By Dwight Buracker, CPA, CVA

As our government clients strategically manage finances to meet the increasingly complex needs of the public, compliance with Office of Management and Budget (OMB) requirements is critical.

Certain departments incur indirect costs that include administrative expenses related to other departments or agencies. These expenses might be for HR, technology, facilities, legal, finance, etc.

Government Finance Office Association (GFOA) recommends that governments allocate these indirect costs.

However, trying to track each expense and identify a cost center doesn’t make sense from a cost/benefit perspective. As such, it’s acceptable to calculate estimates to link indirect costs to the appropriate departments or programs. According to the OMB, these estimates must be made using a systematic process.

Failure to demonstrate compliance with OMB requirements is common but often unintentional. The source of the problem is typically a lack of communication or misunderstanding of compliance requirements.
Below, we’ve summarized six best practices for indirect cost allocation.

6 Best Practices for Indirect Cost Allocation

GFOA breaks down best practices into six questions that can help you determine an appropriate allocation process for indirect costs.

The allocation can be made by staff or by an external party. To make the best choice, consider these factors:

  • Will constituents be expecting an externally prepared cost allocation?
  • What is the purpose of the allocation? An allocation performed by an external party may make more sense in some situations.

After determining who will perform the allocation, be sure that management is closely involved throughout the allocation process and understands the rationale behind the calculations.

Naturally, independence will be a factor, but other considerations include:

  • Does the external party have relevant knowledge and experience?
  • How will the external team ensure that classifications — to the greatest extent possible — maximize the amount recovered from grant providers, when applicable?
  • The minimum involvement from the government staff should be acquiring a basic understanding of the allocation rationale and process.
  • Government must ensure its accounting system properly classifies the allocations.
  • Government owns the final work product.

It’s important to note that there are more complicated considerations for indirect costs related to grants.

According to best practice guidance, the allocation should be made on an annual basis in order to ensure any new funds or cost centers can be captured.

The process used to review the allocation for accuracy and fairness should be assessed periodically. The frequency will vary based on a few factors, including:

  • Complexity of the calculation and how it will be used
  • Any changes in grant requirements, government administration, or economic factors that may impact cost basis

First, several stakeholders from various departments and agencies should work together to perform the allocation. For accountability purposes, it will make sense to appoint a team leader to resolve any conflicts that arise.

Other considerations include:

  • Does the internal staff have the requisite knowledge and experience to properly analyze the allocation methodology?
  • Is the internal staff aware of and familiar with the applicable laws and regulations related to this type of cost allocation process?
  • How will the team ensure that classifications, to the greatest extent possible, maximize the amount recovered from grant providers, when applicable?
  • Will data be captured and/or manipulated in a manner that avoids audit problems down the road?

Because an indirect cost allocation plan requires more detail and more complex calculations, the OMB recommends, “…a government should determine whether increased cost recovery from grantors and ratepayers would justify the extra effort .”

In addition to ensuring the methodology is “fair, rational, and consistently applied with few exceptions,” GFOA recommends the basis should also “reasonably approximate the proportional share of service received from the service provider.”

Take a Proactive Approach

Preparing a cost allocation plan in accordance with OMB requirements helps to promote awareness and accountability that can minimize the risk of failing to meet various requirements.

However, a proactive and carefully planned and executed indirect cost allocation can also satisfy several objectives from a management perspective.

Because these considerations can demand significant training, time, and effort, our team can simplify and streamline the indirect cost allocation process. Contact us today  for a complimentary consultation.