UNDERSTANDING FEDERAL GRANTS FOR NOT FOR PROFITS

Imagine that you have just received your first federal grant. You are feeling a great sense of accomplishment and there is a temptation to sit back and relax. You think there are no other obligations to the granting agency to worry about. What is wrong with this picture?

There are significant responsibilities inherent in managing major federal grants. The administrative cost to develop compliant accounting systems can be substantial. Government regulations resemble a minefield of hidden requirements and potential serious penalties.

Let’s briefly introduce some key areas of concern that will help you to fully recover costs related to your federal grant:
Full recovery of indirect costs
Development of an indirect cost rate
Procedures to meet government compliance requirements
Comprehensive accounting system

First, you must understand why indirect cost rates are integral to federal grants and full cost recovery.

Indirect Cost Rates

In preparing the IRS Form 990, Part II Statement of Functional Expenses (SFE), Not For Profit Organizations (NFPO’s) have to determine which portion of their expenses are attributable to Management and General (M&G). This is how some organizations first determine their indirect costs, i.e. the overall support cost and infrastructure to support operations. Every organization has some methodology to identify and distribute M&G expenses to programs.
 
NFPO’s often allocate indirect cost expenses such as payroll taxes, employee benefits or rent to programs using full time labor equivalents, actual salaries and wages or another predetermined method.  Sometimes direct and indirect salaries are allocated based on set budget percentages. Using estimates to approximate indirect wages in M&G results in a less accurate calculation of support functions for purposes of IRS 990 reporting.  Since 990s are public information, it would not be surprising that organizations might be tempted to artificially lower their M&G expense allocations to give the appearance that their administrative costs are at a minimum.

For federal grants, the government requires complete accuracy of both direct and indirect labor charges by requiring the use of timesheets to record and document actual labor charges.  Indirect costs cannot be based on some arbitrary method.  Using actual labor charges as recorded in employee timesheets will give a precise methodology for allocating indirect costs.

Indirect costs are computed and allocated based on the following rather simplistic percentage. The percentage is computed based on a fractional ratio containing a specific numerator and denominator.  The numerator is M&G total expense, which is divided by a denominator representing the total of program expenses plus fundraising expenses per the allocation methodology from OMB Circular A-122.  Only the appropriate amount of indirect cost can be allocated to federal grants using this percentage. When you prepare a grant proposal, the goal is to recover not only your direct program costs but also the applicable indirect costs as computed using your indirect cost rate.
 
Full Cost Recovery

Can you imagine not recovering 10% of indirect cost on a $300,000 federal grant? That equates to $30,000. How long could a NFPO remain viable and not impact their reserves? Understanding the dynamics of indirect costs for federal grants before you submit your grant proposal will help you to fully recover the indirect costs you are entitled to receive.

From the onset of preparing your grant proposal to a federal agency, you should include a provision for indirect cost, i.e. fringe benefits and M&G. Fringe pertains to the benefits associated with salaries such as payroll tax, workers compensation, pension, medical, life insurance, etc. Unfortunately, you will not be able to use an indirect rate until it is approved by the cognizant agency. It is recommended that when you submit your grant proposal, you also provide an Indirect Cost Rate Proposal (ICRP).

The two larger grant-making federal agencies are U.S. Department of Health and Human Services (DHHS) and U.S. Department of Labor (DOL).  Some agencies use their ICRP templates which are available at the following web sites.
DOL http://library.dol.gov/oasam/programs/boc/ocd-guide-main.htm
DHHS http://rates.psc.gov/fms/dca/np_exall2.html

A grant is not like a contract. If awarded a cost reimbursable contract, the NFPO is entitled to recover 100% of their incurred cost. Although grants are cost reimbursable, depending on the federal program, the government might be looking to cost share with the NFPO. Often grants have matching requirements such as cooperative agreements. For example, the government may provide 80% of a $100,000 grant but the agency is expecting the NFPO to cover the remaining 20% or $20,000 by incurring costs not reimbursed by the government; usually by in-kind contributions from existing volunteer donors in the form of contributions or services.

Since the grantee will receive only 80% on the dollar, it is imperative that they recover all of their indirect costs. Consequently your indirect cost will not be recovered unless you include them in your grant proposal with an ICRP submittal to your cognizant agency. Let’s discuss the indirect rate development process.

Indirect Rate Development

The process of developing indirect cost rates can be time consuming. You should not develop your Indirect Cost Rate Proposal (ICRP) until your financials are audited so that you are using a post-audit Trial Balance. OMB Circular A-122 requires an ICRP submittal within 6 months after year-end. If you have just received your first federal grant, you have 90 days to submit a provisional rate to your cognizant agency.  You should consider providing your initial ICRP with your grant proposal to expedite the process.

Most likely you will not have computed a provisional rate if this is your first federal grant. Until you receive a provisional rate, the government will not include your indirect expenses based on your provisional rate until the beginning of the next federal government fiscal year starting October 1st. The provisional rate will be used in invoicing and submitting proposals to the federal government.

A provisional indirect rate is developed based on the prior year’s historical data adjusted by the forecast for the upcoming fiscal year.  Often, agencies use the final actual rate for the prior year as the provisional rate for upcoming fiscal periods. Most agencies have a focal point, such as the division of cost allocation, to review and issue both provisional and final rates. Since a grantee might have awards with different federal agencies, the agency with the largest dollar concentration of government grants negotiates the rates on the behalf of all other departments. At the end of a fiscal period, the grantee submits their ICRP to the cognizant agency to settle their final rate as well as establishing next year’s provisional rate.

In establishing the final (actual) rate for a grantee’s previous fiscal year, if the provisional rate was higher than actual expenses, the grantee must pay back the difference or offset their next invoice. If the historical rate is higher than the provisional rate, the grantee must quickly submit this information to their grants officer for recovery. However, four scenarios might limit recovery.

First, if there was a ceiling rate, the grantee can only recover their actual indirect costs up to the ceiling rate. If the actual (historical or final) rate is lower than the ceiling rate, they will recover 100% of their indirect expenses. Second, the grant may not permit the recovery of indirect expenses after the final, actual rate is determined.

Third, if the grantee has expended all of its funding, the grantee would not be reimbursed. However, the grantee is not precluded from requesting additional funds in next year’s budget to recover the additional indirect expenses, but often this is not accomplished because of political reasons, i.e. the agency is generally not willing to pay for more cost than originally planned. The fourth limitation on cost recovery is the impact of not complying with government regulations.

Compliance Requirements

Different agencies rely on different means of oversight to ensure the indirect cost rates comply with the regulatory provisions of OMB Circular A-122. The agency cost negotiator will review the grantee’s ICRP to settle final rates. This may include questions about the submittal, or the agency may request their Inspector General, an outside contracted CPA firm or even the Defense Contract Audit Agency (DCAA) to perform a review.

Depending on the level of agency oversight, the grantee may have greater risk of non-compliance. For instance, DCAA would perform a more involved audit. In order to assure that the grantee would have no deficiency, the NFPO would have to establish a more robust system of internal controls.  Grantees having limited interaction with a cost negotiator might have less internal controls because of a lower chance of direct audit oversight.

An adequate project cost accounting system must be able to segregate costs and funds by grant, distinguish between direct and indirect cost, and identify unallowable cost per OMB Circular A-122. This regulation has 52 cost principles addressing cost recovery. If the grantee does not comply with the regulations, certain costs will be disallowed.

Since the potential for non-compliance would have a negative affect, there is a higher administrative cost to maintain a robust compliance system. This form of self governance would include formal timekeeping, travel, and other procedures to ensure a strong system of internal controls is in place. If the grantee incurs more than $500,000 from federal awards during a fiscal year, their financial statements must not only be audited, but must issue a supplemental audit in accordance with Generally Accepted Government Auditing Standards that ensures that the financial statements for a federal program are free of material misstatement to be in compliance with the provisions of OMB Circular A-133.

Conclusion

As you can see, obtaining a government grant may be a good source of income, but it comes with strings attached. The knowledgeable grantee will understand the regulatory implications of contracting with the federal government. They will know about the potential limits on recovery and try to negotiate and receive the total amount of indirect cost based on a properly developed indirect cost rate.

Contracting with the government has inherent administrative cost for specialized accounting software, and maintaining stringent internal controls. There are other areas to consider when contracting with the federal government that should also be addressed though not discussed in this article to ensure a comprehensive accounting system.

Cost accounting structures (chart of accounts to included program identifiers)
Specialized grant cost reporting
How the government views time allocation and allocability,
How to develop:
An indirect cost rate,
An annual indirect cost rate proposal,
A cost allocation plan,
A transition plan.
How to compute total cost by grant,
How to apply interim burden offsets,
How to record rate variances.

Paul H. Calabrese is a senior manager at Rubino & McGeehin, Chartered, CPAs and Consultants, providing accounting and consulting services to the firm's non profit and government contracting clients. He has considerable experience with OMB Circular A-122, cost principles and indirect cost recovery for non-profit organizations. He has presented seminars through the Greater Washington Society of CPAs, Center for Non-Profit Advancement, and the Executive Office of the (DC) Mayor, Office of Partnerships and Grants Development on related matters. He can be reached at 301-214-4137 or pcalab@rubino.com. 

The following is a list of upcoming seminars that Mr. Calabrese will be presenting the fall of 2006:
“OMB Circular A-122 Cost Principles and Internal Controls for A-133 Audits” - Part of the A-133 all day conference through the GWSCPA, Washington, DC, Tuesday, September 19, 2006.
“Indirect Cost Rates and Design for Not For Profits and Other Organizations,” 4 hours CPE, morning session, Tuesday, October 17, 2006 through the GWSCPA, Washington, DC.
“Federal Grants Management” breakout session at the DC Public Private Partnership through the DC Executive Office of the Mayor, Office of Partnerships and Grants Development at GWU, Washington, DC, Monday, October 30, 2006.

A. Michael Gellman, CPA is a shareholder at Rubino & McGeehin, Chartered, CPAs and Consultants, where he is responsible for the firm's Not-For-Profit Specialty Group Consulting Practice. Mr. Gellman has more than 25 years experience in nonprofit accounting working as a financial and management consultant. He has conducted numerous seminars and has written articles on budgeting, reserve and investment policies, strategic planning, fees for services, endowment funds and board development. Mr. Gellman is currently serving is a past president of the Greater Washington Society of CPAs. He can be reached at 301-214-4197 or mgellman@rubino.com.

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