllc.com8

Terminology Shared Costs– Direct costs that benefit two or more programs Overhead Costs– Facilities for program, program supervision, equipment General & Administrative (G&A) Costs– Accounting, finance, president, facilities for administrative staff Facilities & Administrative (F&A) Costs– May be further split into two where Facilities is depreciation and useallowances on buildings and equipment and administration is G&A. Aronson LLC aronsonllc.com9

Determining Chargeable CostsREASONABLE Ordinary and necessary Supports operation Contributes to ability to conduct program missionALLOCABLE Tied to cost objective, contract, grant or service Proportional to benefitsALLOWABLE Allowability determined by OMB Guidelines, Uniform Guidance, and grant provisions Aronson LLC aronsonllc.com10

Different Methods for Allocating2 CFR § 200.56 continues: “Indirect cost pools must be distributed tobenefitted cost objectives on bases that will produce an equitable resultin consideration of relative benefits derived.”Indirect cost pool / Direct cost base Indirect cost rateLook at it this way: if the indirect rate is 35%, then for every direct dollarspent on the program, the organization is incurring 35 cents of indirectcost.Where it gets complex is determining the what goes into the indirectpool and which allocation base to use. Aronson LLC aronsonllc.com11

Different Methods for Allocating (Cont.)You may also have multiple rate structures: Simple Method– Single-rate – used when indirect costs benefit major functions to thesame degree Multiple Allocation Base Method– Two-rate (separate rates for fringe and overhead)– Three-rate (fringe, overhead, and G&A) – used when indirect costsbenefit major functions to varying degrees Direct Allocation Method– when programs are charged for all costs directly Aronson LLC aronsonllc.com12

Polling Question 2What method of allocating does your organization use? Simple methodMultiple allocation base methodDirect allocation methodDon’t know Aronson LLC aronsonllc.com13

More on Direct Allocation Common bases for allocating using the direct methodDirectly Allocated CostBaseOccupancy Cost of programs Square footage by programInformation Technology Number of computers perprogram Number of personnel servicedby program Hours spent by departmentHuman Resources Number of employees perdepartment or program Amount of payroll by program Aronson LLC aronsonllc.com14

Common basesDirectly Allocated CostBasesProperty insurance Square footage by program Cost of property per departmentInternal audit Number of employees by program Hours worked by auditor perdepartmentMaintenance services Square footage by program Actual cost Aronson LLC aronsonllc.com15

Direct Allocation MethodRentExpenseNon-federalgrantGrant AIndirectCost PoolGrant B Aronson LLC aronsonllc.com16

How to Compute Simple Indirect RatesMethod A: (total indirect 500,000)/(salary and fringe 1,500,000) 33%Method B: (total indirect 500,000)/(total direct 2,300,000) 22%Method may be determined by grant award or NICRA.Must be consistently applied. Aronson LLC aronsonllc.com17

Applying an Indirect RateMethod A: Using rate calculated on total of all programs’ salary and fringe, applied tospecific program portion of salary and fringe.Method B: Using rate calculated on total of all programs’ costs, applied to totalspecific program cost. Aronson LLC aronsonllc.com18

Joint CostAllocation

Polling Question 3Have you heard of joint cost?Yes, I know what it is.Yes, I’ve heard of it, but not clear.No, it’s a new term for me. Aronson LLC aronsonllc.com20

Joint CostThe term joint cost has a very particular meaning in the nonprofit world. It refers to acost that has components that include both program and fundraising.Statement of Position 98-2, Accounting for Costs of Activities of Not-for-ProfitOrganizations and State and Local Governmental Entities that Include Fund Raising[now under Accounting Standards Codification (ASC) 958-720]Some nongovernmental not-for-profit organizations solicit support through a variety offund-raising activities. These activities include direct mail, telephone solicitation, doorto-door canvassing, telethons, special events, and others. Sometimes fund-raisingactivities are conducted with activities related to other functions, such as programactivities or supporting services.External users of financial statements—including contributors, creditors, accreditationagencies, and regulators—want assurance that fundraising costs, as well as programcosts and management and general costs are stated fairly. Certain financial statementdisclosures are required if joint costs are allocated between fund-raising and program. Aronson LLC aronsonllc.com21

Criteria In order to be eligible as joint costs, certain criteria must be met. From SOP 98-2: “If the criteria of purpose, audience, and contentare met, the costs of a joint activity that are identifiable with aparticular function should be charged to that function and joint costsshould be allocated between fund raising and the appropriateprogram or management and general function. If any of the criteriaare not met, all costs of the joint activity should be reported as fundraising costs, including costs that otherwise might be consideredprogram or management and general costs if they had beenincurred in a different activity.” Aronson LLC aronsonllc.com22

Purpose Purpose – The purpose criterion is met if the purpose of the jointactivity includes accomplishing program objectives. Just educating the audience about the nonprofit’s mission ormotivating the audience to otherwise engage in specific activitiesthat will educate them about causes is not a call for specific actionby the audience that will help accomplish the entity’s mission. Asking the audience to make contributions is not a call for specificaction by the audience that will help accomplish the entity’s mission. Aronson LLC aronsonllc.com23

Purpose (cont.) Another condition required in order to meet the purpose criteria isthat there should be a similar program component that is conductedwithout the fund-raising component using the same medium and ona similar or greater scale. The organization should examine tangible evidence of intent (e.g.,agreements, policies or other written guidance) to ensure that: (1)the organization intended to engage the audience in a call to actionto help accomplish the organization’s mission, and (2) the majority ofcompensation of any party performing any part of the joint activity isnot based on the contributions raised. Aronson LLC aronsonllc.com24

Audience A presumption exists that the audience criterion is not met if theaudience includes prior donors or is otherwise selected based on itsability or likelihood to contribute to the entity. That presumption canbe overcome if the audience is also selected for one of more of thefollowing reasons:– The audience’s need to use or reasonable potential for use of thespecific call to action.– The audience’s ability to take specific action to assist the entity inmeeting the goals of the program component. Aronson LLC aronsonllc.com25

Content Criterion The activity should have what is referred to as a call to action. Thiswould be a specific action that the audience can do that helpsaccomplish the entity’s mission.– Example: The American Heart Association sends out a mailer includingactions the reader can take to improve their heart health by stoppingsmoking.Although the content criterion overlaps to some extent with the purposecriterion, the purpose criterion focuses on intention, while the contentcriterion looks at execution. Aronson LLC aronsonllc.com26

Allocating Joint Cost Once all three criterion are met, the cost allocation methodologyused should be rational and systematic, it should result in anallocation of joint costs that is reasonable, and it should be appliedconsistently given similar facts and circumstances. Although there are various possible allocation methodologies, themost frequently used is the physical allocation methodology and theunit of measure typically used is space per page. Each activity should be separately analyzed and supportable. It isnot appropriate to use a round “guesstimate” of 35% fund-raising. Aronson LLC aronsonllc.com27

Ratios and Charity Watch Groups Nonprofit organizations are keenly aware that charity watch groupsare paying attention to fund-raising ratios. People generally will bereluctant to give if 50% of every dollar given goes to raise the nextdollar. This creates an incentive to keep fund-raising expenses low. Many charity watch groups feel that joint cost allocation can beeasily manipulated to artificially deflate fund-raising costs or mayincorporate management’s bias. Therefore several charity watch groups ignore any joint costallocation, counting the entire expense as fund-raising. Aronson LLC aronsonllc.com28

More onIndirects andNICRAs

Polling Question 4Alcohol costs are and communication costs are . Allowable and unallowable.Allowable and allowable.Unallowable and allowable.Unallowable and unallowable. Aronson LLC aronsonllc.com30

Allowable vs UnallowableA selection from 2 CFR §200.420 and OMB CircularA-122* Exceptions and restrictions may bedetailed in the grant award document,the compliance supplement, orreferenced on the agency website. Aronson LLC aronsonllc.com31

Allowable vs UnallowableEquipment and othercapital expendituresAllowability based onspecific requirementsFines and penaltiesUnallowable with exceptionFundraising andinvestment managementcostsGoods or services forpersonal useUnallowable withexceptionsUnallowable Aronson LLC aronsonllc.com32

Allowable vs Unallowable Aronson LLC aronsonllc.com33

Allowability Factors2 CFR §200.403 Factors affecting allowability of costs. Except where otherwise authorized by statute, costs must meet the following general criteria inorder to be allowable under Federal awards: (a) Be necessary and reasonable for the performance of the Federal award and be allocablethereto under these principles. (b) Conform to any limitations or exclusions set forth in these principles or in the Federal awardas to types or amount of cost items. (c) Be consistent with policies and procedures that apply uniformly to both federally-financed andother activities of the non-Federal entity. (d) Be accorded consistent treatment. A cost may not be assigned to a Federal award as a directcost if any other cost incurred for the same purpose in like circumstances has been allocated tothe Federal award as an indirect cost. (e) Be determined in accordance with generally accepted accounting principles (GAAP), except,for state and local governments and Indian tribes only, as otherwise provided for in this part. (f) Not be included as a cost or used to meet cost sharing or matching requirements of any otherfederally-financed program in either the current or a prior period. See also §200.306 Cost sharingor matching paragraph (b). (g) Be adequately documented. See also §§200.300 Statutory and national policy requirementsthrough 200.309 Period of performance of this part. Aronson LLC aronsonllc.com34

Reasonable and Consistent National Institutes of Health defines reasonable as: “A cost may beconsidered reasonable if the nature of the goods or servicesacquired or applied and the associated dollar amount reflect theaction that a prudent person would have taken under thecircumstances prevailing when the decision to incur the cost wasmade.” And continues to describe consistency: “Costs may be charged aseither direct costs or F&A costs, depending on their identifiablebenefit to a particular project or program, but all costs must betreated consistently for all work of the organization under similarcircumstances, regardless of the source of funding.” Aronson LLC aronsonllc.com35

What to Do with Unallowable Cost Unallowable doesn’t mean you can’t have it at all, it means it can’tbe included in your indirect cost pool. However, unallowable costsneed to be included in your base as part of total expenses. Governmental agencies may reject costs as unallowable that itdeems do not meet the allowability guidelines. Aronson LLC aronsonllc.com36

Definitions 2 CFR 200 Appendix 4 Indirect (F&A) Costs Identification andAssignment, and Rate Determination for Nonprofit Organizations– Cognizant Agency for indirect costs – the federal agency responsiblefor negotiating and approving indirect cost rates for a nonprofitorganizations on behalf of all federal agencies.– Predetermined Rate – an indirect cost rate, applicable to a specifiedcurrent or future period, usually the organization’s first year. The rate isbased on an estimate of the costs to be incurred during the period. Apredetermined rate is not subject to adjustment.– Fixed Rate – similar to a predetermined rate except that the differencebetween the estimated costs and the actual costs of the period iscarried forward as an adjustment to the rate computation of asubsequent period. Aronson LLC aronsonllc.com37

Definitions (cont.)– Final Rate – an indirect cost rate applicable to a specified past periodbased on the actual costs of the period. A final rate is not subject toadjustment.– Provisional Rate – a temporary indirect cost rate applicable to aspecified period which is used for funding, interim reimbursement, andreporting indirect costs on federal awards pending the establishment ofa final rate for the period.– Indirect Cost Proposal – the documentation prepared by anorganization to substantiate its claim for the reimbursement of indirectcosts. The proposal provides for the review and negotiation leading tothe establishment of an organization’s indirect cost rate. Aronson LLC aronsonllc.com38

Negotiation and Approval of Rates In general, the federal agency with the largest dollar value of federalawards with an organization will be designated as the cognizantagency for the negotiation and approval of the indirect cost rate. Except as otherwise provided in 2 CFR § 200.414, a nonprofitwithout a previously established rate must submit its indirect costproposal no later than three months after the effective date of thefederal award. 2 CFR § 200.414 provides that a nonprofit that has never received anegotiated indirect cost rate may elect to charge a de minimus rateof 10% of modified total direct cost (MTDC) which may be usedindefinitely. Aronson LLC aronsonllc.com39

Negotiation and Approval of Rates (cont.) Organizations that have previously established indirect cost ratesmust submit a new indirect cost proposal to the cognizant agencywithin six months after the close of each fiscal year. The results of each negotiation must be formalized in a writtenagreement between the cognizant agency for indirect costs and thenonprofit organization. Aronson LLC aronsonllc.com40

Allocation of Indirect Costs and Determination of Indirect Cost Rates If an organization has only one major function or where all its majorfunctions benefit from its indirect costs approximately equally, theallocation and computation of an indirect cost rate may beaccomplished through simplified allocation procedures. Each organization will have to determine what it considers to be itsmajor programs. The base period for the allocation would generally be theorganization’s fiscal year but in any event must be so selected as toavoid inequities in the allocation of costs. Aronson LLC aronsonllc.com41

Simplified Allocation Method If an organization’s major functions benefit from its indirect costs toapproximately the same degree an indirect cost rate can becomputed by the following calculation:Total allocable indirect costsEquitable distribution baseThe distribution base may be modified total direct costs or directsalaries and wages or another base which results in an equitabledistribution. Aronson LLC aronsonllc.com42

Simplified Allocation ant AGrant B Aronson LLC aronsonllc.comNon-federalcontract43

Multiple Allocation Base Method If an organization’s indirect costs benefit its programs in varyingdegrees, indirect costs must be accumulated into separate costgroupings. Groupings are generally categorized within two broadcategories “facilities” and “administration”. Many organizations break out cost groupings into fringe andoverhead or possibly overhead and G&A. Fringe benefits are thenallocated based on salary and wages and overhead gets allocatedon Modified Total Direct Costs (MTDC). Costs incurred for the same purpose in like circumstances have tobe treated consistently as direct or indir

Statement of Position 98-2, Accounting for Costs of Activities of Not-for-Profit Organizations and State and Local Governmental Entities that Include Fund Raising [now under Accounting Standards Codification (ASC) 958-720] Some nongovernmental not-for-profit organizations soli

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