Indirect Cost Recovery: What You Need to Consider. August 2017

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1 Indirect Cost Recovery: What You Need to Consider August 2017 BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms.

2 AGENDA OVERVIEW What are Indirect Costs? Does your Indirect Cost Rate Structure Matter? INDIRECT COST RATE STRUCTURE Indirect Cost Pools Allocation Bases Summary of Indirect Cost Pools & Allocation Bases INDIRECT COST RATE CALCULATIONS Fringe Rate Calculation (Example) Overhead Rate Calculation (Example) G&A Rate Calculation (Example) FEDERAL FUNDING Cost Principles Cost Allocation Methodologies Direct Cost Allocation (Example) Simplified Cost Allocation (Example) Types of Indirect Cost Rates INDIRECT COST RATE ASSESSMENT Key Drivers Organizational and Strategic Analysis Benchmarking Analysis Scenario Analysis Optimal Rate Structure Page 2

3 OVERVIEW

4 OVERVIEW WHAT ARE INDIRECT COSTS? Indirect costs represent the expenses of doing business that are not readily identified with a particular grant, contract, project function or activity, but are necessary for the general operation of the organization and the conduct of activities it performs. Examples: Accounting and legal expenses Administrative salaries Office expenses Rent Telephone expenses Utilities Page 4

5 OVERVIEW DOES YOUR INDIRECT COST RATE STRUCTURE MATTER? The indirect cost rate structure of an organization depends on the organization s business structure and processes. It may be challenging for small businesses to define costs into an overhead pool; therefore, having just two pools is sufficient (i.e. Fringe & G&A) Indirect rate structures are influenced by many factors and should reflect as accurately as possible: The most efficient operating structure of the organization The proper identification of the true cost of an organization s final cost objectives A realistic projection of the anticipated future direction of the organization A competitive allocation of costs to the organization s final cost objectives Meaningful information upon which management can base its decision making process Favorable cost recovery and cash flow scenario Page 5

6 INDIRECT COST RATE STRUCTURE

7 INDIRECT COST RATE STRUCTURE INDIRECT COST POOLS To help determine what the proper structure should be it s important to understand the definition of these indirect cost pool types. Fringe Includes employee related costs including payroll taxes, health insurance, and compensated absences (i.e. Vacation, Holiday, and Sick Leave) Overhead These are costs directly related to projects but cannot be identified to one project or contract (i.e. Rent, Utilities,etc.) G&A Includes expenses necessary to run or manage the business as a whole (i.e. Accounting/Finance, Human Resources, Marketing and Sales, etc.) Page 7

8 INDIRECT COST RATE STRUCTURE ALLOCATION BASES Indirect costs are required to be allocated in an equitable manner. The widely accepted allocation bases are: Fringe Total Employee Labor Fringe is allocated not only to direct activities but indirect as well. When calculating rates, fringe must be allocated to the other indirect cost pools that include labor. Overhead Direct Labor The most widely accepted allocation base is Direct Labor; however, some organizations use the sum of Direct Labor and Fringe which is acceptable as well. General and Administrative Expense (G&A) There are two allocation bases that can be used: o o Total Cost Input 1 - This is defined as all costs less G&A expense Value Added Base 2 This is defined as total cost input less material and subcontract costs 1 This is the preferred allocation base 2 - To be used where inclusion of material and subcontract costs would significantly distort the allocation of the G&A pool Page 8

INDIRECT COST RATE STRUCTURE SUMMARY OF INDIRECT COST POOLS AND ALLOCATION BASES The bottom-line is that the allocation base selected must be representative of the entire business activity and must

9 INDIRECT COST RATE STRUCTURE SUMMARY OF INDIRECT COST POOLS AND ALLOCATION BASES The bottom-line is that the allocation base selected must be representative of the entire business activity and must be equitable. Pool Description Typical Allocation Base Employee Costs, Payroll Total Employee Labor or Fringe Taxes, Fringe benefits, Payroll Compensated Absences. Direct Labor or Direct Labor and Fringe. Overhead Operations Support Costs Direct labor includes G&A Overall costs to run or operate a business as a whole. B&P/IR&D labor. Total Cost Input or Value Added Base when TCI proves inequitable. Page 9

10 INDIRECT COST RATE CALCULATIONS

11 INDIRECT COST RATE CALCULATIONS FRINGE RATE CALCULATION (EXAMPLE) Fringe Pool Amount Payroll Taxes $20,000 Compensated Absences $15,000 Employee Benefits $25,000 Total Fringe Pool $60,000 Allocation Base Amount Direct Labor $80,000 OH Labor $15,000 G&A Labor $30,000 IR&D/B&P Labor $15,000 Other Labor $ 5,000 Total Allocation Base $145,000 Fringe Rate 41.38% Page 11

12 INDIRECT COST RATE CALCULATIONS OVERHEAD RATE CALCULATION (EXAMPLE) Overhead Pool Amount Overhead Labor $ 15,000 Rent $ 30,000 Depreciation $ 25,000 Supplies $ 10,000 Other $ 5,000 Less: Unallowable Costs $ (207) Fringe Allocated to OH Labor (Fringe Rate * OH Labor) $ 6,207 Total Overhead Pool $ 91,000 Allocation Base Amount Direct Labor $ 80,000 B&P/IR&D $ 15,000 Fringe Applicable to Direct Labor $ 33,103 Fringe Applicable to IR&D/B&P Labor $ 6,207 Total Allocation Base $134,310 Overhead Rate 67.75% Page 12

13 INDIRECT COST RATE CALCULATIONS G&A RATE CALCULATION (EXAMPLE) G&A Pool Amount G&A Labor $30,000 Rent $10,000 Professional Services $25,000 Business Development $15,000 Travel $25,000 Other $ 5,000 Less: Unallowable Costs $(5,000) Fringe Allocated to G&A Labor (Fringe Rate * G&A Labor) $12,414 IR&D/B&P Labor $15,000 Fringe Allocated to IR&D/B&P Labor $ 6,207 Overhead Allocated to IR&D/B&P Labor $10,163 Total G&A $148,784 Allocation Base Amount Direct Labor $ 80,000 Direct Materials $ 400,000 ODC $ 100,000 Fringe Applicable to Direct Labor $ 33,103 OH Applicable to Direct Labor $ 54,202 OH Applicable to Fringe $ 22,428 Unallowable OH Costs $ 207 Total Allocation Base $689,940 G&A Rate 21.56% Page 13

14 FEDERAL FUNDING

15 FEDERAL FUNDING COST PRINCIPLES Organizations receiving Federal funding or pursuing USG awards should be familiar with the applicable regulatory requirements prior to preparing an indirect cost rate proposal. The following cost principles should be reviewed to determine if the costs proposed are reasonable, allowable, and allocable to the Federal government. Non-Profit Organizations 2 CFR Part 200 Subpart E Cost Principles for Non-Profit Organizations Commercial Organizations FAR, Part Contracts with Commercial Organizations Page 15

16 FEDERAL FUNDING COST ALLOCATION METHODOLOGIES The three (3) basic methods for calculating indirect cost rates under 2 CFR 200 are: Direct Allocation Method Utilized when an organization treats all costs as direct costs except general administration and general expenses. Simplified Allocation Base Method 1 Where an organization's major functions benefit from its indirect costs to approximately the same degree, the allocation of indirect costs may be accomplished by (i) separating the organization's total costs for the base period as either direct or indirect, and (ii) dividing the total allowable indirect costs (net of applicable credits) by an equitable distribution base. Multiple Allocation Base Method Utilized when an organization determines its major functions benefit from its indirect costs in varying degrees. The organization accumulates indirect costs into separate cost pools (groupings); which, allocates each pool to benefiting functions using a base which best measures the relative benefits (causal/beneficial). 1 Typically, commercial organizations use the simplified method Page 16

FEDERAL FUNDING DIRECT COST ALLOCATION METHODOLOGY (EXAMPLE) The direct allocation method allocates support costs directly to each operating department.

17 FEDERAL FUNDING DIRECT COST ALLOCATION METHODOLOGY (EXAMPLE) The direct allocation method allocates support costs directly to each operating department. Every dollar is allocated out of the support department to an operating department. Rent Expense $50,000 Grant Grant $15,000 G&A Pool Contract $20,000 Cooperative Agreement $8,000 Contract $7,000 Page 17

FEDERAL FUNDING SIMPLIFIED COST ALLOCATION METHODOLOGY (EXAMPLE) The simplified allocation method uses one cost rate to dictate the dollars that are allocated from a cost pool to a unit, batch,

18 FEDERAL FUNDING SIMPLIFIED COST ALLOCATION METHODOLOGY (EXAMPLE) The simplified allocation method uses one cost rate to dictate the dollars that are allocated from a cost pool to a unit, batch, department, or division. In the case of support departments, the rate allocates dollars to another department or division. Rent Expense $50,000 Grant Indirect Cost Pool 25% Grant $12,500 Contract $15,800 Cooperative Agreement $21,700 Page 18

19 FEDERAL FUNDING TYPES OF INDIRECT COST RATES The Office of Management and Budget (OMB) Regulations define four (4) types of indirect cost rates: Provisional Rate A temporary rate, agreed to in advance, based on anticipated future costs. It is subject to retroactive adjustment at a future date after costs are known. Final Rate Established after costs are known. It adjusts the Provisional Rate but is administratively burdensome. Fixed Rate Agreed to in advance and is not retroactively adjusted. Predetermined Rate Agreed to in advance but is generally not subject to adjustment. Page 19

20 INDIRECT COST RATE ASSESSMENT

21 INDIRECT COST RATE ASSESSMENT KEY DRIVERS Organizations typically seek an assessment of their indirect cost rate structure due to the following: Organizational and Operational Changes Increase in regulatory requirements OMB Circulars Supercircular Federal Acquisition Regulation (FAR) Contract Clauses Cost Accounting Standards (CAS) Seeking more competitive rates Maximize cost recovery with minimal administrative burden No current indirect rate structure and are looking to increase pursuit of funding resources and awards Page 21

22 INDIRECT COST RATE ASSESSMENT ORGANIZATIONAL AND STRATEGIC ANALYSIS The first step towards developing an indirect cost rate structure reflective of the organization s strategic goals and business operations is to address various structural alternatives such as: Determining what functions are to be identified as direct or indirect costs Determining the basis for indirect cost allocation Deciding whether the indirect cost structure should be complex (e.g., multiple expense pools and allocation bases) or simple (e.g., single expense pools and single allocation bases) Establishing a material-handling rate to apply to large material purchases or other direct costs on contracts where labor and/or subcontract efforts are not significant. Establishing on-site (home office) rates and off-site (client site) rates to more accurately allocate company facility and administrative support costs and provide for a lower off-site indirect The allocation and recovery of home or corporate office expenses allocated to the various business centers can recover costs generally not included in an indirect cost structure Determining the most equitable allocation process for service centers (e.g., reproduction, graphics, information technology, facilities, communication services, etc.) to interim or final cost objectives Page 22

23 INDIRECT COST RATE ASSESSMENT BENCHMARKING ANALYSIS Organizations need to perform a benchmark of their current indirect cost rate structure to peers and other organizations in its industry. The information gathered during the analysis can be leveraged to develop a competitive indirect cost rate structure. The following are some key metrics necessary to establish a benchmark of industry statistics; however, this will vary depending on the organization: Size and Scale (e.g. Revenue, Expenses, Geographic Location) Business Model (e.g. Business Mix, Type of Funders) Organizational Structure (e.g. Board of Directors, Executive Team) Support Functions (e.g. Accounting, Human Resources) Page 23

24 INDIRECT COST RATE ASSESSMENT SCENARIO ANALYSIS Financial modeling is used to run scenarios using various assumptions to identify the most beneficial indirect cost rate structure to be implemented. The purpose of the scenario analysis is to develop a cost and profit impact model to evaluate the rate impact differences and pros/cons of viable rate alternatives. Financial modeling activities assist in identifying the following depending on the organization: Various rate options (e.g. Total Direct Costs, Modified Total Direct Cost) Treatment and allocation of shared costs Intermediary allocations and basis of distribution Treatment of pass-through costs Recoverability impact of each viable option Page 24

INDIRECT COST RATE ASSESSMENT OPTIMAL RATE STRUCTURE The end result of the indirect cost rate

the following: Facilitate management s decision making process Maximum cost recovery with minimal

organization s competitive position Maintain regulatory compliance Maximum Cost Recovery

25 INDIRECT COST RATE ASSESSMENT OPTIMAL RATE STRUCTURE The end result of the indirect cost rate assessment is to develop an indirect cost rate structure that will help the organization achieve the following: Facilitate management s decision making process Maximum cost recovery with minimal administrative burdens A more sustainable and equitable cost accounting structure Improve the organization s competitive position Maintain regulatory compliance Maximum Cost Recovery Regulatory Compliance Indirect Cost Rate Structure Management Decision Making Process Improve Competitive Position Page 25

26 QUESTIONS? ANDREA WILSON PARTNER

Cost Pools, Indirect Rates & Allocation Plans: Demystified

Cost Pools, Indirect Rates & Allocation Plans: Demystified Maryland Workforce Association 2017 Raising the Bar Conference: Preconference Workshop May 3, 2017 1:00-2:30pm Baker Tilly refers to Baker Tilly