Part 3 – compliance requirements introduction



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Allowable Costs – Special Requirements –Cost Accounting Standards and Disclosure Statements

1. Compliance Requirement – CAS and Disclosure Statements

a. A-21, section C.14 requires educational institutions (institutions) that receive more than $25 million in Federal funding in a fiscal year to prepare and submit a Disclosure Statement (DS-2) that describes the institution’s cost accounting practices. These institutions are required to submit a DS-2 within 6 months after the end of the institution’s fiscal year that begins after May 8, 1996, unless the institution is required to submit a DS-2 earlier due to a receipt of a CAS-covered contract in accordance with 48 CFR section 9903.202-1.

b. These institutions are responsible for maintaining an accurate DS-2 and complying with disclosed cost accounting practices. They are also responsible for filing amendments to the DS-2 when disclosed practices are changed or modified. Amendments should be provided to the cognizant Federal agency for approval.

c. Federal Acquisition Regulation (FAR) Appendix, 48 CFR section 9903.201-2(c), Types of CAS Coverage, requires educational institutions to comply with all of the CAS specified in 48 CFR part 9905 that are in effect on the effective date of a covered contract. Negotiated contracts in excess of $500,000 are CAS-covered, except for CAS-covered contracts awarded to Federally Funded Research and Development Centers (FFRDCs) operated by an educational institution, which are subject to 48 CFR part 9904.



2. Audit Objectives – CAS and Disclosure Statements

a. Obtain an understanding of internal control, assess risk, and test internal control as required by OMB Circular A-133 §___.500(c).

b. Determine whether the educational institution’s DS-2 is current, accurate, and complete and that it has been approved by the cognizant Federal agency as adequate and compliant with A-21 and CAS (48 CFR part 9905).

c. Determined whether the educational institution’s actual accounting practices are consistent with its disclosed accounting practices.

d. Determine whether amendments have been filed with and approved by the cognizant Federal agency.

e. Determine whether the educational institution’s accounting practices for direct and indirect costs comply with CAS applicable to educational institutions (48 CFR part 9905).



3. Suggested Internal Control Audit Procedures – CAS and Disclosure Statements

a. Using the guidance provided in Part 6 – Internal Control, perform procedures to obtain an understanding of internal control sufficient to plan the audit to support a low assessed level of control risk for the program.

b. Plan the testing of internal control to support a low assessed level of control risk for allowable costs/cost principles and perform the testing of internal control as planned. If internal control over some or all of the compliance requirements is likely to be ineffective, see the alternative procedures in §___.500(c)(3) of OMB Circular A-133, including assessing the control risk at the maximum and considering whether additional compliance tests and reporting are required because of ineffective internal control.

c. Consider the results of the testing of internal control in assessing the risk of noncompliance. Use this as the basis for determining the nature, timing, and extent (e.g., number of transactions to be selected) of substantive tests of compliance.



4. Suggested Compliance Audit Procedures – CAS and Disclosure Statements

a. Obtain a copy of the educational institution’s DS-2, amendments, and letters of approval from the cognizant Federal agency.

b. Read the DS-2 and its amendments and ascertain if the disclosure agrees with the policies prescribed in the educational institution’s current policies and procedures documents.

c. Test that the disclosure agrees with actual practices for the period covered by audit, including whether the practices were consistent throughout the period.

d. Test direct and indirect charges to Federal awards to determine that the educational institution’s practices used in estimating the costs in the proposal were consistent with the institution’s cost accounting practices used in accumulating and reporting the costs (A-21, section C.10 and FAR Appendix, 48 CFR section 9905.501).

e. For those costs which are sometimes charged direct and sometimes charged indirect, test for consistent classification of these costs, when incurred for the same purpose and under like circumstances (A-21, section C.11 and FAR Appendix, 48 CFR section 9905.502). For example:

(1) Salaries of administrative and clerical staff are normally treated as indirect costs; however, they may be charged direct to a major project or activity under certain conditions. Sample these costs when they have been charged direct to Federal awards to determine consistent treatment for non-Federal awards, instructional activity, or other institutional activity (A-21, section F.6.).

(2) Office supplies, postage, local telephone costs and memberships are normally treated as indirect. Sample these costs when they have been charged direct to Federal awards to determine consistent treatment for non-Federal awards, instructional activity, or other institutional activity (A-21, section F.6.).

f. Capital expenditures for general and special-purpose equipment may be charged direct to awards with approval of the awarding agency. Sample these costs when they have been charged direct to Federal awards to determine consistent treatment for non-Federal awards, instructional activity, or other institutional activity (A-21, section J.18.).

g. Test costs direct charged to Federal awards and indirect costs accumulated in the educational institution’s accounting system for adequate accounting of unallowable costs (A-21 section C.12 and FAR Appendix, 48 CFR section 9905.505).

h. Determine that the educational institution’s cost accounting period for accumulating costs on Federal awards and indirect cost pools are consistent with the institution’s fiscal year. If not, determine that the institution has met the criteria for an exception described in A-21, section C.13 and that it has been approved by the cognizant Federal agency (A-21, section C.13 and FAR Appendix, 48 CFR section 9905.506).

Allowable Costs – Special Requirements – Internal Service, Central Service, Pension, or Similar Activities or Funds

1. Compliance Requirement

Charges made from internal service, central service, pension, or similar activities or funds, must follow the applicable cost principles provided in A-21.



2. Audit Objectives

Obtain an understanding of internal control, assess risk, and test internal control as required by OMB Circular A-133 §___.500(c). Determine whether charges made from internal service, central service, pension, or similar activities or funds are in accordance with A-21.



3. Suggested Internal Control Audit Procedures

a. Using the guidance provided in Part 6 – Internal Control, perform procedures to obtain an understanding of internal control sufficient to plan the audit to support a low assessed level of control risk for the program.

b. Plan the testing of internal control to support a low assessed level of control risk for allowable costs/cost principles and perform the testing of internal control as planned. If internal control over some or all of the compliance requirements is likely to be ineffective, see the alternative procedures in OMB Circular §___.500(c)(3), including assessing the control risk at the maximum and considering whether additional compliance tests and reporting are required because of ineffective internal control.

c. Consider the results of the testing of internal control in assessing the risk of noncompliance. Use this as the basis for determining the nature, timing, and extent (e.g., number of transactions to be selected) of substantive tests of compliance.



4. Suggested Compliance Audit Procedures

The auditor should consider procedures such as the following:



  1. For activities accounted for in separate funds, ascertain if: (1) retained earnings/fund balances (including reserves) were computed in accordance with
    A-21; (2) working capital reserves were not excessive in amount (generally not greater than 60 days for cash expenses for normal operations incurred for the period exclusive of depreciation, capital costs and debt principal costs); and
    (3) refunds were made to the Federal Government for its share of any amounts transferred or borrowed from internal service, central service, pension, insurance, or other similar activities or funds for purposes other than to meet the operating liabilities, including interest on debt, of the fund.

  2. Test that all users of services are billed in a consistent manner.

  3. Test that billing rates exclude unallowable costs, in accordance with A-21.

  4. Test, where activities are not accounted for in separate funds, that billing rates (or charges) are developed based on actual costs and were adjusted to eliminate profits.

  5. For educational institutions that have self-insurance and certain types of fringe benefit programs (e.g., pension funds), ascertain if independent actuarial studies appropriate for such activities are performed at least biennially and that current period costs were allocated based on an appropriate study which is not over 2 years old.

Note: The suggested audit procedures above for internal control and compliance testing may be accomplished using dual-purpose testing.

OMB CIRCULAR A-122
COST PRINCIPLES FOR NON-PROFIT ORGANIZATIONS


Introduction

OMB Circular A-122 (A-122) establishes cost principles for determining costs of grants, contracts, and other agreements with non-profit organizations. The principles are designed to provide that the Federal Government bear its fair share of costs except where restricted or prohibited by law. These principles are used by all Federal agencies in determining the costs of work performed by non-profit organizations under grants, cooperative agreements, and cost reimbursement contracts. All of these instruments are hereafter referred to as “awards.” The principles do not apply to awards under which an organization is not required to account to the Federal Government for actual costs incurred. In addition to the cost principles established by A-122, the Cost Accounting Standards Board (CASB) has promulgated certain accounting standards that must be followed by non-profit organizations receiving procurement contracts that meet a defined dollar threshold. Generally, organizations are exempt from coverage under CAS unless a single CAS-covered contract or subcontract of at least $7.5 million has been received. After receipt of this trigger contract, CAS coverage is applied to all negotiated awards over $500,000 unless they meet certain exemptions. These exemptions and the requirements of CAS can be found in 48 CFR Chapter 99.



Cognizant Agency

A-122, Attachment A, paragraph E.1.a defines “cognizant agency” as the Federal agency responsible for negotiating and approving indirect cost rates for non-profit organizations on behalf of all Federal agencies. References to cognizant agency in this section should not be confused with the cognizant Federal agency for audit responsibilities, which is defined in OMB Circular A-133, Subpart D, §___.400(a).



Availability of Other Information

Additional information on indirect cost rate determination for non-profit organizations can be found at the following web sites:



  • Department of Labor – http://www.dol.gov/oasam/programs/boc/costdeterminationguide/main.htm

  • Department of Health and Human Services – http://rates.psc.gov/fms/dca/np_exall2.html

  • Department of Education – http://www.ed.gov/about/offices/list/ocfo/fipao/abouticg.html - how-are_indirect_cost_rates_determined.

Allowable Costs – General Criteria

1. Basic Considerations to Determine Cost

The basic considerations used to determine costs (direct and indirect) are identified in


A-122, Attachment A, paragraph A and include the following:

a. Composition of cost – The total cost of an award is the sum of the allowable direct and allocable indirect costs less any applicable credits. The term “applicable credits” refers to those receipts, or reduction of expenditures that operate to offset or reduce expense items that are allocable to awards as direct or indirect costs.

b. Allowable costs – A cost is allowable under an award if the cost meets the following general criteria:


  1. Be reasonable for the performance of the award and be allocable in accordance with A-122.

(a) A cost is reasonable if, in its nature or 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. Consideration should be given to:

(i) 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.

(ii) 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.

(iii) Whether the individuals concerned acted with prudence in the circumstances.

(iv) Significant deviations from the established practices of the organization that may unjustifiably increase the award costs.

(b) A cost is allocable to a particular cost objective, such as a grant, contract, project, service or other activity, in accordance with the relative benefits received. Any cost allocable to a particular award or other cost objective under A-122 may not be shifted to other Federal awards to overcome funding deficiencies, or to avoid restrictions imposed by law or terms of the award. A cost is allocable to a Federal award if it is treated consistently with other costs incurred for the same purpose in like circumstances and if it:

(i) Is incurred specifically for the award.

(ii) Benefits both the award and other work and can be distributed in reasonable proportion to the benefits received.

(iii) Is necessary to the overall operation of the organization, although a direct relationship to any particular cost objective cannot be shown.

(2) Conform to any limitations or exclusions set forth in A-122 or in the award.

(3) Be consistent with policies and procedures that apply uniformly to both federally financed and other activities of the organization.

(4) Be accorded consistent treatment.

(5) Be determined in accordance with generally accepted accounting principles (GAAP).

(6) Not be included as a cost or used to meet cost-sharing or matching requirements of any other federally financed program in either the current or a prior period.

(7) Be adequately documented.

(8) Be net of all applicable credits.



2. Selected Items of Cost

A-122, Attachment B, paragraphs 1 through 52, provide principles to be applied in establishing the allowability of certain items of cost. There principles apply whether a cost is treated as direct or indirect. Failure to mention a particular item of cost is not intended to imply that it is unallowable; rather, determination as to allowability in each case should be based on the treatment or principles provided for similar or related items of cost.



Allowable Costs – Direct Costs

1. Compliance Requirements – Direct Costs

Direct costs are those that can be identified specifically with a particular final cost objective, i.e., award, project or other activity of the organization. Any direct cost of a minor amount may be treated as an indirect cost for reasons of practicality where accounting treatment for such cost is consistently applied to all final cost objectives.

Certain direct costs are unallowable for computing charges to Federal awards, nonetheless they must be treated as direct costs for determining indirect cost rates and be allocated their share of indirect costs if they represent activities that (a) include the salaries of personnel, (b) occupy space, and (c) benefit from the organization’s indirect costs. The cost of activities performed primarily as a service to members, clients, or the general public when significant and necessary to the organization’s mission must be treated as direct costs—whether or not allowable—and be allocated a share of indirect costs. Examples can be found in A-122, Attachment A, subparagraph B.4.

If the auditor identifies unallowable direct costs, the auditor should be aware that directly associated costs might have been charged. Directly associated costs are costs incurred solely as a result of incurring another cost that would not have been incurred if the other cost had not been incurred. For example, fringe benefits are directly associated with payroll costs. When a payroll cost is determined to be unallowable than the directly associated fringe benefit would be determined unallowable as well.



2. Audit Objectives – Direct Costs

a. Obtain an understanding of internal control, assess risk, and test internal control as required by OMB Circular A-133 §___.500(c).

b. Determine whether the organization complied with the provisions of A-122 and CAS (if applicable) as follows:

(1) Direct charges to Federal awards were for allowable costs.

(2) Unallowable costs, determined to be direct costs, should be included in the allocation base for the purpose of computing an indirect cost rate.

3. Suggested Internal Control Audit Procedures – Direct Costs


  1. Using the guidance provided in Part 6 – Internal Control, perform procedures to obtain an understanding of internal control sufficient to plan the audit to support a low assessed level of control risk for the program.

  2. Plan the testing of internal control to support a low assessed level of control risk for allowable costs/cost principles and perform the testing of internal control as planned. If internal control over some or all of the compliance requirements is likely to be ineffective, see the alternative procedures in §___.500(c)(3) of OMB Circular A-133, including assessing the control risk at the maximum and considering whether additional compliance tests and reporting are required because of ineffective internal control.

  3. Consider the results of the testing of internal control in assessing the risk of noncompliance. Use this as the basis for determining the nature, timing, and extent (e.g., number of transactions to be selected) of substantive tests of compliance.

4. Suggested Compliance Audit Procedures – Direct Costs

Test direct costs charged to Federal awards with the following criteria:

a. Costs were approved by the Federal awarding agency, if required. (See Exhibit 1, Selected Items of Cost, in this part of the Supplement.)

b. Costs conform to the allowability of cost provisions of A-122, or limitations in the program agreement, program regulations, or program statute.

c. Costs represent charges for actual costs, not budgeted or projected amounts.

d. Costs are given consistent accounting treatment within and between accounting periods. Consistency in accounting requires that costs incurred for the same purpose, in like circumstances, be treated as either direct costs only or indirect costs only with respect to final cost objectives.

e. Costs are calculated in conformity with generally accepted accounting principles, or CAS when required.

f. Costs are not used to meet cost-sharing requirements of other federally supported activities.

g. Costs are net of all applicable credits, e.g., volume or cash discounts, insurance recoveries, refunds, rebates, trade-ins, adjustments for checks not cashed, and scrap sales.

h. Costs are not included as both a direct billing and as a component of indirect costs.

i. Costs are supported by appropriate documentation, such as approved purchase orders, receiving reports, vendor invoices, canceled checks, and time and attendance records, and correctly charged as to account, amount, and period.

Allowable Costs – Indirect Costs

1. Compliance Requirements – Indirect Costs

a. Indirect costs are those costs that have been incurred for common or joint objectives and cannot be readily identified with a particular final cost objective. Stated differently, indirect costs are those costs remaining after direct costs have been determined and assigned directly. While it is not possible to specify the types of costs that will be indirect, there are three major categories of indirect costs for non-profit organizations (NPOs):

(1) Depreciation and Use Allowance – The expenses under this category are that portion of the costs of the organization’s buildings, capital improvements to land and buildings, and equipment, which are computed in accordance with A-122, Attachment B, section 11. Interest on debt associated with certain buildings, equipment, and capital improvements are computed in accordance with A-122, Attachment B, paragraph 23.

(2) Operation and Maintenance – The expenses under this category are those that have been incurred for the administration, operation, maintenance, preservation, and protection of the organization’s physical plant.

(3) General and Administrative – The expenses under this category are those that have been incurred for the overall general executive, and administration of the organization and other expenses of a general nature that do not relate solely to any major function of the organization.

b. Indirect cost rate proposals (ICRPs) prepared by NPOs are based on the most current financial data, supported by the organization’s accounting system and audited financial statements. These ICRPs can be used to either establish predetermined rates, fixed rates with carry-forward provision, provisional, or final rates.

(1) Predetermined rates are established for the current or multiple future period(s) based on current costs (usually costs from the most recently ended fiscal year, known as the base period).

(2) Fixed rates with carry-forward provisions – rates based on current costs in the same manner as predetermined rates. However, the difference between the base period indirect costs and actual indirect cost recovery are carried forward as an adjustment to the rate computation for the subsequent period.

(3) Provisional rates – temporary rates used for funding and billing indirect costs, pending the establishment of a final rate after actual costs are determined for the period.

(3) Final rates – indirect cost rates applicable to a specified past period based on actual costs of that period. Final rates are not subject to adjustment.

c. Some Federal awards may contain cost limitations on recovery of indirect costs that differ from the federally negotiated indirect cost rates. Normally, this may be due to statutory requirements or limitations contained in program announcements. In these cases, the indirect cost rate approved for that award will be specified in the award letter or agreement. For these awards, the award-specific rate takes precedence over the negotiated rate for purposes of indirect cost recovery.

d. To recover indirect costs, NPOs prepare ICRPs. The ICRP is the rate calculation and supporting schedules used to arrive at the indirect cost pool amounts and the base amounts. NPOs can select one of three different methods to calculate the indirect cost rate.

(1) Simplified Allocation Method

(a) Where an organization’s major functions benefit from its indirect costs to approximately the same degree, the allocation of indirect costs may be accomplished by (i) separating the organization’s total costs for the base period as either direct or indirect, and (ii) dividing the total allowable indirect costs (net of applicable credits) by an equitable distribution base. The result of this process is an indirect cost rate, which is used to distribute indirect costs to individual awards. The rate should be expressed as the percentage that the total amount of allowable indirect costs bears to the base selected. This method should also be used where an organization has only one major function encompassing a number of individual projects or activities, and may be used where the level of Federal awards to an organization is relatively small.

(b) For an organization that receives more than $10 million in Federal funding of direct costs in a fiscal year, a breakout of the indirect cost component into two broad categories, Facilities and Administration, as defined in Circular A-122, Attachment A, paragraph C.3, is required. The rate in each case shall be stated as the percentage that the amount of the particular indirect cost category (i.e., Facilities or Administration) is of the distribution base identified with that category.

(c) A full discussion of the simplified allocation method can be found in A-122, Attachment A, subparagraphs D.2.a. through D.2.e.

(2) Multiple Allocation Base Method

(a) Where an organization’s indirect costs benefit its major functions in varying degrees, indirect costs shall be accumulated into separate cost groupings, as described in A-122, Attachment A, subparagraph D.3.b. Each grouping shall then be allocated individually to benefiting functions by means of a base that best measures the relative benefits. The default allocation bases by cost pool are described in A-122, Attachment A, subparagraph D.3.c.

(b) Cost groupings shall be established so as to permit the allocation of each grouping on the basis of benefits provided to the major functions. Each grouping shall constitute a pool of expenses that are of like character in terms of functions they benefit and in terms of the allocation base which best measures the relative benefits provided to each function. The groupings are classified within the two broad categories: “Facilities” and “Administration,” as described in A-122, Attachment A, subparagraph C.3.

(c) Except where a special indirect cost rate(s) is required in accordance with A-122, Attachment A, subparagraph D.5, the separate groupings of indirect costs allocated to each major function shall be aggregated and treated as a common pool for that function. The costs in the common pool shall then be distributed to individual awards included in that function by use of a single indirect cost rate.

(d) Indirect costs shall be distributed to applicable sponsored awards and other benefiting activities within each major function on the basis of modified total direct costs (MTDC). MTDC consists of all salaries and wages, fringe benefits, materials and supplies, services, travel, and subgrants and subcontracts up to the first $25,000 of each subgrant or subcontract (regardless of the period covered by the subgrant or subcontract). Equipment, capital expenditures, charges for patient care, rental costs and the portion in excess of $25,000 shall be excluded from MTDC. Participant support costs shall generally be excluded from MTDC. Other items may only be excluded when the Federal cost cognizant agency determines that an exclusion is necessary to avoid a serious inequity in the distribution of indirect costs.

(e) A full discussion of the multiple allocation base method can be found in A-122, Attachment A, subparagraphs D.3.a. through D.3.g.

(3) Direct Allocation Method

(a) Some NPOs treat all costs as direct costs except general administration and general expenses. These organizations generally separate their costs into three basic categories: (i) General administration and general expenses, (ii) fundraising, and (iii) other direct functions (including projects performed under Federal awards). Joint costs, such as depreciation, rental costs, operation and maintenance of facilities, telephone expenses, and the like are prorated individually as direct costs to each category and to each award or other activity using a base most appropriate to the particular cost being prorated.

(b) This method is acceptable, provided each joint cost is prorated using a base which accurately measures the benefits provided to each award or other activity. The bases must be established in accordance with reasonable criteria, and be supported by current data.

(c) A full discussion of the direct allocation base method can be found in A-122, Attachment A, subparagraph D.4.a. through D.4.c.



2. Audit Objectives – Indirect Costs

a. For NPOs that charge indirect costs to Federal awards based on federally approved rates:

(1) Obtain an understanding of internal controls, assess risk, and test internal controls as required by OMB Circular A-133, §___.500(c).

(2) Determine whether the organization complied with the provisions of


A-122 and CAS (if applicable) as follows:

(a) Indirect cost rates were applied in accordance with approved rate agreements and any special award provisions/limitations (if different from those stated in the negotiated rate agreement).

(b) Associated billings were the result of applying the approved rate to the proper base amount(s).

(3) For fixed rate agreements, predetermined rate agreements, and provisional rate agreements determine whether the base used to distribute the approved indirect cost rate is accurate and reflects the terms of the agreement.

(4) For fixed rate agreements, determine whether the organization has adequately determined the actual indirect costs for the fiscal year being audited and performed the necessary computations to accurately report the carry-forward adjustment to the rate computation for the subsequent period.

b. For NPOs that charge indirect costs to Federal awards that are not based on federally approved rates:



  1. Obtain an understanding of internal controls, assess risk, and test internal controls as required by OMB Circular A-133, §___.500(c).

(2) Determine whether costs that are directly allocated to an award using the Direct Allocation Method are prorated using a base that accurately measures the benefits provided to each award or activity.

(3) Determine whether an ICRP was prepared and submitted to the organization’s cognizant agency (the Federal agency responsible for negotiating and approving indirect cost rates) as required by A-122. Verify that billings are based on the ICRP.

(4) Determine whether the NPO’s calculated indirect cost rate is (a) consistent with policies and procedures that apply uniformly to both federally funded and other activities of the organization, and (b) applied consistently to the proper allocation bases.

(5) Determine whether the organization complied with the provisions of A-122 and CAS as follows:

(a) Charges to indirect cost pools were for allowable costs.

(b) The base used to distribute indirect costs includes both allowable and unallowable costs.

(c) The cost allocation methodology provides equitable and consistent allocation of indirect costs to benefiting awards or activities.

c. For NPOs that also have awards containing award-specific rates (approved by the Federal awarding agency) that take precedence over the negotiated rate for purposes of indirect cost recovery:

(1) Obtain an understanding of internal control, assess risk, and test internal control as required by OMB Circular A-133 §___.500(c).

(2) Determine if the award-specific rate(s) is the result of special circumstances, e.g., required by law or regulation.

(3) Determine whether indirect cost rates were applied in accordance with the approved special award provisions or limitations. Associated billings were the result of applying the approved rate to the proper base amount.

(4) When the maximum amount of allowable indirect costs under a limitation (i.e. an award-specific rate) is less than the total amount determined in accordance with the principles in A-122, the amount not recoverable under a sponsored agreement may not be charged to other sponsored agreements.



3. Suggested Internal Control Audit Procedures – Indirect Costs

a. Using the guidance provided in Part 6 – Internal Control, perform procedures to obtain an understanding of internal control sufficient to plan the audit to support a low assessed level of control risk for the program.

b. Plan the testing of internal control to support a low assessed level of control risk for allowable costs/cost principles and perform the testing of internal control as planned. If internal control over some or all of the compliance requirements is likely to be ineffective, see the alternative procedures in §___.500(c)(3) of OMB Circular A-133, including assessing the control risk at the maximum and considering whether additional compliance tests and reporting are required because of ineffective internal control.

c. Consider the results of the testing of internal control in assessing the risk of noncompliance. Use this as the basis for determining the nature, timing, and extent (e.g., number of transactions to be selected) of substantive tests of compliance.



4. Suggested Compliance Audit Procedures – Indirect Costs

a. For NPOs that charge indirect costs to Federal awards based on federally approved rates:

(1) Ascertain if indirect costs are material for the major programs being tested. If not, the following suggested audit procedures, b. through e., do not apply.

(2) Obtain and read the current indirect cost rate agreement, including the proposal used in the negotiation of the agreement, and determine the terms in effect.

(3) Ascertain whether the indirect cost rate agreement uses a pre-determined rate, fixed rate, provisional rate, or final rate. For definitions of these rates, see A-122, Attachment A, subparagraphs E (b) through (e).

(a) If a fixed rate agreement with carry-forward provisions has been negotiated with the cognizant agency, determine that the difference between the indirect costs recovered using the fixed rate and the actual indirect costs of the period has been calculated. This adjustment is to be carried forward to the rate computation of the subsequent period.

(b) If a provisional rate was used to bill for indirect costs, determine whether a final rate has been established and appropriate claim adjustments have been made based on the final approved rate.

(4) For NPOs required to file Disclosure Statements (48 CFR section 9903.202), ascertain if the cognizant agency for indirect cost negotiation has been appropriately notified of changes in the cost accounting practices that occurred during the year to which indirect cost rate agreements are being applied.



  1. Select a sample of claims for reimbursement:

(a) Verify that the rates used are in accordance with the rate agreement and the amounts claimed were the product of applying the rate to the applicable base.

(b) Verify that the base includes both allowable and unallowable costs.

(c) When the base is total direct costs or modified total direct costs, verify that the distribution base has been properly calculated and excludes capital expenditures and other distorting items such as major subcontracts or subgrants in excess of $25,000 as approved in the negotiated rate agreement or by the cognizant Federal agency.

b. For NPOs that charge indirect costs to Federal awards that are not based on federally approved rates:

(1) Determine if the indirect costs are based on a certified ICRP that has been submitted to (but not approved by) the NPO’s Federal cognizant agency as required by A-122, Attachment A, subparagraph E. If the ICRP is based on costs incurred in the year being audited, then the ICRP should be audited for compliance with the provisions of A-122 (see procedures in paragraphs 4.b(1)(a) through (1)(c) below).

Note: If the NPO has a certified ICRP, which is based on costs incurred in the year being audited, but it has not been submitted to the Federal cognizant agency, the ICRP should still be audited using the procedures in paragraphs 4.b(1)(a) through (1)(c) below.

(a) The following procedures should be applied to costs in the indirect cost pool used for recovering indirect costs from Federal awarding agencies. These costs must:

(i) Be approved by the Federal awarding agency, if required.

(ii) Conform to the allowability of cost provisions of A-122, or limitations in the award agreement, program regulations, or program statute.

(iii) Conform to the allocability provisions of A-122 or CAS.

(iv) Represent charges for actual costs, not budgeted or projected amounts.

(v) With respect to fringe benefit allocations, charges, or rates, be based on the benefits received by different classes of employees within the organization.

(vi) Be applied uniformly to Federal and non-Federal activities.

(vii) Be calculated in conformity with CAS or generally accepted accounting principles, as required.

(viii) Not be used to meet cost-sharing requirements of other federally supported activities.

(ix) Be net of all applicable credits, e.g., volume or cash discounts, insurance recoveries, refunds, rebates, trade-ins, adjustments for checks not cashed, and scrap sales.

(x) Not be included as both a direct billing and as a component of indirect costs.

(xi) Be supported by appropriate documentation, such as approved purchase orders, receiving reports, vendor invoices, canceled checks, and time and attendance records, and correctly charged as to account, amount, and period.

(xii) Be given consistent accounting treatment within and between accounting periods. Consistency in accounting requires that costs incurred for the same purpose, in like circumstances, be treated as either direct costs only or indirect costs only with respect to final cost objectives.

(b) The following procedures should be applied to costs in the base(s) for recovering indirect costs from Federal awarding agencies. Determine whether:

(i) All direct costs, including unallowable costs, are identified and included in the base for indirect cost allocations.

(A) For fixed price agreements, all direct costs are recorded for the purpose of allocating indirect costs.

(B) For cost-reimbursement awards or contracts that include line item costs that exceed budget limits, all direct costs are recorded for the purpose of allocating indirect costs.

(ii) Costs have been recorded in accordance with CAS, generally accepted accounting principles, or other comprehensive basis of accounting, as appropriate.

(iii) Costs have been assigned to the correct cost objective or activity.

(iv) Costs have been given consistent accounting treatment within and between accounting periods.

(c) The following procedures should be applied to costs allocated using the Direct Allocation Method:

(i) Test statistical data (e.g., square footage, case counts, salaries and wages) to ascertain if the proposed allocation bases are reasonable, updated as necessary, and do not contain any material omissions.

(ii) Review time studies or time and effort reports (where and if used) to ascertain if they are accurate, are implemented as approved, and are based on the actual effort devoted to the various functional and programmatic activities to which the salary and wage costs are charged.

(iii) Review the allocation methodology for consistency and test the appropriateness of allocation methods used.

(2) Determine if the indirect costs are based on a certified ICRP that has been submitted to (but not approved by) the NPO’s Federal cognizant agency as required by A-122, Attachment A subparagraph E. If the ICRP is not based on costs incurred in the year being audited (e.g., the year being audited is fiscal year 2008, but the ICRP is based on fiscal year 2007 costs), a review of the ICRP is not required.

(3) If the indirect costs are not based on a certified and submitted ICRP, in accordance with A-122, this may be required to be reported as an audit finding in accordance with OMB Circular A-133, §__.510(a)(5).

(4) Application of indirect cost rates which are not approved by the cognizant agency – Even though the rate(s) have not been approved by the cognizant agency, unapproved indirect cost rate(s) should be reviewed for consistent application of the submitted rates to direct cost bases to ensure that the indirect cost rate(s) are applied consistent with the NPO’s policies and procedures that apply uniformly to both federally-funded and other activities of the NPO (A-122, Attachment A, paragraph A.(2)(c)).

c. For NPOs that also have awards containing award-specific rates (approved by the Federal awarding agency) that take precedence over the negotiated rate for purposes of indirect cost recovery:

(1) Ascertain that the award-specific rate is only being used for the approved award.

(2) Obtain and read the award terms used to establish an award-specific indirect cost rate(s).

(3) Select a sample of claims for reimbursement and verify that the award specific rate(s) is in accordance with the terms of the award, that the rate(s) was applied to the appropriate base(s), and that the amount claimed is the product of applying the rate to the applicable base. Verify that the cost included in the base(s) is consistent with the terms of the agreement.

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