Federal regulations require that similar costs be treated consistently as either direct costs or indirect costs, in like circumstances. This regulation imposes a requirement on the University to implement institutional decisions to consistently treat certain costs as indirect costs even though at any given time a particular transaction may otherwise legitimately appear to be a direct cost to a sponsored program.

The purpose of this document is to

• identify the fundamental requirements of the federal regulations
• provide interpretations of the regulations
• provide insight to apply the regulations within the University
• explain why decisions are made regarding direct vs. indirect cost
• identify criteria for allowable costs
• identify criteria for assigning direct costs
• describe roles and responsibilities of the parties to the cost allocation process

Cost allocation decisions are subject to verification through internal reviews and external (State and Federal) audits. The guidelines discussed in this document provide a relative measure of the audit risk associated with different allocation methods. Individuals in academic departments are responsible for demonstrating the cost-benefit relationship of any item of cost charged to a sponsored account. Familiarity with the concepts contained in this document is one method to reduce the risk of audit disallowance and to enhance compliance with the federal regulations.

Detailed direction on the treatment of specific costs at Purdue University is contained in a document titled “Costing / Charging Instructions For Sponsored Programs.” The federal regulations referenced in this document are contained in Office of Management and Budget (OMB) Circular A-21, “Cost Principles for Educational Institutions”, and in the Cost Accounting Standards as published in the Federal Register by the Cost Accounting Standards Board and subsequently incorporated into A-21.

The Dean, Director, and Department Head are the chief administrative officers for their area of responsibility and, as such, are expected to manage all programs and funds within their areas of responsibility in accordance with University rules, regulations and policies. The financial responsibility of the Dean, Director, and Department Head includes an assurance that costs are allocated appropriately to the various funding sources under their control, including sponsored programs. In most departments the authority to assign charges to sponsored accounts is vested in the Principal Investigator, however, the Dean, Director, or Department Head remains ultimately responsible for the cost assignment process and any budgetary implications arising from cost assignment.

Where the Principal Investigator assigns costs to individual projects, the Investigator is responsible for certifying the appropriateness of these charges. This certification should be included in the source documentation for a procurement or in other documents assigning the charge. In all cases, this certification signature must be from an authorized individual who has knowledge of both the cost and the project.

Business Administrators have been assigned primary responsibility for assisting Deans, Directors, and Department Heads in fulfilling their fiscal responsibilities. Business Administrators provide assistance in the determination of the allowability of costs and assistance in the determination of appropriate cost allocation techniques. Business Administrators must ensure that certifications are obtained on source documents and that these documents are retained in accordance with University retention requirements. Business Administrators may exercise delegated signature authority from both the Dean / Department Head and the Comptroller.

Sponsored Program Services is responsible for providing detailed technical advice regarding sponsor regulations and business procedures pertaining specifically to sponsored programs.

The Costing Office (Office of the Comptroller) is responsible for providing detailed technical advice regarding costing issues including allowability of cost, cost allocation, indirect cost, effort reporting and effort certification, and business procedures pertaining specifically to these topics.

In order for any cost to be charged to a sponsored program as either a direct or indirect charge, it must first be allowable. There are four separate tests that a cost must meet before the cost can be determined to be allowable. A-21 describes the basic considerations affecting the allowability of costs as follows:

“The tests of allowability of costs under these principles are: (a) they must be reasonable; (b) they must be allocable to sponsored agreements under the principles and methods provided herein; (c) they must be given consistent treatment through the application of generally accepted accounting principles appropriate to the circumstances; and (d) they must conform to any limitations or exclusions set forth in these principles or in the sponsored agreement as to the types or amounts of cost items.”

To determine whether an item is reasonable, one must consider whether both the price of the item and the quantity requested are appropriate given the circumstance prevailing at the time the procurement is made. Does the price of the item reflect its fair market value?

To determine whether a cost is allocable, one must first determine whether there is benefit to the project. Is the item necessary to conduct the work of the project? A secondary consideration, discussed later, is whether the item should be allocated on a direct or indirect basis.

Generally accepted accounting principles (GAAP) have been incorporated into the University’s costing and accounting policies. These policies should provide sufficient assurance that GAAP are followed in decision making in most circumstances.

Simply stated, cost allocation is the process of assigning charges to benefiting accounts in accordance with the relative benefits received. Costs may be assigned (or allocated) to an account by the Principal Investigator as direct charges. Other costs are assigned to a sponsored program account through the application of the University’s facilities and administrative rate. The rules for cost allocation clearly state that similar costs, in like circumstances, must be allocated consistently as either direct costs or indirect costs. That is, costs that are normally assigned by the Principal Investigator as direct charges to sponsored accounts should not be included in the facilities and administrative rate. Likewise, costs normally included in the facilities and administrative rate cannot be assigned by the Principal Investigator as direct charges unless unusual circumstances exist and are sufficiently documented. The specific rules regarding direct costs are contained in the next section of this document.

The key regulatory language and interpretations to illustrate cost allocation are provided below.

The cost accounting standards state that: “Allocate means to assign an item of cost, or a group of items of cost, to one or more cost objectives. This term includes both direct assignment of cost and the reassignment of a share from an indirect cost pool.”

A-21 states that: “A cost is allocable to a particular cost objective (i.e., a specific function, project, sponsored agreement, department, or the like) if the goods or services involved are chargeable or assignable to such cost objective in accordance with the relative benefits received or other equitable relationship.”

A-21 further prescribes that: “If a cost benefits two or more projects or activities in proportions that can be determined without undue effort or cost, the cost should be allocated to the projects based on the proportional benefit. If a cost benefits two or more projects or activities in proportions that cannot be determined because of the interrelationship of the work involved, then, [notwithstanding subsection C.4.b.], the costs may be allocated or transferred to benefited projects on any reasonable basis, [consistent with d.(1) and (2)].”

Therefore, A-21 has described a two step decision process. Can the proportional benefit be determined? If yes, then assign the cost on the proportional benefit. If the proportional benefit cannot be determined, are the projects interrelated? If yes, the Principal Investigator may assign the costs on any reasonable basis.

How are interrelated projects defined? The Public Health Service (PHS) regulations contain a restrictive interpretation of interrelated projects which includes the scientific and technical nature of the project, the projects are under the same P.I., etc. In order to determine whether two or more PHS projects are interrelated please consult those regulations.

In general, other projects may be said to be interrelated if they contain the following characteristics. (It is anticipated that few projects will be interrelated under these criteria.)

• It was disclosed in the project proposal or there is language in the award agreement that the same (similar) work is conducted with funds from other sponsors and
• The projects benefit each other such that the research or area of investigation is aimed at the same subject matter, or the research is being conducted on different aspects of the same subject matter.

If the projects are related, costs may be allocated on a reasonable basis. What is a reasonable basis? If the benefit to the project can be demonstrated, the allocation is reasonable. The allocation may be reasonable if there is a certification from the P.I. that the cost distribution is reasonable on the basis of the distribution of FTE across the projects (where the cost logically follows effort). A cost allocation is not reasonable where it can be shown that the charge was distributed on the basis of the funding available. Documentation supporting the cost allocation basis must be kept at the department level. This documentation is usually part of the procurement files.

Further guidance on cost allocation is contained in the footnotes to this paper.

Once a determination has been made that an item is allowable, one must determine whether the item qualifies as a direct cost or an indirect cost. OMB Circular A-21 and the cost accounting standards both provide guidance to determine whether an item should be treated as direct or as an indirect cost. Since the University is subject to both sets of regulations, it is important to understand the requirements of each when making cost allocation decisions. The determinants of a direct cost are as follows.

“Direct costs are those costs that can be identified specifically with a particular sponsored project, an instructional activity, or any institutional activity, or that can be directly assigned to such activities relatively easily with a high degree of accuracy. Costs incurred for the same purpose in like circumstances must be treated consistently as either direct or indirect cost.”

OMB Circular A-21 further describes the delineation between direct vs. indirect cost in the accumulation of costs in the indirect cost study. A-21 prescribes that certain costs such as salaries of technical staff, lab supplies, etc., should be treated as direct costs wherever identifiable to a particular cost objective. A-21 further prescribes that certain other costs such as office supplies, postage, telephones, etc. should be treated as indirect costs. There is an explicit emphasis that special care must be exercised to ensure that costs incurred for the same purpose in like circumstances be treated consistently as either direct or indirect costs.

The following items are treated as direct costs at Purdue University.

• Salaries and Wages
• Faculty (Principal Investigators), technicians, research assistants
• Fringe Benefits
• Subcontracts
• Capitalized scientific and technical equipment
• Long Distance telephone charges
• Materials
• Recharge center and specialized facility costs
• Travel
• Other direct costs, such as consultants

What is “relatively easily”? The identification method can be said to be relatively easy if:

• It does not take a lot of time.
• Most people (reasonable person rule) can understand/relate to the allocation method.
• The benefit to the project is clear and obvious thus making the identification method relatively inexpensive.

When is there a high degree of accuracy? An identification method can be said to be accurate if it contains the following characteristics, presented in decreasing order of accuracy (and therefore acceptability).

• There is a high degree of accuracy if there is a one-to-one relationship of the cost to the project.
• There is a clear and objective measure, such as: A finite amount of the cost item is available for allocation and counts of units used and consumed by the project may be determined, such as item quantity or unit measures (pounds, volume, etc.).
• An allocation measure is clear and objective if there are usage schedules, or logs, of actual use of the cost item.
• The distribution of salaries and wages is accurate if they are allocated in accordance with the costing principles which permit the initial distribution of payroll charges on the basis of estimates, but require an after-the-fact certification of the actual effort expended.
• An allocation measure may be said to be accurate if an individual investigator with first hand knowledge of his or her own projects estimates the actual utilization of the (non-salary) cost item by each project, and further certifies that estimate in writing (in the source procurement documentation).
• For cost items which benefit multiple investigators, the allocation measure may be accurate if the cost is distributed on the basis of prior utilization such as:
• Time used or expended (usage schedules or log pages);
• Materials or units produced (an output measure).
• For cost items which benefit multiple investigators, the allocation may be accurate if authorized individuals (such as the Principal Investigator or laboratory manager) with first hand knowledge of the proposed usage of the item estimate the utilization of the item on a project by project basis.

It is important to understand that any cost allocation decision is subject to audit verification, sometimes at a date significantly later than the decision was made. Individuals who allocate costs in the academic department must be able to demonstrate the cost-benefit relationship between any item of cost charged to a sponsored account and the sponsored project on an after-the-fact basis. When less accurate methods of allocation are used, such as estimates of proposed usage, the risk of audit disallowance increases. If the proposed utilization does not materialize, or if the initial estimate is significantly different than actual usage, the charge to the project may be disallowed or adjusted to the actual utilization measure. The financial burden of audit disallowance will reside with the academic unit responsible for the cost allocation decision.

Source documentation for all cost items must contain the rationale for split funding (i.e., multiple funding sources), and must contain signatures of the individuals authorized to commit funds against those projects, including multiple signatures where there are multiple funding sources across Principal Investigators.

The CASB believes that as an ideal, each item should be directly assigned to the cost objective it was intended to benefit or that caused the incurrence of the cost. The Board believes in the desirability of the direct identification of costs with final cost objectives when the following characteristics exist.

1. The beneficial or causal relationship between the incurrence of cost and cost objectives is clear and exclusive.
2. The amount of the resource used is readily and economically measurable.

However, if all items of cost incurred for the same purpose in like circumstances do not have these characteristics, then none of them should be identified directly with final cost objectives.”

What is a beneficial or causal relationship between the cost and the project?

• There is a beneficial or causal relationship if the cost is consumed by the project, such as:
  • Chemicals are ordered, received, and used entirely for the scientific work of the project.
  • Contractual services are rendered and / or used to achieve the stated purpose of the project.
• The cost enables the project to make progress and meet its goals.
• The cost is necessitated by the project.
• If there is a utilization measure, the cost is easier to identify with the project(s) involved and the beneficial relationship is clearer.

However, someone with knowledge of the program and the cost has to determine the relationship (i.e., benefit) of the cost to the project.

What is readily and economically measurable?

• The ability to easily assess the price or effort on a project is “readily and economically measurable”.
• The cost is economically measurable if the invoice cost is readily available.

From a broader perspective Deans, Department Heads and University Administrators should equate the concept of “economically measurable” with the concept of cost effectiveness. Institutional decisions may be made to treat certain cost items as indirect costs across the entire University because it is not feasible to establish the measurement systems to assign the cost on a direct basis. Likewise, departmental recharge centers should only be established if the income to be received from direct charging exceeds the costs of measurement and billing the item or service. The net income from direct billing should also exceed the potential indirect cost recovery on a University basis. Additionally, the consistency requirement enumerated above must be met before new recharge centers will be established.

Indirect costs are those that are incurred for common or joint objectives and therefore cannot be identified readily and specifically with a particular sponsored project, an instructional activity, or any other institutional activity.

Examples of Indirect Costs Generally Not Charged Directly to Sponsored Programs

The following cost categories are normally treated as indirect costs, but may be charged as direct costs depending on the purpose of the activity or the circumstance involved.

• Salaries and Wages of administrative and clerical personnel
• Office Supplies
• Local telephone charges
• Costs associated with providing the general computing environment, such as the Purdue Data Network (PDN) or the Engineering Computer Network (ECN).

The above items are normally considered indirect costs. They may be charged directly to federally sponsored projects when unlike circumstances can be documented.

Examples Of Circumstances Where Costs That Are Generally Indirect May Be Charged Direct

The following are examples of unlike circumstances that apply to Purdue University and have been disseminated as part of the decision criteria for determining when costs that are normally indirect may be charged directly to federal projects. (These examples were initially published by OMB following the 1993 revision to OMB Circular A-21.)

• Large complex programs such as General Clinical Research Centers, Program Projects, environmental research centers, and other grants and contracts that entail assembling and managing teams of investigators from a number of institutions.
• Projects which involve extensive data accumulation and entry, surveying, tabulation, cataloging, searching literature and reporting, such as epidemiological studies, clinical trials, and retrospective clinical record studies.
• Projects whose principal focus is the preparation and production of manuals and large reports, books, and monographs (excluding routine progress and technical reports.)
• Projects that are geographically inaccessible to normal department administrative services, such as seagoing research vessels, radio astronomy projects, and other research field sites that are remote from campus.
• Individual projects requiring project specific database management; individualized graphics or manuscript preparation; human or animal protocol, IRB preparations and other project specific regulatory protocols; and multiple project related investigator coordination and communications.

When the above circumstances exist, or other unusual situations exist that can likewise be documented, the cost of items required for the conduct of the project must be budgeted and fully justified in the proposal to the federal sponsor in order to be subsequently charged to the project.

Items that are normally considered as indirect costs must be included in the award, or subsequently approved in accordance with the funding agency regulations, in order to be allowable charges to the project. The University will consider the costs approved if the agency awards the proposed budget in full, or does not explicitly remove the budget line item for those costs.

These items may be charged directly to non-federal projects if they are not restricted by the sponsor’s guidelines and the cost / benefit relationship can be documented appropriately.

Continued – Costing/Charging Instructions for Sponsored Programs