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Financial Management

Division of Cost Allocation

REVIEW GUIDE FOR
STATE AND LOCAL GOVERNMENTS
STATE/LOCAL-WIDE CENTRAL SERVICE COST ALLOCATION PLANS
AND INDIRECT COST RATES

U.S. Department of Health and Human Services Division of Cost Allocation

(DATED 1/31/00)

STATE AND LOCAL GOVERNMENTS

STATE/LOCAL-WIDE CENTRAL SERVICE COST ALLOCATION PLANS
AND INDIRECT COST RATES

TABLE OF CONTENTS

  1. Introduction

  2. Preliminary Review

    1. General

    2. Reconciliation of Proposal To Financial Statements

    3. Trend Analysis

    4. File Documentation

    5. Reference Material

  3. State-Wide Cost Allocation Plans
    1. Section I Costs
    2. Section II Costs
      1. Internal Service Funds
      2. Self-Insurance Funds
      3. Fringe Benefits
  4. Indirect Cost Rates
  5. Attachment A - Reconciliation of Retained Earnings Sample Formats

I. INTRODUCTION

This review guide was developed to assist Division of Cost Allocation (DCA) staff in reviewing and negotiating state-wide cost allocation plans and indirect cost rates for state, local and Indian tribal governments. The guide includes suggestions, facts and concerns that should be considered in planning and conducting reviews of proposed state-wide cost allocation plans and indirect cost rates. Alternative approaches and allocation methods are considered and discussed in detail. The development of billing rates for internal service funds and other interagency services is also discussed at length. Although the guide is intended to be reasonably detailed and comprehensive, it is not a substitute for professional experience and judgment. DCA staff should consider the complexity of the proposal, the level of Federal reimbursement, and prior experience with the governmental unit when planning his/her review.

The Office of Management and Budget (OMB) has issued cost principles for all Federal agencies that award grants and contracts to state and local (including tribal) governments. OMB Circular A-87 (A-87) establishes cost principles for determining costs applicable to those grants and contracts. A-87 contains general principles for determining allowable costs, both direct and indirect. It also contains information and guidance concerning the development and submission of state-wide cost allocation plans, indirect cost rates and public assistance cost allocation plans. This document addresses the review and negotiation of state-wide cost allocation plans and indirect cost rates. Guidance with regard to public assistance cost allocation plans will be provided in a separate issuance.

A-87 was originally issued in 1969, with a number of revisions since that time. In 1995, A-87 was completely updated and reissued including expanded guidelines in a number of areas which had produced conflicts and confusion during the preceding 25 years. Among the changes to A-87 were increased documentation requirements for salaries and wages, expanded allowability of certain interest expenses and clarification of policies with regard to pension and post-retirement health benefits. Of particular significance was the new requirement for extensive documentation in support of internal service funds, self insurance funds, and fringe benefits. It also included, for the first time, a special attachment dealing specifically with public assistance cost allocation plans. The changes to A-87 are, in part, the reason this guide has been prepared.

The objective of A-87 is to provide specific and consistent principles and standards for determining costs of Federal awards carried out through grants, cost reimbursement contracts, and other agreements with governmental units. These principles are for the purpose of cost determination and are not intended to dictate the extent of federal reimbursement for a program or project. There is a basic assumption that governmental units are responsible for the efficient and effective administration of Federal awards, and A-87 does not attempt to impose specific organization or management techniques to assure proper and efficient administration of Federal awards. The reviewer should keep these basic concepts in mind when drawing conclusions about the allowability of costs assigned to Federally financed activities.

A-87 contains five (5) attachments: Attachments “A” and “B” address allowable costs and include specific guidance on various selected costs; Attachment “C” provides information related to state/local-wide central service cost allocation plans; Attachment “D” relates to public assistance cost allocation plans; and Attachment “E” deals with indirect cost rate proposals. As previously noted, this guide will provide DCA staff with recommended review procedures for state/local-wide cost allocation plans and indirect cost rate proposals. Public assistance cost allocation plans are dealt with in separate documents.

In addition to A-87, the Department of Health and Human Services (HHS), in coordination with OMB, has developed an implementation guide for A-87 entitled, “A Guide for State, Local and Indian Tribal Governments” (ASMB C-10). The ASMB C-10 is intended to assist governmental units in applying the principles and standards contained in A-87. It was issued in April, 1997 by the HHS Office of Audit Resolution and Cost Policy in accordance with the mandate contained in A-87. ASMB C-10 provides clarification and procedural guidance to implement the provisions of A-87, and will also provide the reviewer with answers to many of the issues concerning cost policy not specifically addressed in A-87 itself.

II. PRELIMINARY REVIEW
A. GENERAL REVIEW

STEPS COMMENTS
  1. Determine whether the proposal package is The proposal package should include: complete; in sufficient detail to permit an adequate review; and is in a format that can be readily C followed by the reviewer.
  • The proposal itself, including detailed schedules on the composition and allocation of all allocated, billed or indirect cost centers.
  • A copy of the state’s Comprehensive Annual Financial Report (CAFR) and any other financial records supporting the amounts included in the proposal.
  • A detailed and understandable reconciliation of the costs included in the proposal to the state’s official accounting records and/or the CAFR.
  • An explanation of any significant increases in individual cost centers or rate components. (e.g. a proposed central service or significant indirect cost rate component that is more than 10% higher than the level negotiated for the prior year).
  • A computation of the actual/estimated Federal Financial Participation (FFP) for each applicable agency with Federal funds.
  • Any other information specifically requested by the DCA as a condition of prior negotiation agreements
  • A signed Certificate of Cost Allocation Plan or Certificate of Indirect Costs as required by A-87, Attachment A, Section H.
  • Justification for deviations from the standard allocation bases prescribed by A-87.
  1. Review the prior negotiation workpapers and determine the following:
    1. When was the last on-site review conducted?
    2. Were there any findings/recommendations contained in the most recent A-133 audit report that should be considered in the current review?
    3. Review negotiation adjustments and insure corrections were included in the current proposal.
    4. Did the negotiation agreement contain any conditions? If so, has the grantee complied with those conditions?
    5. If fixed rates/amounts were negotiated, does the carry-forward amount in the current proposal agree with the prior written carry-forward agreement?

 







Review the Audit Clearance Document to determine if agreed adjustments have been included in the proposal.



If the corrections were not made, or conditions were not fulfilled, appropriate adjustments should be made.

 

  1. By comparing the submission with prior negotiations, identify any aspects of the proposal which appear out-of-line and are not fully explained or discussed in the proposal package.
  1. Determine the areas of the proposal that appear to require an in-depth review and/or an on-site review.
On-site reviews are usually required for state-wide cost allocation plans and indirect cost proposals from agencies that receive substantial Federal funding.
  1. Determine if the grantee is proposing any cost/rate increases beyond those based on historical costs.
Proposals which include projected costs usually require a more detailed review. See separate sections of this guide for a more thorough discussion of projected cost increases.
  1. “Test-check” the mathematical computations to ensure their accuracy.
These verifications and the extent to which the verifications were made should be noted on the proposal, workpapers, etc.

B. RECONCILIATION OF PROPOSAL TO THE FINANCIAL STATEMENTS

Costs included in the cost allocation plan or indirect cost rate proposal must ultimately be reconciled to the state’s Comprehensive Annual Financial Report (CAFR) or other official accounting records. The reconciliation process will generally require the use of detailed accounting records such as appropriation statements or similar budget and expenditure documents. These documents are the official accounting records of the state/locality and are the source of the expense information contained in the CAFR. The information in these statements should provide the necessary information to determine that cost have been properly categorized as allowable or unallowable. The reconciliation should be part of the proposal and the proposal is incomplete without it.

STEPS COMMENTS
  1. Reconcile the proposal to the CAFR and/or other official accounting records.
Total costs for each agency should be reconciled first to the Statement of Appropriations or similar document. These documents are the source of the expenditure information included in the CAFR. In many cases the amount reported in the CAFR will be the sum of a number of appropriation accounts and may include reclassifications or other adjustments. A careful examination of these accounts is necessary to insure that all appropriate costs have been included in the proposal. It will also enable the negotiator to identify any unallowable or unallocable costs.
  1. Once the negotiator is assured that the costs included in the proposal agree with the CAFR/appropriation statements, adjustments for unallowable or additional costs should be examined for appropriateness.
Refer to A-87, Attachment B, for a discussion of allowable and unallowable costs. Additional costs not recorded on the books of account, such as “use allowances”, must be reviewed for adequate support. Additional information regarding the reconciliation and verification of costs included in the proposal is contained in sections of this guide dealing with specific types of rate/cost allocation proposals.

C. TREND ANALYSIS

A trend analysis of the costs, rates, and allocation bases should be performed during the preliminary review for all state/local-wide cost allocation plans and for those indirect cost rates where significant federal funds are involved. A trend analysis can be completed in a short time and may provide the negotiator with insight into the areas of the proposal needing a more detailed review.

STEPS COMMENTS
  1. Complete a detailed trend analysis of the cost pools, allocation bases, and indirect cost rates as appropriate. The analysis should compare costs for a minimum of three (3) years.

There are a variety of areas in which a trend analysis may be useful. For cost allocation plans, both the costs being allocated and the bases used to allocate the costs should be considered. This will allow the negotiator to determine not only cost centers with significant increases, but also important shifts in the allocation of those costs among various benefitting agencies. In indirect cost rate proposals it is critical to analyze changes in both the indirect cost base and the indirect cost pool. Finally, the trend analysis will identify new cost centers included in the proposal.

More guidance on trend analysis as it relates to specific types of proposals is contained in later sections of this guide.

  1. Evaluate the state’s justification for any significant changes or additions.
If the state has not included the required justifications the negotiator should request them immediately.

D. FILE DOCUMENTATION

The negotiation workpaper files should contain sufficient documentation (e.g. file notes, schedules, interview/meeting notes, etc.) to clearly show:

  • What aspects of the proposal were reviewed.
  • What portions of the proposal were not reviewed and why.
  • What adjustments were made to the proposal, the reasons for the adjustments and supporting computations.
  • How the approved rates/costs were computed and negotiated.
  • How any cost savings were computed.
  • Required certifications

E.  REFERENCE MATERIAL

  • OMB Circular A-87, “Cost Principles for State, Local and Indian Tribal Governments”
  • OMB Circular A-102, “Grants and Cooperative Agreements with State and Local Governments”
  • OMB Circular A-133, “Audits of States, Local Governments, and Non-Profit Organizations”
  • ASMB C-10, “A Guide for State, Local and Indian Tribal Governments”
  • Grants Administration Manual/Grants Policy Directives
  • 45 CFR Part 16, “Procedures of the Departmental Grants Appeals Board”
  • 45 CFR Part 74, “Uniform Administrative Requirements for Awards and Subawards to Institutions of Higher Education, Hospitals, Other Nonprofit Organizations, and Commercial Organizations; And Certain Grants and Agreements with States, Local Governments and Indian Tribal Governments” - Departmental Implementing Regulations for OMB A-110
  • 45 CFR Part 92, “Uniform Administrative Requirements for Grants and Cooperative Agreements to State and Local Governments” - Departmental Implementing Regulations for OMB A-102

Internet Sites:

  1. OMB Circulars - www.whitehouse.gov/omb/grants/index.html
  2. GASB Statements - www.rutgers.edu/Accounting/raw/gasb/st/summary
  3. FASB Statements - www.rutgers.edu/Accounting/raw/fasb/st/summary
  4. HHS Cost Policy Issuances (including ASMB C-10) - www.hhs.gov/progorg/grantsnet
  5. CFR Sections - www.access.gpo.gov/nara/cfr/index.html
  6. DAB Decisions - www.hhs.gov/dab/index.html
  7. Actuarial Standards of Practice - www.actuary.org/standard.htm

See separate sections for specific reference material related to individual areas.

III. STATE-WIDE AND LOCAL COST ALLOCATION PLANS

Most governmental units provide certain services, such as motor pools, computer centers, purchasing, accounting, etc., to operating agencies on a centralized basis. Since Federally supported awards are performed within the individual operating agencies, there needs to be a process through which these central service costs can be identified and assigned to benefitting activities on a reasonable and consistent basis. The central service cost allocation plan (commonly referred to as the state-wide cost allocation plan or SWCAP and for local governments, LOCAP) provides that process.

A. SECTION I

The allocated costs of the central service cost allocation plan are commonly referred to as “Section I” costs. These central service costs are allocated to benefitting operating agencies on some reasonable basis (e.g., number of warrants issued, number of employees) - not on a fee-for-service basis.

STEPS COMMENTS
SECTION A - PRELIMINARY STEPS
  1. Determine that the plan is accompanied by all required supporting documentation:

  1. A certification by the State Budget Officer or other authorized state official as required by A-87.

  2. The state’s official financial statements.

  3. An organization chart that shows the state-wide organizations rendering services, all the state departments/ agencies receiving the services, and all the departments/agencies not receiving the services.

  4. Exhibit A in an electronic file.

Where a local-wide cost allocation plan is being negotiated, the word “state” should be read as “local” for this step and all subsequent steps.

The documentation required to support the plan may vary depending on the circumstances involved in the negotiation. The items listed here are considered to constitute the minimum documentation necessary to permit an evaluation of the plan.

Only changes to the organizational structure need to be submitted after the initial organizational chart has been submitted.

Lotus or Excel is preferred but an ASCII file is acceptable. See Section D, Concluding Step 4.

  1. Determine whether the plan, as a minimum, contains:

    1. The nature of the services provided and their relevance to Federal grants and contracts.
    2. The items of expense included in the central service costs.
    3. The methods used in distributing the costs.
    4. Identify both state departments/agencies rendering the services and those receiving the services.
    5. A summary schedule showing the allocation of each service to the specific benefitted agencies.
  1. Coordinate the negotiation with interested Federal agencies.
Federal agencies interested in participating in a negotiation will notify the negotiator. In these cases, the interested agency should be notified upon the receipt of a proposal or audit report on the organization and asked to advise the negotiator of any factors that should be taken into account in the negotiation. If the Federal agency has not received a copy of the proposal or audit report, the negotiator should send (or arrange for the state or audit agency to send) a copy of the document to the agency.

If a formal negotiation is deemed necessary, the agencies which expressed an interest in participating in the negotiation should be invited to send a representative to the pre-negotiation conference as well as to the formal negotiation conference. If an agency does not wish to send a representative to either of these two conferences the negotiator will act on behalf of that agency.

After the negotiation is concluded and an agreement issued, a copy of the agreement will be distributed to other Federal agencies as part of the normal responsibility for the distribution of agreements.

  1. Review negotiation agreements, cost allocation plans, correspondence, and workpapers applicable to prior years to determine:

    1. Whether the state has complied with the terms and conditions of the prior negotiation related to the development of future cost allocation plans.
    2. Whether the “carry-forward” amount was correctly computed and included as part of the plan (if central service costs were approved on a “fixed” basis in prior years).
    3. What adjustments were made in the prior year’s negotiation.
In prior negotiations, advance agreements may have been established for future negotiations to preclude disputes or problems or to help insure equitable cost determinations in the future. Examples of such agreements include those involving the performance of special studies or refinements in allocation bases, the treatment of certain types of costs, changes in the state’s accounting system.
  1. Review the organization chart and the amount of Federal grant/contract costs incurred by each organization receiving the central services to determine the services which should be most thoroughly evaluated because of their ultimate impact on grant/contract costs.
  1. Complete a trend analysis of the cost pools and allocation bases.
For the analysis of the allocation bases, select high Federal subvention agencies to determine if the percentage of costs allocated to these agencies has changed. The state needs to account for any significant increases.
  1. Obtain a copy of the A-133 Single Audit report. Determine if there are any audit findings that effect the scope of the review.
If the applicable A-133 Single Audit report has not been issued, review the most recent audit report.
  1. Determine the appropriate level of negotiation effort and whether or not a HHS audit is needed.

Final determination on these matters may not always be possible at this point. However, they should be made as early in the negotiation process as possible.

If the negotiator concludes that an audit is necessary, he/she needs to identify the specific areas which the negotiator feels are critical to the determination of the reasonableness of the proposal and which cannot be satisfactorily evaluated without an on-site audit review. A special audit request should be sent to the Regional Audit Director. The request should indicate the specific reason(s) why the audit is needed and should include the negotiator’s recommendations on the scope of the audit. If an audit is conducted, the negotiator should discuss the scope of the audit with the auditor to determine whether the specific areas of the proposal are being adequately covered during the audit, The negotiator should not duplicate the work being performed by the auditor.

  1. If an audit is not to be conducted, reconcile the plan to the state’s financial statements or other financial documents used to support the plan.
If the amounts do not reconcile and if they cannot be readily reconciled via telephone, the state should be requested to submit additional data.

SECTION B - REVIEW OF COSTS

STEPS COMMENTS
  1. Determine whether all central services (allocated and billed) are accounted for by Sections I and II of the plan.
To assure that duplicate charges do not occur, the plan must account for all central service costs, including those which are billed to the user departments/agencies and institutions (e.g., state hospitals or universities).
  1. Determine if any new allocated central service costs were added.
Review the justification for including the item as a Section I cost.
  1. Determine whether the costs included in the plan appear to be allowable, reasonable and allocable to Federal awards.
For definitions of cost allowability, reasonableness and allocability, refer to A-87, Attachment A, Part C, 1-3.
  1. Determine that applicable portion of the costs of department/agency heads and their immediate staff are excluded from the plan, if there are any unallowable functions reporting to them.
  1. Determine whether the central services costs in the plan exclude the following unallowable costs: 
    1. Alcoholic beverages (4.)
    2. Bad debts (7.)
    3. Contingencies (12.)
    4. Contributions and donations (13.)
    5. Entertainment (18.)
    6. Equipment and other capital expenditures (19.)
    7. Fines and penalties (20.)
    8. Fund raising (21. a.)
    9. General government expenses (23.)
    10. Investment management (21. b.)
    11. Legal expenses for prosecution of claims against the Federal government (14. b.)
    12. Lobbying (27. & 30. e.)
    13. Underrecovery of costs under Federal agreements (42.)
The numbers next to each item refer to the section number in A-87 which prescribe the handling of these costs. Unless otherwise noted, the references refer to Attachment B of A-87.
  1. Review the following costs to determine whether they have been treated properly in the cost allocation plan:

    1. Depreciation or use allowances:
      1. Determine that the value of the assets for depreciation/use allowances purposes was properly established.
      2. Determine that cost of land and the portion of assets that are Federally financed or financed with grantee matching contributions have been eliminated from the computation.
      3. Determine that a combination of the depreciation and use allowance methods have not been used for a single class of fixed assets.
      4. If depreciation is proposed, determine that the depreciable lives that have been established are reasonable.
      5. Determine that the depreciation methods used result in an equitable allocation of costs to the time periods in which the assets are used.
      6. Determine that the charges for use allowances or depreciation are adequately supported by property b. Rental costs records.
      7. If use allowances are proposed, determine that a factor no greater than 6 2/3 percent has been used for equipment and 2 percent has been used for buildings.
    2. Rental costs

The value for depreciation/use allowances purposes is acquisition cost. This cost should reflect the actual amount recorded in the records of the state or, if cost records do not exist, an estimate of the acquisition cost, which is usually based on an independent and professional appraisal. Where such appraisals are used, care should be exercised to insure that the amount used reflects the cost at the time of purchase and not replacement cost at the time of the appraisal.  Where depreciation or use allowances are material in amount the negotiator should satisfy himself that the valuation bases are proper and, if the amounts are based on appraisals, that such appraisals were performed by independent and professional appraisers or by other reliable methods (e.g., insurance valuations).

In the absence of historical usage patterns, guidance in this area can be found in A-87, Part B, Paragraph 15, e. or IRS depreciation guidelines.

Depreciation methods other than the straight line method should not be accepted unless the circumstances fully justify their use (i.e., when it can be demonstrated that assets are being consumed faster in the earlier years than in the latter years of their useful lives).

When the depreciation method is followed, depreciation records indicating the amount of depreciation taken each period must also be maintained.

Refer to A-87, Attachment B, Part 38, for limitations on the amount of rental costs that may be charged to Federal awards under various types of leasing arrangements (e.g., sale and leaseback arrangements, less-than-arms-length leases or capital leases). Also refer to Chapter 6-10 of the Grants Administration Manual.
  1. Determine whether the central service costs which are allocated in the plan properly exclude the “general cost of government.”
The “general costs of government” are not explicitly defined in A-87. They have been construed, however, to include the general costs required to carry out the overall responsibilities of the state or local unit of government. The principle examples of these costs are those incurred in operating the governor’s office and those incurred in operating state/local legislative bodies. This does not preclude the recovery of special, identifiable expenses incurred pursuant to the administration of Federal grants/contracts in one of these normally unallowable activities.
  1. Determine whether the central services included in the plan benefit Federal awards.
Unless specifically unallowable, central services benefit Federal programs if they benefit the program directly or if they are necessary for the overall operations of departments/agencies performing the programs.
  1. Determine whether appropriate consideration was given to any “applicable credits” in the determination of the expenses included in the plan.
Income generated by activities conducted by the state agencies providing central services and certain negative expenditure types of transactions should be used to off-set or reduce expense items (e.g., sale of scrap and publications, parking fees, cafeteria income, purchase discounts and rebates, etc.).

SECTION C - REVIEW OF COST ALLOCATION METHODS

The central service costs are normally distributed on a number of different bases dependent upon the element of cost being distributed. This area is critical to the propriety of the plan. The negotiator, therefore, should thoroughly analyze the bases to determine whether their use results in an equitable distribution of costs to the benefitting activities.

STEPS COMMENTS
1. Determine whether the bases chosen by the state are appropriate for allocating each central service. Any method of distribution which will produce an equitable distribution of the cost can be used. In selecting one method over another consideration should be given to the additional effort required to achieve a greater degree of accuracy. Suggested bases are shown in Part 4.6.2 of the Guide for State, Local and Indian Tribal Governments (ASMB C-10).

2. Determine whether the proposed bases include all activities which benefit from the central services being allocated, including all departments/ agencies benefitting from the services, and where appropriate:

  1. Activities associated with general funds
  2. Activities associated with restricted, special purpose, or other funds
  3. Grants and contracts
  4. State institutions (e.g., hospitals, universities)
  5. Costs used for cost sharing or matching purpose
  6. Non-state organizations which receive services (e.g., an affiliated foundation, a local government agency, etc.)
3. Determine whether the data included in the bases (e.g., square footage, number of employees, time studies, etc.) are current and accurate.
4. Determine that activities supported by “flow-through” funds have been properly treated. In some state department/agencies, notably Departments of Education, the state acts mainly as a conduit of certain grant funds which “flow through” the state to local units of government and, in some cases, to other types of organizations (e.g., universities, non-profit institutions, etc.). In such cases, the activities supported by the funds generally do not receive central services from the state and, therefore, should normally be excluded from the base(s) used to allocate the central service costs.
5. If the proposed base is state operating expenditures, determine if recipient payments are excluded. Inclusion of recipient payments (e.g., financial assistance, food stamps or medical vendor payments) in the base will distort the distribution of costs to benefitting departments/agencies.

SECTION D - CONCLUDING STEPS

STEPS COMMENTS
1. Determine whether there are any significant anticipated changes in the state’s operations (e.g., organization structure, accounting system, etc.) that should be take into account in negotiating provisional or fixed central service costs. Normally these costs should be based on the actual costs for the state’s most recently completed fiscal year. However, if the state anticipates significant changes in its operations that would affect the costs, the state would be permitted to use appropriated budget amounts which reconcile to official documents.
2. Determine whether an advance agreement covering future  negotiations should be established. Advance agreements should be established when they are needed to preclude future disputes or problems or when they will help insure equitable cost determinations in the future.  Examples of areas where these agreements may be needed include (a) the performance of special studies or analyses in the development of future plans, (b) changes or refinements in allocation bases, (c) the treatment of certain types of costs, (d) changes in the state’s accounting system, etc. If an advance agreement is established it should be included in the letter transmitting the Negotiation Agreement.
3. Complete Summary of Negotiation. A summary of negotiation should be prepared which shows the amounts negotiated that are different from the amounts submitted, and the reasons for the negotiated differences. The summary should be sufficiently detailed to permit an independent reviewer to quickly see and understand how the negotiated amounts were arrived at.
4. Transmit the electronic file of the negotiated Exhibit A to DCA - Washington DC headquarters. The SWCAP information will be made available to Federal agencies through the government’s intranet.

B. SECTION II COSTS

The billed costs of the central service cost allocation plan are commonly referred to as “Section II” costs. These central service costs include internal service funds, self-insurance funds and fringe benefit funds.

1. INTERNAL SERVICE FUNDS

The internal service funds (ISFs) and other billed services (e.g., general fund revolving fund/accounts) might include billings for:

  • Services provided, e.g., ADP, Motor Pool, etc.
  • Payments made centrally and charged to departments based on established allocation percentages, e.g., telephone costs based on the number of instruments, utility costs based on square footage.
  • Supplies requisitioned at inventory cost plus a mark up for administrative cost.

STEPS COMMENTS
SECTION A - PRELIMINARY STEPS

1. For each ISF or similar activity with an operating budget of $5 million or more, determine whether the plan contains:

  1. A brief description of each service.
  2. A financial report balance sheet.
  3. A revenue/expense statement with revenues broken out by source (e.g., regular billings, interest earned, etc.).
  4. A listing of all non-operating transfers (as defined by GAAP) into and out of the fund.
  5. A description of the procedures (methodology) used to charge the costs of each service to users, including how billing rates are determined.
  6. A schedule of current rates.
  7. A schedule comparing total revenues (including imputed revenues) generated by the service to the allowable costs of the service under A-87, with an explanation of how variances will be handled.
  8. A schedule of billing services (by user and consist of all revenues, including unbilled, uncollected and imputed revenues).
Although the documentation is required by A-87 for those ISFs with operating budgets of $5 million or more, the negotiator has the option of requesting any of the information for ISFs with operating budgets less than $5 million. This is applicable when reviewing smaller state governments.

ASMB C-10, Section 4.7 requires a schedule for all funds, including those under $5 million. For example formats, see Attachment A. Other formats may also be acceptable.

See ASMB C-10, Illustration 4-6 for an example.

2. Ensure that all ISFs are identified by reviewing:

  1. Internal Accounting Manuals
  2. Financial Statements (Certified, Internal, other)
  3. Budget Documents
  4. Discussions with appropriate state/local personnel

 

Data on ISFs should have been submitted from the entity in accordance with A-87. The negotiator should be aware that requirements are also applicable to activities that function like ISFs but are not formally setup as an ISF. 

The financial statements may only indicate in sub-schedules the existence of centralized service accounts but reviews of accounting manuals and discussions with appropriate state/local personnel would be required to identify all ISFs. Discussions will also highlight areas where functions are "Memo Billed.”

3. Review all ISFs to identify:

  1. Those that are central service versus those of an operating department.
  2. The specific nature of the central service function.
  3. All potential users.
  4. Those with potential Federal recoveries.

 

A Department of Corrections may run a farm, operate a laundry, build furniture, etc., for which ISF was established. A Department of Health may charge out for laboratory services. Responsibility for review of these funds should be the cognizant Federal agency for state/local department providing the services.

This can be a direct charge to a Federal program, an overhead account at the operating department level or a charge to a Section I central service function which is subsequently allocated to Federal programs.

4. Obtain copy of the latest audit to identify departments/agencies with Federal funds and potential problem areas. This would include:

  1. A-133 Single Audit or other independent audits
  2. HHS OIG Audits
  3. State Internal Audits

 

If there is no audit, the negotiator should be alerted to the fact that there may not be a complete tracking of sales and related accounts receivable. Potential problems may be that charges are based on revenue received rather than charges for total usage of the services provided.

5. For new ISFs, discuss with appropriate state/local personnel to determine:

  1. When the fund was first established.
  2. How the fund was initially funded (capital transfer, etc.).
  3. Existence of external and/or internal financial statements.
  4. Manner in which services are charged out, i.e., billing rate system or recorded cost procedures.

 

Billing rate steps are described in Section B. 1. below and cost procedures steps described in Section B. 2.

SECTION B - REVIEW OF BILLING MECHANISMS

Normally under a billing rate system, a formal schedule of user rates is published and used for charging purposes; whereas under cost allocation procedures, the actual cost of the period (e.g., monthly, quarterly) are charged out to the users of the service during the respective periods on the actual allocation statistics for the period.

STEPS COMMENTS

1. Review billing rate system

  1. Review current billing rate schedule of charges and obtain support for rates to determine if data is current and accurate, and unallowable costs are excluded.
  2. Determine whether the rate provides for all costs, e.g., fringe benefits, SWCAP, etc.
  3. Review the schedule of billings by user to determine if all users (including outside the governmental entity) are billed, as well, as billed the same rate for the same service. Also, ensure that there are no differences in billing state and non-state functions.
  4. Determine that serviced departments are not overbilled because of another department’s underbilling.
  5. Identify procedures followed by service and serviced departments where billings exceed original appropriated amounts.
  6. Review rate base to determine whether it equitably distributes the cost of the service
  7. Determine if past profit/loss is properly treated.

Federal funds are usually billed upon usage of specific service with funds transferred at that point from the Federal program to the ISF. State funds may be handled in the same manner or the entire funds appropriated to operating departments may be transferred to the ISF at the beginning of the state year setting up payable/receivable amounts in their respective accounts. Under the latter approach, the billings to state programs during the year only result in reductions to payable/receivable accounts.

A problem consistent with the billing method is that the
billing rate may provide for replacement of assets rather
than depreciation on existing equipment.

Cars can be purchased directly under Federal awards.
The consistency principle must be applied where the
same department is being billed from a central motor
pool.

As a general rule, separate billing rates for Federal
programs should not be required from those that a state
uses for its own purposes.

The review should address the need for multiple rates.
In addition, outside expertise may be needed (e.g., ADP reviews).

 
NOTE: Once a billing rate system is established and approved, it should be selectively reviewed in the future to be satisfied that the system is working as intended.

2. Review cost allocation procedures

  1. Review the method used to bill out the cost.
  2. Determine the composition of cost. The data should be current and accurate, and unallowable costs excluded.
  3. Determine if all users are charged on the same basis.
  4. Determine that serviced departments are not overbilled because of another department’s underbilling.
  5. Identify procedures followed by service and serviced departments where billings exceed original appropriated amounts.
  6. Review charge out base (i.e., allocation statistics) to determine whether it equitably distributes the cost of the service provided.

 

Under this approach, costs are charged out on a periodic basis, e.g., monthly based on actual usage during that period.

Comments noted under Section B. 1. above apply here also. In addition, the review must include the identification of non-recurring items and instances where bills are paid by the state in lump sum as opposed to the
same billing cycles as it charges its users. If these costs are charged out based on one month's statistics it could result in charging inappropriate programs.
NOTE: Once a system is approved, a review of at least one billing cycle is needed to assure compliance with approved procedures.

SECTION C - REVIEW OF RECONCILIATION OF RETAINED EARNINGS

STEPS COMMENTS

1. Review annual reconciliation of retained earnings, i.e., the schedule comparing total revenue (including imputed revenue) to the allowable costs. Need to determine if variances were properly treated.

  1. Determine whether funds which utilize multiple billing rates/functions should be required to have separate reconciliation schedules for each billing rate/function.
  2. Verify the accuracy of the reconciliations to supporting documents (e.g., CAFR). Also, math check the schedules.
  3. Review the accuracy of the beginning A-87 R.E. balances.
  4. Determine that the A-87 Revenue reflects total charges for all services provided for the year whether billed or not.
  5. Verify the accuracy of interest earned or imputed interest. Review fund statements to determine if applicable credit has been given for earnings on ISF cash balances. If earnings are not reported, the negotiator should impute the interest amount and determine through discussion with state personnel if cash balances are invested.
  6. Review the expenditure amounts to ensure that unallowable costs are excluded and that remaining costs meet A-87 requirements.
  7. Review the allowable reserve to determine if the amount is excessive.
  8. Review the adequacy of fund transfers made during the year.

  9. Determine if there is an excess balance to the fund.

Sample formats are shown as Attachment A. Other formats may also be acceptable.

For example, an ISF may consist of both ADP and Telecommunication services where each function separately identifies its own revenues and expenditures. An overall fund balance may not be appropriate, because excess charges may occur in one billed service but undercharges may occur in other billed services. In addition, various users do not utilize each billed service to the same extent.

If the fund has not been reviewed or if adjustments have not been made for overcharges in prior years, the beginning balance is the R.E. balance on the state’s CAFR including allowable adjustments (e.g., transfers in/transfers out, A-87 unallowable/allowable costs, imputed interest).

If the fund has been reviewed in prior years, the beginning balance will be the ending balance from the previous year’s reconciliation schedule.  However, if adjustments for excess reserve balances have been made, then a zero balance may be the appropriate starting balance.

If some users were not billed for services (or not billed at a full rate), a schedule showing the full imputed revenues should be provided (see ASMB C-10, Illustration 4-6). The revenue should also include all other revenues the fund earns from its operations and interest earned on reserves.

When known, actual earnings should be used. However, if the state commingles its funds, earnings may be imputed by applying the government’s rate (e.g., the state’s Treasury Average Rate of Return) to the monthly average cash balance for the year.

Common problem areas:

  • Replacement costs.
  • Expensing of capital assets rather than depreciating.

ISFs are dependent upon a reasonable level of working capital reserve to operate one billing cycle to the next. A working capital reserve as part of the retained earnings of up to 60 days cash expenses is considered reasonable. See ASMB C-10, Illustration 4-7 for detailed instructions on computing allowable reserves.

A concern is that the funds were transferred out to the general fund which could indicate an overbilling of services.

Variances may be handled as adjustments to future billing rates, cash refunds, credits to individual programs, or, if less than $500,000, as a Section I allocated cost. If a method other than a cash refund is negotiated, an interest assessment may need to be considered.

2. SELF INSURANCE FUNDS

What does self-insurance include? Anything for which insurance can be purchased commercially, unless specifically disallowed, as indicated by A-87 - “Type of coverage and the extent of coverage and the rates and premiums would have been allowed had insurance (including reinsurance) been purchased to cover the risks.” Some common self-insurance items could be for workers compensation or unemployment insurance, property, liability, health, dental, life insurance, and severance pay.

A-87 and ASMB C-10 list the submission requirements for self-insurance funds. The effort required will depend on what information is submitted for the self-insurance funds. The following are some steps to follow:

STEPS COMMENTS

1. Identify all self-insurance where funded reserves are used through review of:

  1. Internal Accounting Manuals

  2. Financial Statements and notes

  3. Budget Documents

  4. Discussion with appropriate state personnel

This can be accomplished through:

  • Establishment of Internal Service Fund.
  • Accounting for funding within the General Fund.

Data on self-insurance funds should have been requested from the entity in the attachment to last negotiation agreement.

Estimate federal share of the annual cost or fund balance of the insurance being reviewed. Where the federal share is limited, we cannot expect to exert much influence on the reserve balances maintained. Our focus should be on determining whether federal programs are paying the same per unit costs as state funded programs and have transfers been made from the fund.

2. Identify and document the kinds of risks, for example buildings, liability which the organization’s policy is to cover losses on a “pay as you go” basis, i.e., as losses occur or to the extent funds are available. “Pay as you go” is not a self-insurance fund. The allowability of costs as a result of losses incurred by an entity using such an approach are severely limited by A-87.
3. Obtain copies of applicable financial statements, including actuarial reports. If financial statements are not available, the fund manager should have some internal statements for use.
4. Determine which insurance coverages, identified in Steps 1 and 2, are charged to federally funded programs. Only those coverages ultimately charged to federally funded programs should be considered for review.
5. Determine the specific coverage for items identified in Step 4, the cost of such and the mechanism used to charge Federal programs. Depending on the coverage, Federal programs could be charged through the central service plan (Section I), billing rates to departments (Section II), “pass-thru” vendor bills, fringe benefit rate, or other mechanisms. Review should include determining the reasonableness of the method(s) used to allocate the cost of insurance.
6. If the organization has changed from purchased insurance to self-insurance obtain rationale for conversion and a comparison of before and after rates. If rates have increased significantly, obtain an explanation for the increases. For most of these changes you can only reasonably expect to be kept informed as to the current situation. Any actuarial analysis involved in the rate setting will be difficult to contest. If you believe there are significant overcharges or excessive reserves, consult with your branch chief early in the review process for guidance in how to resolve your concerns.

7. Where funded reserves are used:

  1. Obtain rationale and support for year’s insurance expense
    • If actuarially determined, obtain copy of study
    • If historical experience, obtain supporting data
    • If created by law/statute, obtain copy and note any pertinent provisions.

















  2. Reconcile expense to the financial statements




  3. Review expense support to identify
    • Contingencies included
    • Unallowable costs under OMB A-87
    • Unallocable costs
  4. Review fund statements to identify:
    • Extent of contributed capital
    • How interest and other investment earnings on reserves are accounted for.
    • Reserve balances that represent an aggregate of several activities/billing centers must be analyzed separately. The entity must be requested to present this information.
    • Reserve balance amounts and support to demonstrate the reserve is not excessive.
    • The purpose of intergovernmental transfers such as “Amounts due the General Fund” and similar accounts/ transactions.
    • Verify actual funding
  5. Have entity identify all transfers during the year other than charges for self-insurance.
  6. Verify all funds, programs, etc. are charged consistently.
  7. Determine the reasonableness of the allocation or charging basis depending on the specific insurance coverage.

 

The level of federal participation of the balance should be considered in the extent of the review of the actuarial report. The range of review items listed in order based on federal participation are:
  • obtain a copy
  • does it identify the three reserve balance components identified in A-87?
  • does it contain rate recommendations?
  • are the rate recommendations used by the state to fund the reserve?
  • do the assumptions appear reasonable?
  • how has recent investment earnings (i.e. stock market) impacted the reserve balances?

At most, you can probably expect to use the actuarial report to ask what the state’s plans are concerning increasing or reducing the fund balance in the future.

Attempts to obtain refunds based on perceived faulty actuarial assumptions and computations are not generally recommended. Your branch chief should be consulted early in your review if you are contemplating a determination for a refund based on issues you have with an actuarial report.

Accrual basis of accounting should be used. Cash basis will not reflect true reserves because cash statements will only reflect users paying for services rather than actual costs of services provided during the accounting period to all users.


Catastrophic loses, etc.
Coverage of Federal Government Property.
Coverage for false arrest, tort claims like injury due to falling lamp posts, etc.

Depending on source of contribution, this part of the reserve balance would not be a potential credit to the Federal government.

All interest and other investment earnings must be credited to the reserve to ultimately be used for the purpose of the fund.

Federal participation can vary significantly among the billing centers.

Determination must be made on the need for a reserve and explanation of any level in excess of claims run-off. 
That include claims that are: submitted and adjudicated, but not paid; submitted but not adjudicated; or incurred but not submitted.

Such accounts/transactions may include unallowable transfers of excess reserve balances or interest/investment income from the fund.

Federal programs must be credited their share if the transfer is not for self-insurance payments or return of contributed capital.

All users should be charged the same rate for the same service.

Do all state agencies/departments pay their costs in the same manner? If not, determine if the “cost per” is the same for federally funded programs as it is for non-federally funded programs. As a result, Federally funded programs may be charged inflated actuarially determined rates based on state funded programs underpaying their costs in previous years.

Do funds flow directly from state agencies to the insurance fund? If not, additional opportunities for transfer of funds for other uses exist. If funds are not transferred promptly, interest earnings may in effect be transferred for other uses.

Overall average rates of certain components may not be appropriate, e.g., workers’ compensation expenses may vary significantly from department to department based on employee classifications i.e., office worker, mechanic, laboratory worker, etc.

8. Where “Pay as You Go” method is followed:

  1. For liability and property insurance, assure compliance with A-87, Attachment B, 25.
  2. For fringe benefit type insurance, e.g., unemployment, workers compensation, health, etc., determine whether the amounts proposed represent “employee benefits in the form of employers’ contribution or expense”, (A-87, Attachment B, Section 11d(5)), for the year and such amounts are properly determined and allocated.







  3. Determine reasonableness of the allocation bases.






The entity may use trust or agency funds to account for these items. You should determine:

  • The basis of the grantee’s expense, i.e., the amount paid to the fund or the actual payment from the fund. (If the expense is handled as an agency fund rather than a trust fund, the expense of the period should be the payments from the fund. An agency fund is basically a holding account and the payment from the fund is the true expense of the period.)
  • Whether there were any transfers from the fund to the General Fund.
  • Extent of interest earned and need to credit Federal programs, etc.
Allocations should be based on benefits received.
9. Where the cost of administering these programs is charged as either part of the billing rates or allocated as a Section I activity, you must assure that only costs applicable to the state activity are included for allocation. Many states administer fringe benefit programs such as health, dental, pension, etc. for both themselves and other governmental entities such as local governments. The methodology for charging administrative costs of the program must result in federally funded programs not paying more than their share of these administrative costs. The state must use some combination of (1) charging the non state entities their relative share of the administrative costs and (2) paying for them with only state funds.

REFERENCE MATERIAL

The following material can be helpful to the negotiator during the review of self insurance funds:

  • HHS Department Appeals Board Decisions

No. 1635 Alabama (Transfers of self-insurance reserves and related interest)
No. 1668 Oklahoma (Diversion/transfer of group insurance collections for other purposes.)

3. FRINGE BENEFITS

The following guidance on the review of fringe benefits is primarily based on the general requirements of A-87, as well as specific requirements contained in Attachment B, Sections 11, d., e., and f. of A-87. In addition, the negotiator should be aware of publications of both the Governmental Accounting Standards Board (GASB) and the Financial Accounting Standards Board (FASB) that provide information and guidance on accounting for the cost of various fringe benefits. A listing of applicable publications is contained in the guide at the end of this section.

STEPS COMMENTS

1. The following information should be submitted by the grantee as part of its proposal:

  1. Listing of fringe benefits (FB’s) and the annual cost of each.

  2. Current FB policies for each FB listed including coverage and funding.

  3. Method used for budgeting and charging FB’s to Federal awards.

  4. Future changes in FB policies or charging/ budgeting methods.

  5. FB proposal.

  6. Reconciliation to financial statements (CAFR) or other official expenditure reports for each component of the FB proposal.
  7. Copies of any state, CPA, or other audits of any FB component.

  8. Copies of the most recent actuarial reports.
  9. Any applicable state laws or regulations concerning any of the FB’s.

After the initial review it is only necessary that the grantee submit changes.

If the grantee uses a “specific identification” method to account for FB’s annual costs may not be readily available.







Multiple rates may be necessary if there are different classes of employees or pension systems.

Including annual reports prepared by/for Retirement Systems, Insurance Commissions, etc.

An actuarial valuation should be performed at least every two (2) years.

2. Review the financial statements and especially any notes relative to FB costs.

The financial statements are an important source of background information on FB’s and any changes with respect to their provisions. Information on the status of reserves and transfers of funds will also be found in the financials.
3. Discussions should be held with appropriate grantee representatives to obtain a complete understanding of the methods used to both charge and budget FB’s, including budgeting, accounting and recoInternal Service Fundsery of all FB cost claimed for Federal reimbursement.

Several methods can be used by the grantee in the accounting for the various FB costs. The scope of review will vary depending on the method followed, e.g.:

  • FB’s appropriated centrally where an average rate is developed, similar to an indirect cost rate, and charged to federal awards. An internal billing system is used only for federal funds and other third parties; there is no billing for grantee funded programs.
  • FB’s appropriated at the department level resulting in internal billings for all funds. Billing rates may be based on:
    • Average rates developed for individual FB components under the same process described for central appropriations above.
    • Specific FB’s identified with each department and departmental rates developed and billed accordingly.
    • Individual rates needed because department experience varies, e.g., workers’ compensation, unemployment, etc.
    • Specific FB’s identified with individual employees and charged directly to the programs the employees are working on.

In any case, the negotiator must assure him/herself that Federal programs have been charged in a manner consistent with other sources of funds, particularly state general funded activities.

Where the grantee uses the average rate method (whether it is a grantee-wide FB rate under a central appropriation process or a rate charged under the departmental approach) all of the following steps must be performed. Where FB’s are specifically identified to individual employees, the negotiator must identify the method used to assign the specific FB costs and perform only those steps that are applicable.

4. Review of the Salary and Wages (S&W;) base should include:

  1. Reconciliation to the financial statements.
  2. Complete description of the base, i.e., is it total S&W; as recorded in the accounting system or are certain components excluded, e.g., over-time, part-time employees, etc?
  3. Determine if all departments, divisions, agencies, etc., of the grantee are considered.
  4. Review actuarial reports.
  5. Determine if a multiple rate structure for different classes of personnel is needed.
  6. Determine the method followed by the grantee to account for vacation, holiday, sick or other leave, i.e., accrued when earned or pay-as-you-go.

The review must determine whether it is equitable to include S&W; of part-time employees, etc., in the base. Some FB’s, such as pension, may not apply to these employees. In such cases a separate FB rate may be appropriate.

Where there are several classes of personnel, e.g., uniformed (police, fire, corrections), teachers, etc., a multiple rate system may be needed or certain areas should be excluded because they skew the rate and have little relevance to Federal programs. Usually uniformed personnel as well as judicial and legislative members should be excluded because they have high FB costs and little or no Federal reimbursement. The significance of this differential is usually, but not always, highlighted in the actuarial valuation of pension costs.

See A-87, Attachment A, Section 11.d.3 and 4 for guidance on allowable costs. Particular attention should be paid to accrual methods of accounting to insure appropriate credit when leave is used.

5. Review of pension costs should include:

  1. Identification of all pension costs by plan and basis of the recorded expense whether its actuarially based or pay-as-you-go.
  2. Determine which classes of personnel should be included in the pension rate for Federal purposes.
  3. Verify that the pension expenditures recorded in the financial statements and the FB proposal are funded.
  4. Differences between expenses determined under GAAP and actual funding should be identified and explained.
  5. For plans based on actuarial methods of funding, obtain an analysis of the composition of the year’s expenses.
  6. Determine if interest amounts included in pension costs are allowable.
  7. The grantee, where possible, should be requested to identify the various unfunded liabilities and their amortization periods. Each should be reviewed for allocability to Federal programs.
  8. Review the pension plan’s financial statements to determine if the fund is maintaining a contingency reserve which has not been included in the actuarial computations.
  9. If pension obligation bonds were used to liquidate some or all of the unfunded liability, were Federal regulations and guidelines followed?
  10. Where early retirement programs are initiated determine their allocability to Federal programs and, that required prior approval was obtained.
  11. Review actuarial assumptions and computations to determine if any areas require further consideration.
  12. Review the pension plan, trust agreement, etc., to determine if it is possible for the grantee to access the pension funds for reasons other than the payment of pensions. Ascertain if any withdrawals or diversion of assets have taken place.
  13. The funding status of the plan should be reviewed to determine if there is apparent overfunding. The state should explain the overfunding and how it will be liquidated.
  14. Where the state administers the pension plan, determine how administrative costs are handled, i.e., part of the pension rate, separately recovered as a Section I cost, other.
  15. The method used to compute the state contribution to the pension plan should be compared to the method used to compute charges to Federal programs.

In some cases, the state is responsible for funding the employer’s share of pension costs for teachers and other local government employees. In such cases, the negotiator must include those costs in the assessment of allowable pension expenses.

Usually police, judiciary and the like should be eliminated or separate rates should be developed.

The A-87, Attachment A, Section 11.e.(2) and (3) provides guidance on the timing of actual contributions to a pension system. In general, the costs must be funded within six months after the end of the fiscal year to be included in that year’s expenses. Further guidance concerning allowable pension costs is also contained in ASMB C-10, A Guide for State, Local and Indian Tribal Governments, on pages 3-8 through 3-10.

Overfunding may occur in a year because funds are available. Such excess is not acceptable as a current period expense but is a prepaid expense which should be applied to a future period. (See A-87, Attachment A, Section 11.e.(3)) Underfunding will increase future costs due to interest lost and an increase in the unfunded liability of the pension plan.

This could include normal costs, amortization of prior service costs, life insurance, etc. The costs included could vary depending on the actuarial method used. The negotiator should also determine what assumptions, regarding timing of contributions, were made by the actuary for valuation purposes and whether or not they were followed. The effect on Federal reimbursement should be considered.

Further information on the requirements of accounting for and reporting pension plan expenditures is also available in GASB Statement No. 25.

Pension expenses may include an element of interest expense arising from several sources, e.g.,

Allowable:

  • Unfunded liability from the establishment of the plan or changes to the plan (past/prior service costs).
  • Unfunded liability created by a prior failure to adequately fund the plan in accordance with actuarial determinations because of a lack of funds or other considerations.
  • Unfunded liability caused by the use of outdated actuarial assumptions.

Unallowable:

  • Late payments to the pension fund. 
  • Delay in contribution caused by a state mandate.

Review may highlight areas where the allocability to Federal programs is questionable.

Failure to consider all funds held by the pension system could understate assets and result in excess contributions.

See OMB interpretation dated 1/31/94. If this was done in a prior period, determine if the actuary or single auditor has reported any changes.

Refer to ASMB C-10, question 3-13 for further information.

If the grantee withdraws funds from the pension system for general fund purposes, such a transfer would require an appropriate credit to the Federal government. This issue is most likely to present itself during times of economic downturn and can be an attractive alternative to raising taxes. Such transfers/withdrawals will most often be identified in the CAFR and/or the annual report of the pension fund.

Because the funding status of the plan must be viewed in the “long run”, it is not easy to sustain a finding of overfunding. However, suspected overfunding should be discussed with both the state and its actuary to obtain a through understanding of the status of the plan.

Assure amounts are not duplicated. In addition, costs associated with administering portions of the pension plan not related to state employees (local government employees, teachers) should be identified and not included in any allocation at the state level.

The negotiator should satisfy him/herself that the state contribution is the same percentage of S&W; as is used to claim Federal reimbursement. Where the state amount is based on estimated S&W;, it may be necessary to make an adjustment to reflect actual S&W; cost at year end to equalize the contribution, if the state uses a specific identification method to charge pension expense.

6. Review of Other Fringe Benefits

  1. Determine if amounts and benefits are allowable and reasonable.
  2. Verify that coverage is the same for all employees
  3. Obtain an analysis of the portion of cost paid for current/retired employees, e.g. health insurance.
  4. Determine the reasonableness of including the cost of retiree’s benefits in the FB pool.
  5. Determine if there were any rebates or other applicable credits which should be considered in arriving at the allowable costs (e.g., rebates of unemployment compensation insurance, life insurance dividends/rebates, etc.).
  6. Determine if any FB is handled through Trust or Agency Funds. If so, obtain appropriate financial statements/annual reports for review.
  7. Determine if coverage is consistent among all employee groups and, the grantee treats the cost of benefits consistently for both Federally and non-Federally funded personnel.
  8. In some cases the grantee may elect to be self-insured for certain FB’s, e.g., workers’ compensation and unemployment. In such cases, the negotiator should assure him/herself that the costs are allocated in accordance with A-87.
  9. For FB’s that are self-insured, see separate section of this guide for further review steps.

The employer share of post-retirement health insurance may be funded on a pay-as-you-go basis or actuarially determined, similar to pension costs. In some cases post-retirement health insurance may be paid by the pension system and treated as an element of the pension rate. Consistent treatment of this, and all costs, is extremely important.

Adjustments may be necessary because:

  • Some employees, like police, may have shorter service requirements to qualify for a pension. Such employees would therefore make up a larger proportion of retirees. An adjustment would be necessary to compensate for these employees where the health costs are higher and there is little or no Federal involvement.
  • Assure that amounts paid by retirees through direct contribution or reduction of pension benefits are properly credited against total cost of the benefit.

This could highlight transfers to the general fund, interest earned on funds awaiting disbursement, or other areas requiring further review. Note that interest can be earned on the employer contribution portion as well as the employee withholdings for Social Security, Federal taxes withheld, etc. Interest earned on both employee and employer contributions may be a proper credit against Federal programs.

If benefits for any group are higher than another, the need to adjust the FB rate computation must be considered. This is especially true for Workers’ Compensation or Unemployment Insurance where expense could vary significantly between departments or other employee groups.

The A-87, Attachment B, Item 25.e. requires such cost to be “allocated as a general administrative expense to all activities of the governmental unit.” It is not appropriate to allocate these cost directly to the program to which the employee receiving the benefit had been assigned.

REFERENCE MATERIAL

The following is a list of publications and other guidance, in addition to Circular A-87, which can be helpful to the negotiator during the review of fringe benefits:

  • Actuarial Standard of Practice No. 4 “Measuring Pension Obligations” Actuarial Standards Board, 10/93
  • Governmental Accounting Standards Board (GASB) Statement No. 16 “Accounting for Compensated Absences” 11/92
  • GASB Statement No. 25 “Financial Reporting for Defined Benefit Pension Plans and Note Disclosure for Define Contribution Plans” 11/94
  • GASB Statement No. 26 “Financial Reporting for Postemployment Healthcare Plans Administered by Defined Benefit Pension Plans” 11/94
  • GASB Statement No. 27

“Accounting for Pensions by State and Local Government Employees” 11/94

  • FASB Statement No. 43 “ Accounting for Compensated Absences” 11/80
  • FASB Statement No. 74 “Accounting for Special Termination Benefits paid to Employees” 8/83
  • FASB Statement No. 87 “Employers’ Accounting for Pensions” 12/85
  • FASB Statement No. 106 “Employers’ Accounting for Postretirement Benefits Other Than Healthcare” 12/90
  • FASB Statement No. 112 “Employers’ Accounting for Postemployment Benefits” 11/92
  • FASB Statement No. 132 “Employers’ Disclosures about Pensions and Other Postretirement Benefits” 2/98

HHS Secretary’s Letter to Governors Charging of different contribution rates to Federal and state programs and diversion of Trust Fund reserves.

HHS Department Appeals Board Decisions

No. 8 Connecticut (Consistent application of pension billing rates)
No. 29 Rhode Island (Consistent application of pension billing rates)
No. 314 Indiana (Consistent application of pension billing rates)
No. 1034 Massachusetts (Conversion from pay-as-you-go to actuarial method)
No. 1465 West Virginia (Offsetting contributions to pension funds)
No. 1592 California (Qualifying state contributions to pension reserves)
No. 1608 Texas (Health insurance reserves related to new members)
No. 1635 Alabama (Transfers of self-insurance reserves and related interest)
No. 1659 Maine (Offsetting contributions to pension funds)

IV. INDIRECT COST RATE PLANS

Indirect costs are those that have been incurred for common or joint purposes. These costs include (i) the indirect costs originating in each department or agency of the governmental unit carrying out the Federal awards, and (ii) the costs of central governmental services allocated through the central services cost allocation plan. Indirect costs are usually charged to Federal awards by the use of an indirect cost rate.

SECTION A - PRELIMINARY STEPS

STEPS COMMENTS

1. Determine whether a rate is needed.

 

A rate is needed if the state agency has any awards that provide for the reimbursement of indirect costs or if it anticipates such awards in the near future. However, if only training awards that limit reimbursement to eight (8) percent of total direct costs are involved, a rate is not required.
2. If a rate is required, determine whether it is the agency’s first negotiated rate with HHS. The establishment of the initial rate with an agency is critical. This negotiation will set the tone for subsequent negotiations. As such, dollar involvement should not be the principal factor in determining the level of effort to be expended. Extra effort should be expended at this time to insure that the grantee understands Federal requirements and that the agency’s accounting system and method of operation can accommodate these requirements.
3. Determine whether coordination is necessary with other Federal agencies. See comments for Part III, A, Section A, 3.
4. Determine that all of the necessary supporting data and documentation has been submitted.
  1. A copy of financial data (financial statements, expenditure reports, etc.) upon which the rate is based.
  2. The approximate amount of direct base costs incurred under Federal awards. These costs should be broken out between salaries and wages and other direct costs.
  3. A certification of the proposal by a responsible official.
  4. An organizational chart and functional statement(s) noting the duties and/or responsibilities of all units that comprise the agency.

This documentation may vary depending upon the particular circumstances involved in the negotiation. The items listed here are considered to constitute the minimum documentation necessary and will normally have been requested in previous correspondence with the agency.

In many cases state and local government agencies will not have certified financial statements but will have statements that have been audited by state or local auditors and will submit these statements in lieu of certified statements.

The agency should also indicate the amount of salaries and wages (or total direct costs) incurred under grants and contracts which limit indirect cost reimbursement.

See A-87, Attachment E, Part D, 3. for an example of the required certification.

If the agency submitted these documents with a previous proposal, only revisions to them need to be submitted with the subsequent proposal.

 
5. Determine that the proposal is adequately cross-referenced and reconciled to the financial data. Since the agency is primarily responsible for reconciling the proposal to the financial data, an inordinate amount of time should not be spent on this by the negotiator. If the amounts do not reconcile and if they cannot be readily reconciled via telephone, the agency should be requested to submit additional data.
6. Review prior proposals, negotiation workpapers, Negotiation Agreements and other correspondence maintained in the file to ascertain what adjustments have been made in previous years.
7. Determine whether any advance agreements were established in prior negotiations and, if so, whether the institution complied with the agreements for the proposal currently under review. In prior negotiations, advance agreements or letters to grantee delineating discrepancies that should be corrected in their future proposals may have been established for future negotiations to preclude disputes or problems or to help insure equitable cost determination in the future. Examples of such agreements include those involving (a) changes in the institution’s accounting system, (b) performance of special studies or analysis in connection with the development of future proposals, (c) changes or refinements in allocation bases, (d) the treatment of certain types of costs (e.g., rent, depreciation, computer costs, idle facilities costs), and (e) limitations of certain costs. In some cases, a prior rate may have been accepted with the condition that the institution take certain actions in the development of future proposals.
8. Determine whether a restricted or special rate(s) is needed or whether separate rates are needed for major organizational components of the institution.

 

 

Guidelines on the use of restricted and special rates are contained in the cost principles and in Chapter 6-110 of the Grants Administration Manual (GAM).

Separate rates for major organizational components of a department/agency are generally not required. However, they should be considered where the dollars involved are substantial and the characteristics of certain organizational components of the institution are such that there is reason to believe that they generate significantly different levels of indirect costs than other components. This is true for an agency which includes significantly different types of operations (e.g., state mental health departments and subordinate state hospitals).

The U.S. Department of Education (ED) requires “restricted” indirect cost rates for use on some ED programs awarded to State agencies for which HHS is cognizant. ED should inform DCA of those state agencies, for which HHS is cognizant, needing restricted rates. The negotiator should review the proposal to ensure the required restricted rate has been included. When the negotiator receives a proposal which includes a restricted rate, a copy will be provided to ED for review. ED will examine the proposal and provide comments within a reasonable period of time (30 days). Based on ED input, DCA will negotiate the rate as part of the normal process.

 

9. Obtain a copy of the OMB A-133 Single Audit report. Determine if there are any audit findings that affect the scope of the review. If the applicable A-133 Single Audit report has not been issued, review the most recent audit report.
10. Determine the appropriate level of negotiation effort and whether or not a HHS audit is needed. See comments for Part III, A, Section A, 8.

SECTION B - REVIEW OF COST ALLOWABILITY

To be allowable, costs must be (a) reasonable, (b) allocable to the government sponsored activities, (c) treated in conformance with any specific limitations, conditions or exclusions prescribed in the applicable cost principles, and (d) treated consistently (i.e., assigned to benefitting activities in a consistent manner). The steps set forth in this section are designed to help insure that the criteria for cost allowability are met.

STEPS COMMENTS
1. Determine whether the proposed expenses were incurred within the period under review.  Normally, if the expenses as shown in the proposal reconcile to the financial data it can be assumed that they were incurred within that period.
2. Determine through the performance of a comparative analysis with prior years whether the proposed costs are reasonable. The prior years’ figures maintained in the file should be used in making a comparative analysis between years.
3. Determine whether the proposed costs benefit Federal awards. Generally an expense that is necessary to the overall operation of the department/agency is allocable to Federal awards. When there is a multi-tier distribution involving more than one pool, the criteria is - does the expense benefit all activities included in the particular distribution base?
4. Review the financial data to determine if there are any applicable expense off-sets. Income generated by the activities in the indirect cost pool and certain negative expenditure types of transactions should be used to off-set or reduce the expenses in the indirect cost pool (e.g., the sale of scrap, parking fees, cafeteria income, purchase discounts or rebates, etc.).

5. Review the proposal and financial statements to determine whether the indirect cost pool includes any of the following unallowable costs:

  1. Equipment and capital expenditures (19.)
  2. Alcoholic beverages (4.)
  3. Bad debts (7.)
  4. Contingencies (12.)
  5. Contributions and donations (13.)
  6. Legal expenses for prosecution of claims against the Federal government (14. b.)
  7. Entertainment (18.)
  8. Fines and penalties (20.)
  9. Fund raising (21.)
  10. General government expenses (23.)
  11. Lobbying (27. & 30. e.)
  12. Underrecovery of costs under Federal agreements (42.)

The numbers next to each item refer to the section number in A-87 which prescribe the handling of these costs. Unless otherwise noted, the references refer to Attachment B of A-87.

Capital expenditures are allowable as direct costs if they are approved by the awarding agency. They are not allowable as indirect costs but instead are recovered through depreciation or use allowances.

6. Review the following costs to determine whether they are properly treated.

  1. Depreciation or use allowance:
    1. Determine that the value of the assets for depreciation/use allowance purposes was properly established.
    2. Determine that cost of land and the portion of assets that are Federally financed or financed with grantee matching contributions have been eliminated from the computation.
    3. Determine that a combination of the use charge and depreciation methods has not been used for a single class of fixed assets.
    4. If depreciation is proposed, determine that the depreciable lives that have been established are reasonable.
    5. Determine that the depreciation/use allowances on idle facilities have been properly handled.
    6. Determine that the depreciation methods used result in an equitable allocation of costs to the time periods in which the assets are used.
    7. Determine that the charges for use allowances or depreciation are adequately supported by property records.
    8. If use allowances are proposed, determine that a factor no greater than 6 2/3 percent has been used for equipment and 2 percent has been used for buildings.
  2. Rental costs.
  3. Specialized facilities (e.g., computer centers).
  4. Idle (excess) facilities or capacity

The costs listed here are particularly sensitive and should therefore be thoroughly reviewed when dictated by materiality.

The value for depreciation/use allowances purposes is acquisition cost except where the asset was donated to the institution by a third party. Where the asset was donated by a third party, the value is the market value at the time of donation. Where acquisition cost is used it should reflect the actual amount recorded in the records of the state or, if cost records do not exist, an estimate of the acquisition cost, which is usually based on an independent and professional appraisal. Where such appraisals are used, care should be exercised to insure that the amount used reflects the cost at the time of purchase and not replacement cost at the time of the appraisal. Where depreciation or use allowances are material in amount the negotiator should satisfy himself that the valuation bases are proper and, if the amounts are based on appraisals, that such appraisals were performed by independent and professional appraisers or by other reliable methods (e.g., insurance valuations).

In the absence of historical usage patterns, guidance in this area can be found in A-87, Part B, Paragraph 15, e. or IRS depreciation guidelines.

See Step 6.d. below.

Depreciation methods other than the straight line method should not be accepted unless the circumstances fully justify their usage (i.e., when it can be demonstrated that the assets are being consumed faster in the earlier years than in the latter years of their useful life).

See A-87, Part B, Paragraph 15, d. and f. for guidelines on treatment of building components.

When the depreciation method is followed, depreciation records indicating the amount of depreciation taken each period must also be maintained.

Refer to A-87, Attachment B, Part 38, for limitations on the amount of rental costs that may be charged to Federal awards under various types of leasing arrangements (e.g., sale and leaseback arrangements, less-than-arms-length leases and capital leases). Also refer to Chapter 6-10 of the GAM.

The inclusion of the costs of these types of facilities in the indirect cost pool should not be allowed when they are material in amount or when the facilities benefit a limited number of activities. Normally, costs of this nature should be charged directly to benefitting activities via a schedule of rates designed to recover their total costs.

The costs of the facility should consist of its direct costs as well its allocated share of indirect costs, including general administration, operations and maintenance, depreciation/use allowances, fringe benefits, etc. Variances between the actual costs of the facilities and the direct charges to benefitting activities in a given period should be adjusted in accordance with A-87.

 
7. Determine whether state or local central service costs have been included in the proposal and, if so, that they are properly supported. Idle facilities are defined as completely unused facilities that are in excess of the institution’s current needs. Idle capacity is the unused capacity of partially used facilities 
  • i.e., the difference between 100 percent capacity and actual usage of the facility. See A-87, Attachment B, Paragraph 24.

To be allowable, the costs must be supported by a cost allocation plan prepared by the state or locality. For plans prepared by the state, they must be approved by HHS/DCA. The state’s cost allocation file should be reviewed to determine whether the cost allocations were approved and whether they agree with the proposed costs.

The localities must also prepare cost allocation plans but are generally not required to obtain approval unless specifically requested to do so by the cognizant Federal agency. If there is no indication that the plan required approval, the institution should be queried as to whether the locality prepared a plan and, if so, the proposed amounts should be accepted.

8. Review fringe benefit costs. Since the fringe benefit policies of a state or local government usually apply uniformly to all its agencies, the review of such policies are performed during the review of the central service cost allocation plan. Therefore, the negotiator should verify that the treatment of fringe benefits in the indirect cost rate proposal is consistent with the central service cost allocation plan.
9. Determine if the types of costs included in the indirect cost pool are consistently treated as indirect costs. The department or agency should be queried to determine whether any costs included in the indirect cost pool have also been charged to any Federal awards as direct costs. Where such costs are charged directly, they should be removed from the indirect cost pool except to the extent that they apply to indirect activities. The allocation bases are the methods by which indirect costs are allocated to benefitting activities. 

SECTION C - REVIEW OF ALLOCATION BASES

The allocation bases are the methods by which indirect costs are allocated to benefitting activities. For multiple allocation base proposals, the agency’s indirect costs benefit its major functions in varying degrees and are accumulated into separate cost groupings. Each grouping is then individually allocated to benefitted functions by means of a base which best measures the relative benefits. For simplified proposals, a single base is used to allocate all indirect costs to benefitting activities, including grants and contracts.

The base selected for each allocation should be the one which results in an equitable allocation to benefitting activities and is practical under the circumstances. The cost principles and the Guide for State, Local and Indian Tribal Governments (ASMB C-10) contains criteria for the selection of appropriate bases as well as suggested bases that generally are considered to be equitable. However, a base different from the suggested base may be used if the suggested base is either inequitable or impractical. The steps contained in this section are designed to help insure that the bases used result in an equitable allocation of costs. Except where otherwise noted, these steps apply equally to both multiple allocation base and simplified proposals.

STEPS COMMENTS
1. Determine that the proposed bases result in an equitable distribution of indirect costs. Generally, if the proposed bases conform to the suggested or required bases they should be accepted. However, there may be circumstances which indicates that an inequity will result if a suggested base is used. For example, total expenditures exclusive of capital expenditures is a suggested base. However, the existence of major subcontracts will usually require the use of a modified total expenditure base excluding major subcontracts or a different base such as salaries and wages.

2. Determine that the proposed bases include all activities which benefit from the indirect costs that are allocated, including where appropriate:

  1. Activities associated with general funds
  2. Activities associated with restricted, special purpose, or other funds
  3. Grants and contracts
  4. State institutions (e.g., hospitals, universities)
  5. Costs used for cost sharing or matching purposes
  6. Non-state organizations which receive services (e.g., an affiliated foundation, a local government agency, etc.)
3. Determine whether the data included in the bases (e.g., square footage, number of employees, time studies, etc.) are current and accurate. This step applies only to multiple allocation base proposals. The negotiator may be able to reconcile the data to central service cost allocation plan statistics.

SECTION D - CONCLUDING STEPS

STEPS COMMENTS
1. Determine whether there are any anticipated significant changes in the level of the institution’s activities, its organization structure, or its accounting system that should be taken into account in the negotiation of a provisional, fixed or predetermined Normally this rate(s) is based on the actual costs for the most recently completed fiscal year. However, if the agency anticipates significant changes in its operations that should affect the costs, the changes should be reflected in the establishment of the rate(s).
2. Determine whether an advance agreement covering future negotiations should be established. Advance agreements should be established when they are needed to preclude future disputes or problems or when they will help insure equitable cost determinations in the future. Examples of areas where these agreements may be needed include (a) changes or refinements in allocation bases, (b) the treatment of certain types of costs, (c) changes in the state’s accounting system, and (d) limitations of certain costs. If an advance agreement is established it should be included in the letter transmitting the Negotiation Agreement.
3. Negotiate the appropriate type of rate(s) (e.g., provisional, fixed, predetermined, or final) and complete negotiation agreement form.

Contact will more than likely be maintained with the agency throughout the review of the proposal. The negotiator at the conclusion of the negotiation, should contact the agency to (a) summarize the adjustments (if any) and the term or conditions incident to the acceptance of the rate(s) and (b) gain concurrence on a final position.

Guidance on the circumstances under which costs should be negotiated on a provisional, final, fixed or predetermined basis are as follows:

  • Provisional rates will be used only in those situations in which the negotiator has little confidence in the rate proposed and cannot negotiate a rate which will fairly reflect an agency’s operations during the period to which the rate applies. Provisional rates should also be used when (i) the propriety of the rates are contingent upon the occurrence of a future event which is uncertain at the time of negotiation or (ii) the agency plans to reorganize or otherwise substantially change its operations in the future. When a provisional rate is established, a final rate must be negotiated when the actual costs for the period become known.
  • Predetermined rates may only be negotiated in those situations where there is a high probability that the rate negotiated will result in a dollar recovery to the agency not in excess of the amount that would have been recovered had the rate been established on an “after-the-fact” basis. Predetermined rates are not authorized if there are contracts awarded to the grantee agency.
  • Fixed rates with carry-forward provisions may be used except where the carry-forward adjustment would be difficult or impossible to make because:
  1. the agency is unlikely to have active awards in the future periods to affect the carry-forward adjustment against,
  2. the mix of Federal/non-Federal work performed by the agency from year to year is too erratic to permit a fair carry-forward adjustment,
  3. the operating activities of the agency are unstable, 
  4. the negotiator is not satisfied that the rate proposed will approximate the actual rate.
  • The negotiator should avoid setting fixed rates which result in major carry-forward adjustments. Consider setting limitations on the amount of permissible adjustment (e.g., spread over more than one fiscal year).
  • If a fixed or predetermined rate is used, a provisional rate should be normally established to cover the period subsequent to the period covered by the fixed or predetermined rate. This will preclude potential problems in funding awards made after the expiration of the fixed or predetermined rate.
4. Complete Summary of Negotiations. A summary of negotiations should be prepared which shows the amounts negotiated that are different from the amounts submitted, and the reasons for the negotiated differences. The summary should be sufficiently detailed to permit an independent reviewer to quickly see and understand how the negotiated rates were arrived at.
 

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Last revised: April 2, 2004

 

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