Overview of Requirements

The following cost principles apply to Head Start grantee agencies:

• 2 CFR 230 for non-profit organizations;
• 2 CFR 220 for colleges or universities;
• 2 CFR 225 for local government organizations; and
• 48 CFR Part 31 for commercial organizations.

In general, the Federal cost principles permit a grantee agency to establish and use its own accounting system to determine costs, provided its system is based on sound accounting principles that are consistently applied to all organizational activities regardless of the source of funds supporting these activities. Although costs may be charged either as direct or indirect costs depending on their specific benefit to a project or program, such costs must be treated consistently for all work of the overall organization under similar circumstances in order to fairly distribute costs and avoid duplicate charges. To be allowable under an award, a cost must be reasonable and necessary for the performance of the project and be allocable to the award. Indirect costs are the shared costs incurred by an organization that may not be readily identifiable with a particular project or program but are necessary to the overall operation of the organization and the performance of its programs. Indirect costs are primarily administrative, such as the cost of a single organization-wide audit.

Common examples of indirect costs for Head Start grantees include

• General management - administrative salaries such as for the executive director, superintendent, president, vice-president, chief executive officer, etc.
• Fringe benefits applicable to administrative staff, and, occasionally, fringe benefits applicable to project staff.
• General organizational expenses - insurance, taxes, telephone expenses, legal services (including contracted services as well as agency staff who perform these duties), etc. Note: Child liability insurance might be classified as a direct program expense.
• Administrative services - personnel, administration, procurement, grant and contract administration, business office, accounting (including contracted services as well as agency staff who perform these duties), etc.
• Depreciation or use allowances on buildings and equipment.

In theory, all of these costs might be charged directly to each of the benefiting programs (by computing each program's fair share of the costs). However, practical difficulties frequently prevent grantees from using the direct cost allocation approach since it can become cumbersome and complicated. Instead, grantees may choose to group these costs into a common pool(s) and distribute costs through a different cost allocation process-the end product of which is an indirect cost percentage rate (or rates). This rate is then applied to individual grant award's base to determine the amount chargeable to each award for all the indirect costs in the pool.

The indirect cost rate(s) will be the ratio (percentage) between the indirect costs and a direct cost base. The direct cost base may be direct salaries or wages, direct salaries plus fringe benefits, or total direct costs excluding capital expenditures and other distorting items. A definition of the direct cost base (including the types and amounts of distorting items that will be excluded from the direct cost base) will be agreed upon as part of the approval process in establishing the grantee agency's indirect cost rate(s) and will be contained in the rate agreement.

A rate agreement is established on the basis of an indirect cost proposal submitted by grantee agencies to the appropriate cognizant agency. The Regional Division of Cost Allocation (RDCA) of the Department of Health and Human Services is cognizant for local governments and non-profit organizations that receive the majority of funds from HHS. The Department of Interior and individual state Departments of Education are responsible for Indian tribal organizations and school districts, respectively.

When the RDCA is cognizant, their approval is required for indirect rates for non-profit organizations. If non-profit organizations use other types of cost allocation procedures (CAP), approval from the RDCA is not required. However, the non-profit organization must develop these procedures in writing and they are subject to review by the regional office. Local governments must have a CAP or indirect cost rate on file. However, neither of them has to be approved by the RDCA. If an organization has a different cognizant agency, they still must have the indirect cost rate approved by that agency prior to claiming indirect costs to the Head Start/Early Head Start grant.

Indirect costs of a grantee agency may be charged to the Head Start grant based on the established rate. It is ACF policy to fully fund a grantee agency's requested indirect costs, if such costs are determined to be allowable and consistent with the Indirect Cost Negotiation Agreement. However, since some programs including Head Start have limits on the total amount of administrative costs that may be charged-Head Start has a 15 percent cap on administrative costs-this could preclude payment of all indirect costs if the rate is too high. In that situation, grantee agencies must find another funding source willing to pay the excess costs, or find a way to reduce the amount of their overall administrative costs. If a non-Federal funding source pays the excess indirect costs, that amount may be applied as a grantee agency's matching requirement, as long as the 15 percent limitation is not exceeded.

Clarifying definitions

Allocable cost means that the cost of an item can be allocated. The cost of an item is allocable to a particular grant program (such as Head Start) or other activity in accordance with the relative benefits that a program receives from the item. A cost is allocable to a Federal award if it is treated consistently with other costs incurred for the same purpose in like circumstances and if it

• is incurred specifically for the award;
• benefits both the award and other work and can be distributed in reasonable proportion to the benefits received; or
• is necessary to the overall operation of the organization even though a direct relationship to any particular cost objective cannot be shown.

Awarding agency means, for Federal Head Start grants, the Department of Health and Human Services (HHS) Administration for Children and Families (ACF).

Cognizant agency means the Federal agency responsible for reviewing, negotiating, and approving cost allocation plans or indirect cost proposals developed under the cost principles for Federal agencies. The Federal agency assigned cognizance is the one with the largest dollar value of awards with an organization. For Head Start grants awarded to non-profit organizations, this generally will be HHS/ACF.

Cost allocation plan means the plan developed by an organization receiving funding for more than one program, which enables them to fairly and equitably allocate the shared costs of the organization to each of its programs. (Some types of cost allocation plans include central service cost allocation plan, public assistance cost allocation plan, or indirect cost rate proposal.)

Cost objective means a function, organizational subdivision, contract, grant (such as a Head Start or Early Head Start grant), or other activity for which cost data are needed and for which provision is made to accumulate those costs.

Direct cost means those costs that can be identified specifically with a particular project, program or activity (i.e., a particular award, project, service, or other direct activity of an organization). A cost may not be assigned to an award as a direct cost if any other cost incurred for the same purpose, in like circumstances, has been allocated to an award as an indirect cost. (Plans for allocating direct costs are to be included as part of the annual refunding application. The ACF regional grants officer will review the types of costs to be treated as direct to ensure they are allowable and that they are not also included as indirect costs.)

Indirect cost means those costs that have been incurred for common or joint objectives and cannot be readily identified with a particular sponsored project, program or activity but are nevertheless necessary to the operations of the organization. For example, the costs of operating and maintaining facilities, depreciation, and administrative salaries are generally treated as indirect costs.

Indirect cost proposal is the documentation prepared by a recipient to substantiate its claim for the reimbursement of indirect costs. This proposal provides the basis for review, audit, and negotiation leading to the establishment of the organization's indirect cost rate(s).

Indirect cost rate means the ratio, expressed as a percentage, of an organization's total indirect costs to its direct cost base. Direct cost bases are normally the total direct costs less exclusions on salaries plus fringe benefits. When a rate is established for a specific activity or program, the rate represents the ratio of the total indirect costs allocated to the activity or program to the direct cost base costs of the activity or program.

Non-profit organization means any corporation, trust, association, cooperative, or other organization which

• is operated primarily for scientific, educational, service, charitable, or similar purposes in the public interest;
• is not organized primarily for profit; and
• uses its net proceeds to maintain, improve, or expand its operations.

Prior approval means securing the awarding agency's written permission, from the authorized granting official in advance to incur cost for those items that are designated as requiring prior approval by the applicable cost principles. If such costs are specifically identified in a Federal award document, approval of the document constitutes approval of the costs.

Narrative

Process for establishing indirect cost rates

A. Submission of Proposals

Indirect cost rates must be supported by the timely submission of an indirect cost proposal for each fiscal year in which the Head Start grantee agency claims such costs. Indirect cost proposals will be prepared in accordance with the applicable cost principles for each type of organization.

Specific guidance on the preparation and submission of indirect costs proposals is also provided in indirect cost guides for each type of organization, and may be obtained from the grantee's cognizant agency.

1. Initial Indirect Cost Rates - An organization that has not previously established an approved indirect cost rate must submit an initial indirect cost proposal to the cognizant agency, immediately after being notified that a grant providing for the reimbursement of indirect costs will be awarded by ACF. Where possible, this proposal should be submitted prior to the date the grant is awarded, but no later than three months after the effective date of the grant.
2. Rates for Subsequent Years - Grantee agencies that have previously established indirect cost rates must submit a new indirect cost proposal to the cognizant agency at the direction of that agency. The type of rate(s) reflected in the proposal and the fiscal year(s) on which the rate should be based will be governed by the specific circumstance involved for each grantee agency.

B. Regional Division of Cost Allocation (RDCA)

The HHS/RDCA will review the indirect cost proposal(s) submitted, and, based on these reviews, will negotiate appropriate indirect cost rates with the grantee agency. If an audit is deemed necessary, the RDCA will request the audit from the OIG Office of Audit or will request ACF review to ensure there is no duplication of costs.

Updated names, addresses and telephone numbers of the RDCA for each area can be found on the internet at: http://rates.psc.gov/fms/dca/map1.html.

C. Indirect Cost Negotiation Agreement

The results of each negotiation will be formalized in a rate agreement, called an Indirect Cost Negotiation Agreement, and will be signed by the appropriate cognizant agency official and an authorized representative of the grantee agency.

Each agreement will include the following provisions:

• The agreed upon rate(s) and information directly related to the use of the rate(s) (e.g., type of rate, effective period, direct cost base, etc.).
• The treatment of fringe benefits as either direct or indirect costs.
• General terms and conditions of the agreement.
• Special terms and conditions of the agreement, if any (e.g., the direct charging of a type of cost that is normally treated as indirect by other grantee agencies).

D. Disputes

If the RDCA is the cognizant agency, disputes arising in the negotiation of indirect costs rates will be resolved at the HHS regional office level in accordance with the informal appeals procedures described in the Department's indirect cost appeals regulations (45 CFR Part 74.90).

Disputes that cannot be resolved at the HHS regional office level will be resolved in accordance with the procedure contained in the Department's grant appeals regulations (45 CFR Part 16). This involves an appeal to the HHS Departmental Appeals Board (DAB).

E. Special Procedures for Local Governments

Local Government Agencies (other than local education agencies) are not required to submit their indirect cost proposals unless they are specifically requested by the cognizant Federal agency. But they must nevertheless substantiate their claims in order for indirect costs to be paid with Head Start grant funds. This substantiation must be in the form of an indirect cost rate computation for each fiscal year in which indirect costs are claimed. The computation along with the supporting documentation must be available as of the time the claim is made and must be retained by the local government agency for possible audit by, or on behalf of, HHS. Guidance on substantiation of their claims may be found in an informational brochure applicable to local governments that may be obtained from the Division of Cost Allocation responsible for the HHS region in which the grantee agency is located.

F. Special Procedures for Local Education Agencies

Local education agencies (LEA) will receive their indirect cost rates from their State departments of education. The State department of education will be responsible for negotiating appropriate rates with each school district or LEA in conformance with special agreements entered into between the Federal Department of Education and each State.

G. Negotiation Cognizance Assigned to Other Federal Agencies

When a Federal agency, other than HHS has been assigned indirect cost negotiation cognizance, for an institution of higher education, a local government agency, or an Indian tribal organization, the grantee agency must submit its indirect cost rate proposals and establish its rates with the cognizant agency in accordance with the policies and procedures of that agency.

Process for applying indirect cost rates

The dollar amount of indirect costs applicable to a grant or subgrant-supported project will be determined by multiplying the appropriate indirect cost rate(s) by the direct cost base of the program.

For example, say an indirect cost rate of 5% has been approved for the community action agency, with a direct cost base that was determined to be salaries and fringe. Then, to determine the Head Start portion, they would multiply the total of all the Head Start salaries and fringe benefits by 5%, and that would be the maximum allowable amount of Head Start's share of the indirect costs.

In applying indirect cost rates to individual grants, the rates established for the periods in which the direct costs are actually incurred under the grants will be applied to those costs. Consequently, when a grant budget period does not coincide with the grantee agency's fiscal year, it is necessary to use two rates in computing the amount of indirect costs applicable to the grant (i.e., the rates established for the two fiscal years during which the grant was performed).

Audit Requirements

Under the Single Audit Act, and OMB Circular A-133, auditors are required to assess internal control and compliance. In the area of indirect costs, this includes assessing whether the grantee agency fairly allocated shared costs, such as costs attributable to common or joint use of facilities or services, among all the various programs that utilized them, and in accordance with the applicable cost principles.

To accomplish this, the auditor will likely review the grantee agency's cost allocation plan and Indirect Cost Negotiation Agreement to determine whether costs were treated consistently as either direct or indirect costs, and whether the shared costs were allocated equitably and fairly to every benefiting program. The auditor will also likely determine whether costs were charged to each benefiting program in accordance with the cost allocation plan and Indirect Cost Negotiation Agreement. However, since not all auditors perform their reviews in exactly the same way, the grantee agency may want to stipulate in the audit contract that the audit is to include assessment of the process and allocation of indirect costs.

The most frequent audit findings in this area are

• not allocating shared costs to all benefiting programs;
• not obtaining a new indirect cost rate annually;
• continuing to use a rate that is no longer in effect;
• not revising the cost allocation plan or indirect cost proposal to include the addition or loss of programs; and
• not maintaining supporting documentation.