Effective Cost Allocation Strategies

Effective Cost Allocation Strategies Kay Sohl Head Start Fiscal Conference April 5, 2011 kay@kaysohlconsulting.net

Cost Allocation Systematic method for determining the portion of specific costs which should be attributed to specific cost centers (final cost objective)

Cost Allocation Pleasure Zone Portion of the brain which transmits sensations of extreme pleasure when thinking of cost allocation

Nonprofit Compliance Framework GAAP IRS Funding agreements

GAAP Nonprofit Accounting Expenses incurred for 3 distinct functions: Programs Management and General Fund Raising

Administration/Management in GAAP Financial management Board support Strategic planning HR management

Fund Raising in GAAP Unsolicited requests for contributions All forms of contact with individual donors Most foundation grant-seeking activity

IRS Form 990 Program services Management and general Fundraising

Funding Agreements Most state and local agreements require compliance with federal rules Funder may impose additional requirements and limitations Legally obligate recipient of funds to comply

Federal Funds Framework OMB Circular A-110 (2 CFR 215) Circulars A-122, A-87, A-21 ( 2 CFR 230, 225, 220) A-133 Auditing Requirements Head Start 45 CFR 1300.

OMB A-110 Administrative Requirements Standards for Financial Management Systems Allowable Costs Much, much more!

OMB Cost Allocation Circulars: cost principle requirements A-122 Nonprofit Organizations A-21 - Educational Institutions A-87 State, local, & tribal government

OMB Rules address both function and behavior of costs Function: Cost is incurred for a program, admin, or fundraising purpose Behavior: Cost can be directly or indirectly attributed to a function/cost center/final cost objective

Behavior of Costs Direct Costs: costs that can be identified specifically with a function/program (final cost objective) Indirect Costs: costs which are not directly identified with a single function/program (final cost objective)

Direct Costs Costs easily identified with a specific cost center Example: Head Start teacher easily identified with Head Start cost center

Indirect Costs Costs incurred for common or joint objectives Costs which benefit multiple cost objectives Costs which must be shared among some or all cost centers

Indirect Administrative Cost Administrative Costs function as indirect costs Not all indirect costs are administrative Facilities and other shared costs may behave indirectly but not be administrative

Exhibit 1 Organization A - Indirect cost rate of 6.6% TOTAL EXPENSES Programs A B C Admin Indirect Total Expenses: Salaries & wages $ 18,613 19,500 23,347 18,557 5,150 85,167 Employee benefits 2,792 2,925 3,502 2,784 772 12,775 Materials & supplies 5,200 8,900 3,581 1,124 0 18,805 Postage & shipping 605 987 4,251 895 2,088 8,826 Printing & publications 1,000 1,355 756 201 50 3,362 Telephone 756 1,222 1,336 2,285 2,263 7,862 Occupancy 2,219 4,590 9,675 11,116 0 27,600 Depreciation 684 758 95 151 0 1,688 Total direct expenses 31,869 40,237 46,543 37,113 10,323 166,085 Allocation of indirect costs 2,112 2,667 3,084 2,460 (10,323) 0 $ 33,981 42,904 49,627 39,573 0 166,085 1. The effective indirect cost rate = 6.6% [$10,323/($166,085 - $10,323)] 2. The administrative rate = 23.8% [$39,573/$166,085] 3. Indirect costs are allocated by applying indirect cost rate (6.6%) to each cost center's total direct expenses [e.g., Program A: 6.6% X $31,869 = $2,112]

Exhibit 3 Organization C - Indirect cost rate of 0% TOTAL EXPENSES Programs A B C Admin Indirect Total Expenses: Salaries & wages $ 19,255 21,621 25,388 18,903 -- 85,167 Employee benefits 2,881 3,050 3,727 3,117 -- 12,775 Materials & supplies 5,200 8,900 3,581 1,124 -- 18,805 Postage & shipping 923 1,612 4,541 1,750 -- 8,826 Printing & publications 1,025 1,380 800 157 -- 3,362 Telephone 1,290 1,417 2,244 2,911 -- 7,862 Occupancy 3,219 4,590 8,675 11,116 -- 27,600 Depreciation 188 334 671 495 -- 1,688 Total direct expenses 33,981 42,904 49,627 39,573 -- 166,085 Allocation of indirect costs -- -- -- -- -- -- $ 33,981 42,904 49,627 39,573 -- 166,085 1. The indirect cost rate = 0%. No indirect allocation mechanism is used; all expenses are charged directly 2. The administrative rate = 23.8% [$39,573/$166,085]

Exhibit 4 Organization A - Indirect cost rate of 6.6%; administrative and indirect costs combined TOTAL EXPENSES Direct Programs Indirect A B C Admin Total Expenses: Salaries & wages $ 18,613 19,500 23,347 23,707 85,167 Employee benefits 2,792 2,925 3,502 3,556 12,775 Materials & supplies 5,200 8,900 3,581 1,124 18,805 Postage & shipping 605 987 4,251 2,983 8,826 Printing & publications 1,000 1,355 756 251 3,362 Telephone 756 1,222 1,336 4,548 7,862 Occupancy 2,219 4,590 9,675 11,116 27,600 Depreciation 684 758 95 151 1,688 Total direct expenses 31,869 40,237 46,543 47,436 166,085 Allocation of indirect costs 2,112 2,667 3,084 (7,863) 0 $ 33,981 42,904 49,627 39,573 166,085 1. The effective indirect cost rate = 6.6% [$10,323/($166,085 - $10,323)] 2. The administrative rate = 23.8% [$39,573/$166,085] 3. Indirect costs are allocated by applying indirect cost rate (6.6%) to each cost center's total direct expenses

Terminology Challenges A-122 permits nonprofits to define indirect to mean either: Administrative Costs or Administrative Costs plus other Shared Costs

Other Indirect Costs Not all indirect costs are administrative Facilities and other shared costs may behave indirectly but not be administrative

Administrative Costs Costs associated with performing agency- wide administrative functions Function as indirect costs Specific funding sources may impose limitations on Admin or all indirect costs

Administrative Costs Overall agency management Financial management HR & IT management Contract administration Board support

Direct Federal Funding Agreements Federal agency may require obtaining Federal Indirect Cost Rate Federal agency may permit use of Cost Allocation Plan without Federal Indirect Cost Rate

Federal Indirect Cost Rate Obtained through negotiation with cognizant federal agency Submit Indirect Cost Proposal Rate may be Provisional, Final, Predetermined, or Fixed with Carry- Forward Provision

Fed $ in State/Local Government Agreements State/local government is Recipient nonprofits are sub-recipients Sub-recipients must comply with federal requirements

Sub-Recipient Cost Allocation State/local Recipient is responsible for Sub-recipient compliance Sub-recipients must have cost allocation plans or federally negotiated indirect rates

Cost Allocation Systematic method for determining the portion of specific shared costs which should be attributed to specific cost centers

Cost Allocation Plan Writtendescription of how costs will be allocated Established by nonprofit Must comply with A-122

Cost Allocation Plan Basics Identify direct costs Identify non-administrative indirect costs and method used to allocate them Identify administrative costs and method used to allocate them

Cost Allocation Plan Basics May include multiple cost allocation methods Must apply allocation methods consistently to cost centers Key issue in A-133 audits

Cost Allocation Plan Methods May use same methods as in Federally Negotiated Indirect Rates May also use other reasonable methods

Cost Allocation Methods Federally Negotiated Indirect Cost Rate requires calculation of Indirect costs as a % of Base Resulting % is applied to direct costs of each program to determine allowable indirect costs

Allowable Allocation Methods Indirect $ as % of direct $ Indirect $ as % of personnel costs % of staff time (FTE) devoted to each program/cost center % of square feet devoted to each program/cost center

Impermissible Allocation Method Availability of funds Cannot base allocation of costs on limits on indirect or admin costs imposed by specific funders

Cost Allocation Approaches Transaction by transaction allocation Pool shared costs allocate pool total using allowable method Use of indirect rate must be substantiated by tracking actual indirect costs

Documenting Personnel Costs Allocate personnel costs based upon actual use of staff time Contemporaneously maintained time records are essential

Time Records Employee record maintained for each pay period Both employee & supervisor must sign Employees must reflect actual use of time

Time Record Challenges Exempt & Non-Exempt employee format may differ Non-Exempt employees track specific hours Exempt employees may track % of effort during pay period

Non-Exempt Time Record Hours Worked Total Supervisor 4 Apr 5 Apr 6 Apr 7 Apr 8 Apr Period Signature Head Start 4 3 5 2 6 20 CSBG 2 2 0 0 1 5 Weatherization 2 3 3 6 1 15 Management 0 0 0 0 0 0 Total 8 8 8 8 8 40

Exempt Time Record Supervisor April 4 April 8, 2011 % of time Signature Head Start 70% CSBG 30% Weatherization 0% Management 0% Total 100%

For all Time Records I hereby certify that this is an after-thefact determination of my actual activity for the above referenced period and is true & accurate to the best of my knowledge. Signature Date

Translating Time into $$$ Time records result in computing % of time devoted to each cost center % of time used to allocate gross pay to cost centers

City of Chicago Challenge Must report cost of specific positions each pay period When actual use of time exceeds budget plan, payment may be held up Strategies to address

Fringe Benefit Costs May allocate employee by employee May establish rates for groups of employees May allocate based on overall fringe benefit rate

Vacation Benefit Issues Must have written policy Accrual method results in matching allocation of benefit expense to use of time in period earned Cashmethod results in allocation based in period used

Impact of Growth/Contraction Indirect costs generally rise/fall more slowly than direct costs Use of out-of-date allocation formulae to apply methods can result in unsubstantiated costs

Indirect as % of Direct Costs Pre Cuts Post Cuts Direct Expenses 20,000,000 16,000,000 Indirect Expenses 3,000,000 2,750,000 Indirect as % of Direct 15% 17%

???? During Constrictions How will Admin or other Indirect Costs change as % of Direct costs? Does revised calculation of share of Admin costs exceed Admin limits of any source? Does org have other sources of funds to cover Admin gap?

Next Steps Review Cost Allocation Plan Review timesheets format Review procedure for allocating payroll costs Determine impact of overall budget growth or contraction

Resources OMB A-122: http://www.whitehouse.gov/omb/circular s/a122 Sample Federal Indirect Cost Rate Proposal: http://rates.psc.gov/fms/dca/np_exall.pd f

More Resources Right on the Money: An Annotated Guide to the Federal Cost Principles for Nonprofit Grantees www.caplaw.org

FY 10-11 Admin Fund Budget Raising CSBG Head Start XYZ Total Support and Revenues Contributions-Indiv & Business 50,000 50,000 Contributions-In-Kind 100,000 100,000 Annual Auction 125,000 125,000 XYC Grant 180,000 180,000 Head Start Contract 889,947 789,947 CSBG Contract 741,406 741,406 TOTAL REVENUES 2,086,353 0 175,000 741,406 889,947 180,000 Expenses Personnel Costs 1,267,000 187,000 40,000 360,000 560,000 120,000 Professional Fees 37,000 Contract Services 10,000 10,000 Board Expenses 2,000 2,000 Staff Training 20,500 2,000 6,000 8,000 4,500 Activities & Supplies 118,000 Client Support 55,500 Telecommunications 15,000 1,000 500 4,500 6,000 3,000 Printing & Copying 15,000 1,000 3,000 4,000 4,000 3,000 Occupancy 200,000 29,527 6,314 56,835 88,382 18,942 Travel & Transportation 36,000 Insurance-Liability 2,900 2,900 Dues & Subscriptions 5,000 1,000 3,000 1,000 Annual Auction expenses 60,000 60,000 Fees & Licences 5,000 5,000 Depreciation 22,000 5,000 6,665 5,335 5,000 Miscellaneous 5,000 1,000 1,000 1,000 1,000 1,000 In-Kind Expenses 100,000 100,000 Sub-Total Expenses 1,975,900 277,427 123,814 637,000 765,217 172,442 Allocated Admin Costs (16.3%) -277,427 20,183 104,406 124,730 28,108 Total Expenses (including Admin Costs) 1,975,900 0 143,997 741,406 889,947 200,550 Net Revenue Over Expense 110,453 0 31,003 0 0-20,550

Exhibit 2 Organization B - Indirect cost rate of 65.8% TOTAL EXPENSES Programs A B C Admin Indirect Total Expenses: Salaries & wages $ 12,500 14,950 19,635 15,400 22,682 85,167 Employee benefits 1,875 2,243 2,945 2,310 3,402 12,775 Materials & supplies 3,300 6,000 895 1,400 7,210 18,805 Postage & shipping 500 1,035 3,675 1,682 1,934 8,826 Printing & publications 950 1,184 642 120 466 3,362 Telephone 1,672 1,724 1,126 2,418 922 7,862 Occupancy 0 0 0 0 27,600 27,600 Depreciation 0 0 0 0 1,688 1,688 Total direct expenses 20,797 27,136 28,918 23,330 65,904 166,085 Allocation of indirect costs 13,184 15,768 20,709 16,243 (65,904) 0 $ 33,981 42,904 49,627 39,573 0 166,085 1. The effective indirect cost rate = 65.8% [$65,904/($166,085 - $65,904)] 2. The administrative rate = 23.8% [$39,573/$166,085] 3. Indirect costs are allocated based on each cost center's direct salaries & wages as a percentage of total direct salaries and wages

Exhibit 5 Organization A - "Fully loaded" cost model TOTAL EXPENSES Direct Programs A B C Admin Indirect Total Expenses: Salaries & wages $ 18,613 19,500 23,347 18,557 5,150 85,167 Employee benefits 2,792 2,925 3,502 2,784 772 12,775 Materials & supplies 5,200 8,900 3,581 1,124 0 18,805 Postage & shipping 605 987 4,251 895 2,088 8,826 Printing & publications 1,000 1,355 756 201 50 3,362 Telephone 756 1,222 1,336 2,285 2,263 7,862 Occupancy 2,219 4,590 9,675 11,116 0 27,600 Depreciation 684 758 95 151 0 1,688 Total direct expenses 31,869 40,237 46,543 37,113 10,323 166,085 Allocation of indirect costs 2,112 2,667 3,084 2,460 (10,323) 0 Total direct & indirect costs 33,981 42,904 49,627 39,573 0 166,085 Allocation of admin costs 10,629 13,420 15,524 (39,573) 0 0 $ 44,610 56,324 65,151 0 0 166,085 1. The effective indirect cost rate = 6.6% [$10,323/($166,085 - $10,323)] 2. The administrative rate = 23.8% [$39,573/$166,085] 3. Indirect costs are allocated by applying rate (6.6%) to each cost center's total direct expenses [e.g., Program A: 6.6% X $31,869 = $2,112] 4. Administrative costs are allocated based on pro rata distribution of total direct & indirect costs of each program [e.g., Program A: $33,981 X ($39,573/($166,085 - $39,573)) = $10,629]

Exhibit 6 Organization A - Adjustment of fully loaded model for GAAP purposes TOTAL EXPENSES Programs A B C Admin Indirect Total Expenses: Salaries & wages $ 18,613 19,500 23,347 18,557 5,150 85,167 Employee benefits 2,792 2,925 3,502 2,784 772 12,775 Materials & supplies 5,200 8,900 3,581 1,124 0 18,805 Postage & shipping 605 987 4,251 895 2,088 8,826 Printing & publications 1,000 1,355 756 201 50 3,362 Telephone 756 1,222 1,336 2,285 2,263 7,862 Occupancy 2,219 4,590 9,675 11,116 0 27,600 Depreciation 684 758 95 151 0 1,688 Total direct expenses 31,869 40,237 46,543 37,113 10,323 166,085 Allocation of certain administrative costs 3,223 4,070 4,707 (12,000) 0 0 35,092 44,307 51,250 25,113 10,323 166,085 Allocation of indirect costs 2,326 2,936 3,397 1,664-10,323 0 $ 37,418 47,243 54,647 26,777 0 166,085 1. The effective indirect cost rate = 6.6% [$10,323/($166,085 - $10,323)] 2. $12,000 of administrative costs are allocated to programs based on total direct expenses [e.g., $31, 869 X ($12,000/($31,869+$46,543))=$3,223] 3. Indirect costs are allocated by applying rate (6.6%) to each cost center's total direct expenses after the allocation of selected administrative costs [e.g., Program A: 6.6% X $35,092 = $2,326]

Exhibit 7 Organization A - 5% cap on indirect costs that can be charged to Program A TOTAL EXPENSES Programs A B C Admin Indirect Total Expenses: Salaries & wages $ 18,613 19,500 23,347 18,557 5,150 85,167 Employee benefits 2,792 2,925 3,502 2,784 772 12,775 Materials & supplies 5,200 8,900 3,581 1,124 0 18,805 Postage & shipping 605 987 4,251 895 2,088 8,826 Printing & publications 1,000 1,355 756 201 50 3,362 Telephone 756 1,222 1,336 2,285 2,263 7,862 Occupancy 2,219 4,590 9,675 11,116 0 27,600 Depreciation 684 758 95 151 0 1,688 Total direct expenses 31,869 40,237 46,543 37,113 10,323 166,085 Allocation of 5% approved indirect cost cap 1,593 0 0 0 (1,593) 0 Total expenses of Program A reportable to contractor 33,462 Allocation of Program A's 1.6% excess 519 0 0 0 (519) 0 Allocation of remaining indirect costs 0 2,667 3,084 2,460 (8,211) 0 $ 33,981 42,904 49,627 39,573 0 166,085 1. $31,869 X 5% = $1,593 = maximum indirect costs chargeable to Program A 2. Total indirect cost rate remains 6.6% [$10,323/($166,085 - $10,323)]

Exhibit 8 Organization B - Multiple cost pools TOTAL EXPENSES Programs Indirect cost pools A B C Admin 1 2 3 Total Expenses: Salaries & wages $ 12,500 14,950 19,635 15,400 22,682 0 0 85,167 Employee benefits 1,875 2,243 2,945 2,310 3,402 0 0 12,775 Materials & supplies 3,300 6,000 895 1,400 7,210 0 0 18,805 Postage & shipping 500 1,035 3,675 1,682 0 1,934 0 8,826 Printing & publications 950 1,184 642 120 466 0 0 3,362 Telephone 1,672 1,724 1,126 2,418 0 922 0 7,862 Occupancy 0 0 0 0 12,589 15,011 0 27,600 Depreciation 0 0 0 0 0 0 1,688 1,688 Total direct expenses 20,797 27,136 28,918 23,330 46,349 17,867 1,688 166,085 Allocation of indirect costs 1 9,272 11,089 14,565 11,423 (46,349) 0 0 0 Allocation of indirect costs 2 6,497 3,249 4,872 3,249 0 (17,867) 0 0 Allocation of indirect costs 3 359 467 718 144 0 0 (1,688) 0 $ 36,925 41,941 49,073 38,146 0 0 0 166,085 FTEs 2.0 1.0 1.5 1.0 0.0 0.0 0.0 5.5 square footage utilized 500 650 1000 200 0 0 0 2350 1. Indirect cost pool 1: costs allocated to programs based on direct salaries and wages 2. Indirect cost pool 2: costs allocated to programs based on FTE 3. Indirect cost pool 3: costs allocated to programs based on squared footage

Exhibit 9 Organization A - Federal indirect cost proposal format - simplified allocation method TOTAL EXPENSES Programs Indirect A B C Fundraising Admin Total Expenses: Salaries & wages $ 18,613 19,500 23,347 0 23,707 85,167 Employee benefits 2,792 2,925 3,502 0 3,556 12,775 Materials & supplies 5,200 8,900 3,581 0 1,124 18,805 Postage & shipping 605 987 4,251 0 2,983 8,826 Printing & publications 1,000 1,355 756 0 251 3,362 Telephone 756 1,222 1,336 0 4,548 7,862 Occupancy 2,219 4,590 9,675 0 11,116 27,600 Depreciation 684 758 95 0 151 1,688 Total expenses 31,869 40,237 46,543 0 47,436 166,085 Less Direct Cost Adjustments: Materials & supplies (1,645) (2,499) (866) 0 0 (5,010) Alterations & Improvements (980) (1,210) 0 0 0 (2,190) Depreciation (684) (758) (95) 0 0 (1,537) (2,625) (3,709) (866) 0 0 (7,200) Less Indirect Cost Adjustments: Occupancy (interest) 0 0 0 0 (762) (762) Depreciation 0 0 0 0 (151) (151) 0 0 0 0 (913) (913) Reclassifications: Fundraising 0 0 0 4,263 (4,263) Public relations 0 0 0 2,044 (2,044) Membership administration 0 0 0 1,700 (1,700) 0 0 0 8,007 (8,007) $ 29,244 36,528 45,677 8,007 38,516 157,972 1. Indirect cost rate = $38,516($157,972 - $38,516) = 32.2%

Exhibit 10 Organization A - Federal indirect cost proposal format - direct allocation method TOTAL EXPENSES Programs Indirect A B C Fundraising Admin Total Expenses: Salaries & wages $ 18,613 19,500 23,347 4,390 19,317 85,167 Employee benefits 2,792 2,925 3,502 790 2,766 12,775 Materials & supplies 5,200 8,900 3,581 0 1,124 18,805 Postage & shipping 605 987 4,251 0 2,983 8,826 Printing & publications 1,000 1,355 756 0 251 3,362 Telephone 756 1,222 1,336 861 3,687 7,862 Occupancy 2,219 4,590 9,675 1,966 9,150 27,600 Depreciation 684 758 95 0 151 1,688 Total expenses 31,869 40,237 46,543 8,007 39,429 166,085 Less Direct Cost Adjustments: Materials & supplies (1,645) (2,499) (866) 0 0 (5,010) Alterations & Improvements (980) (1,210) 0 0 0 (2,190) Depreciation (684) (758) (95) 0 0 (1,537) (2,625) (3,709) (866) 0 0 (7,200) Less Indirect Cost Adjustments: Occupancy (interest) 0 0 0 0 (762) (762) Depreciation 0 0 0 0 (151) (151) 0 0 0 0 (913) (913) $ 29,244 36,528 45,677 8,007 38,516 157,972 1. Indirect cost rate = $38,516($157,972 - $38,516) = 32.2%

Exhibit 11 Organization A - Program A by funding source with multiple caps and limitations Gov't grant Private grant PROGRAM A General ops. Total Expenses: Salaries & wages $ 5,000 0 13,613 18,613 Employee benefits 0 0 2,792 2,792 Materials & supplies 2,600 0 2,600 5,200 Postage & shipping 0 605 0 605 Printing & publications 0 1,000 0 1,000 Telephone 115 0 641 756 Occupancy 400 0 1,819 2,219 Depreciation 0 0 684 684 Total direct expenses 8,115 1,605 22,149 31,869 Allocation of indirect costs 243 106 1,763 2,112 $ 8,358 1,711 23,912 33,981 1. Government grant caps salaries at $5,000, benefits and depreciation at 0, and indirect costs at 3% 2. Private grants pays only postage and shipping, and printing and publications, but accepts the 6.6% indirect cost rate

Exhibit 12 Organization A - Illustration of capital expenditures charged to a government grant Gov't grant Private grant PROGRAM A General ops. Fixed asset elimin Total Expenses: Salaries & wages $ 5,000 0 13,613 18,613 Employee benefits 0 0 2,792 2,792 Materials & supplies 2,600 0 2,600 5,200 Postage & shipping 0 605 0 605 Printing & publications 0 1,000 0 1,000 Telephone 115 0 641 756 Occupancy 400 0 1,819 2,219 Depreciation 0 0 684 684 Capital expenditures 10,000 0 0 (10,000) 0 Total direct expenses $ 18,115 1,605 22,149 (10,000) 31,869