Dave Cotton, CPA, CFE, CGFM Cotton & Company LLP Alexandria, Virginia cottoncpa

May 20, 2013 Federal Cost Principles and Administrative Rules …What You Don’t Know Could Cost You Dave Cotton, CPA, CFE, CGFM Cotton & Company LLP Alexandria, Virginia www.cottoncpa.com

Session Highlights • What principles and rules do you need to memorize? • What are the similarities? • What are the differences? • What’s REALLY important? Session Format: TEST YOUR KNOWLEDGE AND COMPETE AGAINST YOUR PEERS

Teamwork • Form teams of 5-6 each • Answer the easy 15-question quiz • Be ready to explain and defend your answers

Federal Contract and Grant Cost Principles and Administrative Rules Question #1: Cost principles for state and local governments, Indian tribal governments, non-profits, educational institutions, and commercial entities are: • All pretty much the same. • Similar but contain some important differences. • Identical for state governments, local governments, and Indian tribal governments. • All identified in the Federal Acquisition Regulation. • b, c, and d. • b and c.

What Rules Apply …

What Rules Apply … States, local governments, and Indian Tribes follow: • A-87 for cost principles (Relocated to 2 CFR, Part 225) • A-102 for administrative requirements, and • A-133 for audit requirements Educational Institutions (even if part of a State or local government) follow: • A-21 for cost principles (Relocated to 2 CFR, Part 220) • A-110 for administrative requirements (Relocated to 2 CFR, Part 215), and • A-133 for audit requirements Non-Profit Organizations follow: • A-122 for cost principles (Relocated to 2 CFR, Part 230) • A-110 for administrative requirements (Relocated to 2 CFR, Part 215), and • A-133 for audit requirements

What Rules Apply … • FAR Subpart 31.2—Contracts with Commercial Organizations • FAR Subpart 31.3—Contracts with Educational Institutions • FAR Subpart 31.6—Contracts with State, Local, and Federally Recognized Indian Tribal Governments • FAR Subpart 31.7—Contracts with Nonprofit Organizations

Federal Contract and Grant Cost Principles and Administrative Rules Question # 2: For a cost to be allowable under a Federal award (contract or grant), the cost must be: • Reasonable, allocable to the award, and necessary • Given consistent treatment • In conformity with cost principle exclusions or limitations and in conformity with the contract or grant agreement • Net of applicable credits • Adequately documented • All of the above • a and c • a, b, and c

Cost Allowability • The different cost principles contain slightly different wording, but essentially the same baseline requirements

Federal Contract and Grant Cost Principles and Administrative Rules Question # 3: Cost reasonableness is an important consideration in determining the allowability of costs. As long as a cost (a) has actually been incurred and (b) meets the prudent person test, it is presumed to be reasonable and the government has the burden of proving otherwise. TRUE FALSE

Cost reasonableness • “A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business” [FAR 31.201-3] • “A cost may be considered reasonable if the nature of the goods 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.” [A-21]

Cost reasonableness • “A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person under the circumstances prevailing at the time the decision was made to incur the cost.” [A-87 and A-122]

Cost reasonableness considerations FAR 31.201-3: • Whether it is the type of cost generally recognized as ordinary and necessary for the conduct of the contractor’s business or the contract performance; • Generally accepted sound business practices, arm’s-length bargaining, and Federal and State laws and regulations; • The contractor’s responsibilities to the Government, other customers, the owners of the business, employees, and the public at large; and • Any significant deviations from the contractor’s established practices.

Cost reasonableness considerations A-21: • 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; • 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; • whether or not the individuals concerned acted with due prudence in the circumstances, considering their responsibilities to the institution, its employees, its students, the Federal Government, and the public at large; and, • 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.

Cost reasonableness considerations A-87: • Whether the cost is of a type generally recognized as ordinary and necessary for the operation of the governmental unit or the performance of the Federal award. • The restraints or requirements imposed by such factors as: Sound business practices; arm’s-length bargaining; Federal, State and other laws and regulations; and, terms and conditions of the Federal award. • Market prices for comparable goods or services. • Whether the individuals concerned acted with prudence in the circumstances considering their responsibilities to the governmental unit, its employees, the public at large, and the Federal Government. • Significant deviations from the established practices of the governmental unit which may unjustifiably increase the Federal award’s cost.

Cost reasonableness considerations A-122: • Whether the cost is of a type generally recognized as ordinary and necessary for the operation of the organization or the performance of the award. • The restraints or requirements imposed by such factors as generally accepted sound business practices, arms length bargaining, Federal and State laws and regulations, and terms and conditions of the award. • Whether the individuals concerned acted with prudence in the circumstances, considering their responsibilities to the organization, its members, employees, and clients, the public at large, and the Federal Government.

Cost reasonableness—burden of proof A-21, A-87, and A-122 do not specify Prior to July 30, 1987, courts and boards followed the standard set forth in Bruce Construction Corporation, et al. v. The United States, 163 Ct. Cl. 97, November 15, 1963: Where there is an alleged disparity between "historical" and "reasonable" costs, the historical costs are presumed reasonable. Since the presumption is that a contractor's claimed cost is reasonable, the government must carry the very heavy burden of showing that the claimed cost was of such a nature that it should not have been expended, or that the contractors' costs were more than were justified in the particular circumstance. FAR 31.201-3 was revised effective July 30, 1987 to state that: No presumption of reasonableness shall be attached to the incurrence of costs by a contractor. If an initial review of the facts results in a challenge of a specific cost by the contracting officer or the contracting officer’s representative, the burden of proof shall be upon the contractor to establish that such cost is reasonable.”

Federal Contract and Grant Cost Principles and Administrative Rules Question #4: All indirect costs must be treated as indirect costs and should never be charged against direct cost objectives. TRUE FALSE

Federal Contract and Grant Cost Principles and Administrative Rules Question #5: All direct costs must be treated as direct costs and should never be recorded in an indirect cost pool. TRUE FALSE

Direct and Indirect Costs Any direct cost of a minor amount may be treated as an indirect cost for reasons of practicality where such accounting treatment for that item of cost is consistently applied to all cost objectives. Example: photocopying costs of Grantee could be direct-charged, but okay to put such costs in indirect pool (unless not all grants use about the same type of photocopying)

Federal Contract and Grant Cost Principles and Administrative Rules Question #6: Labor costs charged to Federal awards must always be supported by • Reports reflecting the distribution of the activity of employees • An after-the-fact determination of the actual activity of each employee • Reports that account for the total activity of each employee • All of the above • None of the above

Support for labor costs • In general, under FAR 31, A-87, and A-122, labor costs must be supported by time distribution reports reflecting the after-the-fact determination of how all time was spent ... But, there are exceptions (persons working only on one award; substitute system approved by cognizant agency; etc.) • Educational institutions get special treatment: … it is recognized that, in an academic setting, teaching, research, service, and administration are often inextricably intermingled. A precise assessment of factors that contribute to costs is not always feasible, nor is it expected. Reliance, therefore, is placed on estimates in which a degree of tolerance is appropriate.

Federal Contract and Grant Cost Principles and Administrative Rules Question #7: “Uncompensated overtime” refers to situations in which employees who are paid on an hourly basis work more than 40 hours per week but do not get paid for the overtime hours. TRUE FALSE

Relates to exempt, salaried employees who work more than the standard number of hours “Standard” is usually 40 hours per week, 2080 hours per year “Standard hourly rate” equals salary divided by standard hours Accounting problems arise if: Employees don’t record all hours worked Billings to customers are based on the standard hourly rate Expenses are recorded using the standard hourly rate Uncompensated Overtime

Jane’s salary with the Ajax Institute is $41,600 Her standard hourly rate is $20.00 In one particular week, Jane works 25 hours on a cost-reimbursable grant (A), 15 hours on a fixed price grant (B), and 10 hours on G&A. She records 40 hours (the time on the 2 grants) on her time sheet. Ajax bills A $500 + indirect costs; records $500 as labor costs on A and $300 as labor costs on B Problems: Jane’s time on A only cost Ajax $400; her time on B only cost $240; no cost for G&A was recorded Uncompensated Overtime Example 1

Jane’s salary with the Ajax Institute is $41,600 Her standard hourly rate is $20.00 In one particular week, Jane works 25 hours on a cost-reimbursable grant (A), 15 hours on a fixed price grant (B), and 10 hours on G&A. She records all 50 hours on her time sheet. Ajax bills A $500 + indirect costs; records $500 as labor costs on A, $300 as labor costs on B, and $200 as G&A Problems: Jane’s time on A only cost Ajax $400; her time on B only cost $240; Ajax recorded $1,000 of costs, but only paid Jane $800 [$41,600 divided by 52 weeks] Uncompensated Overtime Example 2

Employees should record all hours worked Either: Accumulate the variance between standard and actual in an indirect “variance” account Compute the actual pay rate each pay period and use this for cost-reimbursable billings and recording expenses First option only okay if variance account stays small Second option preferred and more accurate Proper Treatment of Uncompensated Overtime

Federal Contract and Grant Cost Principles and Administrative Rules Question #8: Indirect costs should always be allocated on a cost base (such as total direct costs, direct labor costs, direct labor plus overhead costs, etc.) that results in an equitable allocation of indirect costs to benefitting direct cost objectives. TRUE FALSE

Indirect Cost Allocation Bases The essential consideration in selecting a base is that it be the one best suited for assigning the pool of costs to cost objectives in accordance with benefits derived; a traceable cause and effect relationship; or logic and reason, where neither benefit nor cause and effect relationship is determinable. [A-21] Indirect cost pools should be distributed to benefitted cost objectives on bases that will produce an equitable result in consideration of relative benefits derived. [A-87]

Indirect Cost Allocation Bases … allocation of indirect costs may require the accumulation of such costs into separate cost groupings which then are allocated individually to benefiting functions by means of a base which best measures the relative degree of benefit. [A-122] While a cost base is often used, some other base is allowed as long as the resulting distribution is equitable.

Federal Contract and Grant Cost Principles and Administrative Rules Question #9: Unallowable costs should always be excluded from overhead when calculating indirect cost rates. TRUE FALSE

Unallowable costs must be removed from the pools being allocated (i.e. the numerators in the rate calculations) But, unallowable costs remain in the allocation bases (i.e. the denominators in the rate calculations) Unallowable base costs must receive their fair share of allowable pool costs Unallowable costs cannot be recovered either directly or indirectly In Indirect Cost Rate Calculations ...

Typical Cost Allocation Structure Direct Labor Costs = Unallowable Costs

Typical Cost Allocation Structure Overhead Costs Direct Labor Costs = Unallowable Costs

Typical Cost Allocation Structure Overhead Costs Other Direct Costs Direct Labor Costs = Unallowable Costs

Typical Cost Allocation Structure General & Administrative Costs Overhead Costs Other Direct Costs Direct Labor Costs = Unallowable Costs

But, Unallowable Costs Get Allowable Costs Allocated To Them General & Administrative Costs Overhead Costs Other Direct Costs Direct Labor Costs = Unallowable Costs

Allowable Overhead Rate OH Rate = C/(A+B) Overhead Costs = C D A Direct Labor Costs = B = Unallowable Costs

Allowable G&A Rate G&A Rate = G/(A+B+C+D+E+F) H-- General & Administrative Costs = G Overhead Costs = C D Other Direct Costs F A Direct Labor Costs = B = E = Unallowable Costs

Federal Contract and Grant Cost Principles and Administrative Rules Question #10: Lewis Segusi is executive director of the Consolidated Association of Reputable Politicians (CARP), a (very small) non-profit organization that studies honesty in politics. Lew travels to Festering Shores, CA to attend a legislative retreat where he discusses his views on pending legislation. He is careful to fly at coach air fares and he follows the Federal Travel Regulations for meals and lodging. • Lew’s labor costs are unallowable: TRUE FALSE b) Lew’s travel, meals, and lodging costs are allowable indirect costs: TRUE FALSE

Federal Contract and Grant Cost Principles and Administrative Rules Question #10: Lewis Segusi is executive director of the Consolidated Association of Reputable Politicians (CARP), a (very small) non-profit organization that studies honesty in politics. Lew travels to Festering Shores, CA to attend a legislative retreat where he discusses his views on pending legislation. He is careful to fly at coach air fares and he follows the Federal Travel Regulations for meals and lodging. • Lew’s labor costs are unallowable: TRUE FALSE b) Lew’s travel, meals, and lodging costs are allowable indirect costs : TRUE FALSE

Dave Cotton, CPA, CFE, CGFM Cotton & Company LLP Alexandria, Virginia cottoncpa