Accounting Office

REF: FINANCIAL ANALYSIS OFFICE

All charges to Federal awards must meet the tests of reasonableness, allowability and allocability in accordance with the provision of OMB Circular A-21 and the terms and conditions of the grant or other agreement. The draft Department of Health and Human Services "Guidelines for Audits of Federal Awards to Educational Institutions" details the following determinations to assist the non-Federal auditor in testing specific charges:

  1. DETERMINE WHETHER THE CHARGES ARE NECESSARY AND REASONABLE
    The purpose, authorization and timing of transactions should be examined in relation to whether such transactions are generally recognized as ordinary, prudent, relevant, and necessary within established practices.

    A-21 has defined "reasonable costs" as reasonable if the nature of the goods or services acquired and the amount involved reflect the action that a prudent person would have taken under the circumstances.

    The provision of A-21, which defines allowable and unallowable costs, and costs requiring approval of Federal agencies is particularly pertinent to this determination.

  2. DETERMINE WHETHER THE CHARGES CONFORM TO ANY LIMITATIONS OR EXCLUSION IN THE AWARD. (ALLOWABLE)
    Violations of the terms and conditions of an award will result in the related costs being classified as questionable by the auditor regardless of whether such costs meet other aspects of A-21. For example, one Federal award may have a limitation on the amount of indirect costs that may be charged to it.

  3. DETERMINE WHETHER THE CHARGES WERE GIVEN CONSISTENT ACCOUNTING TREATMENT AND APPLIED UNIFORMLY TO BOTH FEDERAL AWARDS AND OTHER ACTIVITIES OF THE INSTITUTION.
    Consistency relates not only to applying an accounting treatment in a similar manner within a period and from one reporting period to another; it also requires that both the accounting methods and practices be uniformly applied to Federal, non-Federal and all other institution activities with and between reporting periods.

  4. DETERMINE WHETHER THE CHARGES WERE NET OF APPLICABLE CREDITS.
    The phrase "applicable credits" refers to those receipts or negative expenditures that operate to offset or reduce direct or indirect costs (purchase discounts, rebates, trade-ins, etc.)

    The Intent of this requirement is to assure that the Federal awards are being charged for the actual cost or net cash disbursed for charges.

  5. DETERMINE THAT CHARGES ARE ALLOCABLE TO THE FEDERAL AWARD.
    A cost is allocable to a particular cost objective (i.e., a specific function, project, sponsored agreement, department or the like) if the goods or services involved are chargeable or assignable to such cost objective in accordance with relative benefits received or other equitable relationship.

    A cost is allocable to a Federal Award if:

    • it is incurred solely to advance the work under the award.
    • it benefits the award agreement jointly with other activities of the institution and can be documented, or
    • it is necessary for the overall operation of the institution and is assignable in part (under A-21) to Federal awards.

  6. DETERMINE WHETHER THE CHARGES WERE PROPERLY RECORDED i.e., CORRECT AMOUNT, DATE, AND SUPPORTED BY SOURCE DOCUMENTATION.
    To satisfy the source documentation requirement, the auditor needs to examine the existence and evidence supporting the type of cost, the purpose for which it was incurred, the time period incurred, the amount of such cost (itemized to the extent necessary), and approvals in accordance with management's directives.

  7. DETERMINE WHETHER THE CHARGES WERE APPROVED IN ADVANCE, IF SUBJECT TO PRIOR APPROVAL IN ACCORDANCE WITH CIRCULAR A-21 OR TERMS OF THE AWARD.
    Circular A-21 indicates that prior approval is required with respect to specific types of expenditures. In addition, an award agreement may require advance approval for other specific costs.

  8. DETERMINE WHETHER THE CHARGES WERE INCURRED IN ACCORDANCE WITH COMPETITIVE PURCHASING PROCEDURES, IF COVERED BY OMB A-110, ATTACHMENT O - PROCUREMENT STANDARDS.
    Attachment O established standards and guidelines for the procurement of supplies, equipment, construction and services for Federal awards programs.

  9. DETERMINE WHETHER INDIRECT COST RECOVERY WAS BASED ON THE PROPER INDIRECT COST RATE, PROPERLY DISTRIBUTED AND NOT MISSTATED BY PROCESSING ERRORS. Institutions are required to file an indirect cost proposal annually with their respective Federal cognizant agency to establish a basis (subject to negotiation) for the recovery of indirect costs. Institutions may negotiate single or multiple indirect cost rates for Federal award.

Selected Provisions of OMB Circular A-21

  1. Pre-existing Language
    The basic considerations of allowability of cost have been in place since at least the 1974 re-issuance of OMB Circular A-21. They include the following:

    C.2. Factors affecting allowability of costs. The test of allowability of costs under these principles are: (a) they must reasonable; (b) they must be allocable to sponsored agreements under the principles and methods provided herein; (c) they must be given consistent treatment through application of those generally accepted accounting principles appropriate to the circumstances; and (d) they must conform to any limitations or exclusions set forth in these principles or in the sponsored agreement as to types or amounts of cost items.

    C.3. Reasonable costs. A cost may be considered reasonable if the nature of the good or services acquired or applied, and the amount involved therefore, reflect the action that a prudent person would have taken under the circumstances prevailing at the time the decision to incur the cost was made. Major considerations involved in the determination of the reasonableness of a cost are: (a) whether or not the cost is of a type generally recognized as necessary for the operation of the institution or the performance of the sponsored agreement; (b) the restraints or requirements imposed by such factors as arm's-length bargaining, Federal and State Laws and regulations, and sponsored agreement terms and conditions: (c) whether or not the individuals concerned acted with due prudence in the circumstances, considering their responsibilities to the institution, its employees, its students, the Government, and the public at large; and (d) the extent to which the actions taken with respect to the incurrence of the cost are consistent with established institutional policies and practices applicable to the work of the institution generally, including sponsored agreements.

    C.4. A cost is allocable to a particular cost objective (i.e., a specific function, project, sponsored agreement, department, or the like) if the goods or services involved are chargeable or assignable to such cost objective in accordance with relative benefits received or other equitable relationship. Subject to the foregoing, a cost is allocable to a sponsored agreement if (1) it is incurred solely to advance the work under the sponsored agreement; (2) it benefits both the sponsored agreement and other work of the institution, in proportions that can be approximated through use of reasonable methods, or (3) it is necessary to the overall operation of the institution and, in light of the principles provided in this Circular, is deemed to be assignable in part to sponsored projects. Where the purchase of equipment or other capital items is specifically authorized under a sponsored agreement, the amounts thus authorized for such purchases are assignable to the sponsored agreement regardless of the use that may subsequently be made of the equipment or other capital items involved.

    C.4b. Any costs allocable to a particular sponsored agreement under the standards provided in this Circular may not be shifted to other sponsored agreements in order to meet deficiencies caused by overruns or other fund considerations, to avoid restrictions imposed by law or by terms of the sponsored agreement, or for other reasons of convenience.

The core principles for distinguishing between direct and indirect costs are as follows:

Direct Costs

D.1. General.

Direct costs are those costs that can be identified specifically with a particular sponsored project, an instructional activity, or any other institutional activity; or that can be directly assigned to such activities relatively easily with a high degree of accuracy...

Indirect costs

E.1. General.

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