[Federal Register Volume 60, Number 95 (Wednesday, May 17, 1995)]
[Notices]
[Pages 26484-26507]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-11658]




[[Page 26483]]

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Part II





Office of Management and Budget





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Cost Principles for State, Local and Indian Tribal Governments 
(Circular A-87); Notice

  Federal Register / Vol. 60, No. 95 / Wednesday, May 17, 1995 / 
Notices   
[[Page 26484]] 

OFFICE OF MANAGEMENT AND BUDGET


Cost Principles for State, Local and Indian Tribal Governments

AGENCY: Office of Management and Budget.

5ACTION: Final Revision to OMB Circular A-87, ``Cost Principles for 
State, Local and Indian Tribal Governments''.

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SUMMARY: An interagency task force was established to review existing 
cost principles for Federal awards to State and local governments. The 
task force studied Inspector General reports and recommendations, 
solicited suggestions for changes to the Circular from State and local 
governments, and compared for consistency the provisions of other 
Office of Management and Budget cost principles covering non-profit 
organizations and universities. Proposed revisions reflecting the 
results of those efforts were published on October 12, 1988 (53 FR 
40352-40367) and August 19, 1993 (58 FR 44212-44234). The extensive 
comments received on these proposed revisions, discussions with 
interested groups, and other related developments were considered in 
developing this final revision.

DATES: Agencies shall issue codified regulations to implement the 
provisions of this Circular by September 1, 1995.

ADDRESSES: Office of Management and Budget, Office of Federal Financial 
Management, Financial Standards and Reporting Branch, Room 6025, New 
Executive Office Building, Washington, DC 20503. For a copy of the 
revised Circular, contact Office of Administration, Publications 
Office, Room 2200, New Executive Office Building, Washington, DC 20503, 
or telephone (202)395-7332.

FOR FURTHER INFORMATION CONTACT: Non-Federal organizations should 
contact the organization's cognizant Federal funding agency. Federal 
agencies should contact Gilbert H. Tran, Financial Standards and 
Reporting Branch, Office of Federal Financial Management, Office of 
Management and Budget, telephone: (202)395-3993.

SUPPLEMENTARY INFORMATION:

A. Background

    The Office of Management and Budget (OMB) received about 200 
comments from governmental units, Federal agencies, professional 
organizations and others in response to the Federal Register notice of 
August 19, 1993 (58 FR 44212). All comments were considered in 
developing this final revision.
    OMB also considered the National Performance Review's 
recommendations to reduce paperwork and red tape. Changes were made to 
the Circular to streamline the cost negotiation process and defer to 
State and local accounting procedures whenever possible. Also, the 
policy guides in the Circular were amended to provide that Federal 
agencies should work with States or localities which wish to test 
alternative mechanisms for paying costs for administering Federal 
programs.
    Section B presents a summary of the major public comments grouped 
by subject and a response to each comment. Other changes have been made 
to increase clarity and readability. Section C addresses procurement 
issues. Section D discusses the Federal Acquisition Streamlining Act of 
1994.

B. Public Comments and Responses

Basic Circular

    Comment: The policy subsection states that ``no provision for 
profit or increment above allowable cost is intended.'' This statement 
is currently contained in the Circular, but it is different from that 
contained in other OMB cost principles circulars and is literally 
incorrect. This seems to say no profit or increment above cost is 
permitted.
    Response: This sentence was changed to conform with the other OMB 
cost principles circulars. There is no policy change intended by this 
change.

General Principles for Determining Allowable Costs--Attachment A

    Comment: The requirement in the basic guidelines that ``a cost may 
not be assigned to a Federal award as a direct cost if any other cost 
incurred for the same purpose in like circumstances has been allocated 
to a Federal award as an indirect cost'' appears to be too expansive 
and should be clarified.
    Response: There is no policy change intended from that in the 
existing Circular. The wording in the consistency provision was changed 
to make it clear that all costs incurred for the same purpose in like 
circumstances are either direct costs only or indirect costs only with 
respect to final cost objectives (e.g., grants). No final cost 
objective shall have allocated to it as an indirect cost any cost if 
other costs incurred for the same purpose, in like circumstances, have 
been included as a direct cost of that or any other final cost 
objective. For example, a grantee normally allocates all travel as an 
indirect cost. For purposes of a new grant proposal, the grantee 
intends to allocate the travel costs of personnel whose time is 
accounted for as direct labor directly to the grant. Since travel costs 
of personnel whose time is accounted for as direct labor working on 
other grants are costs which are incurred for the same purpose, these 
costs may no longer be included within indirect cost pools for purposes 
of allocation to any other grant.
    Comment: The Circular lists the market price of comparable goods or 
services as one test of reasonableness. This statement may cause 
problems for State agencies that are required to make purchases from 
State-wide contracts.
    Response: OMB recognizes that market fluctuations may result in a 
State paying higher prices on State-wide contracts. However, 
significant differences between State prices and market prices should 
be analyzed. For example, Federal awards should not be paying higher 
prices for State awards based on geographical preferences.
    Comment: The prohibition against shifting costs allocable to a 
particular Federal award or other cost objective to other Federal 
awards needs to be clarified. Governmental units should not be 
precluded from shifting allowable cost in accordance with program 
agreements.
    Response: This section was expanded to recognize that there are 
instances when it may be appropriate for governmental units to transfer 
costs from one cost objective to another cost objective.
    Comment: It is not logical to require governmental units to 
allocate indirect costs to all activities including donated services.
    Response: The Circular is designed to provide that Federal awards 
bear their fair share of costs. If non-Federal activities use donated 
services that require a substantial amount of support costs, it would 
be inequitable to charge these costs to Federal awards.
    Comment: The section on applicable credits needs to be clarified.
    Response: The language in this section has been revised to remove 
inappropriate examples of applicable credits and references to program 
income which are covered by the grants management common rule.

Selected Items of Cost--Attachment B

Advertising and Public Relations Costs
    Comment: Clarify the allowability of certain public relations type 
costs, such as job fairs and activities to promote ridership on public 
transportation.
    Response: The allowability of these types of costs depends upon the 
circumstances surrounding the individual case. In determining whether 
[[Page 26485]] Federal awards should participate in these types of 
costs, the recipient should consider how similar types of costs are 
charged, and whether there is a direct benefit to Federal awards 
resulting from these costs.
Audit Services
    Comment: The Circular limits the allowability of audit costs to 
single audits and does not provide reimbursement for audits of a less 
comprehensive nature.
    Response: This section was revised to allow the costs of other 
audits.
Automatic Electronic Data Processing
    Comment: The requirement for governmental units to amortize the 
costs associated with the development and testing of automated systems 
would impose an unreasonable financial and administrative burden on the 
governmental units.
    Response: OMB eliminated the requirement for governmental units to 
amortize the costs of developing and testing automated systems until a 
uniform Federal policy covering all types of recipients of Federal 
awards can be developed.
Compensation for Personnel Services
    Comment: The potential paperwork burdens associated with accounting 
for employee leave payments and accruals could be substantial.
    Response: This section was simplified by modifying many of the 
prescriptive accounting rules for leave.
    Comment: Interest cost associated with pension contributions should 
be allowed if the governmental unit's contributions are delayed.
    Response: References to interest payments were deleted. However, 
language was inserted into the Circular to make it clear that Federal 
reimbursement of pension cost must be adjusted when the governmental 
unit's payments to the fund are late. The adjustment should compensate 
for the additional cost because of the timing of the charges to the 
Federal Government and the governmental unit's contribution to the 
pension fund.
    Comment: Governmental units should not be required to use separate 
cost allocation procedures for classes of employees that experience 
different actuarial gains and losses (e.g., police and fire 
departments).
    Response: This requirement was deleted from the Circular.
    Comment: The requirement that a governmental unit obtain Federal 
approval for changing its method for determining pension and post-
retirement health benefit costs should be deleted.
    Response: This requirement was deleted. Pension costs and post- 
retirement health benefit costs determined in accordance with Generally 
Accepted Accounting Principles (GAAP) and the provisions of the 
Circular will be allowable. For contracts covered under Cost Accounting 
Standards (CAS), CAS 412 and 413 promulgated by the Cost Accounting 
Standards Board shall establish the allocability of pension costs.
    Comment: The current principles applicable to support of personnel 
costs have worked well and require no change.
    Response: OMB believes additional guidance is necessary. Federal 
agencies have found that the absence of sufficient guidance on 
documentation to support salaries charged to Federal awards has caused 
numerous audit findings and resulted in endless wasted hours of 
negotiation between Federal agencies and governmental units. Based on 
the comments received, OMB made a number of changes to the requirements 
in this section of the Circular to clarify and simplify Federal 
requirements for documenting salaries charged to Federal awards.
Defense and Prosecution of Criminal and Civil Proceedings, and Claims
    Comment: OMB proposed to substantially amend the provisions on the 
allowability of legal and related expenses. In the 1981 version of the 
Circular, this provision is found at Attachment B, section 16 (46 FR 
9552). In the latest proposal, the proposed revisions were at 
Attachment B, section 14 (58 FR 44222).
    State and local governments contended that the proposed revisions 
on the allowability of legal and related expenses would be unfair and 
would deny them due process.
    State and local governments also objected to the specific proposed 
revisions dealing with legal proceedings based on the Major Fraud Act 
and the Federal Acquisition Regulation (48 CFR 31.205-47) in Attachment 
B, sections 14.a. through f. State and local governments contended that 
those provisions are ambiguous, inconsistent and overly broad. In 
addition, these commenters argued that the provisions were designed for 
commercial contractors and should not be applied to grants.
    Response: After reviewing the comments on the proposed revisions, 
OMB decided not to amend the current provision on the allowability of 
legal and related expenses. In the revised Circular, this provision is 
now found at section 14.b.
    In this revision, OMB has added a provision at section 14.a. This 
provision, which was in the proposal, simply restates the currently-
applicable, statutory restrictions in 10 U.S.C. 2324(k).
Depreciation and Use Allowances
    Comment: It is unclear if a use charge can be charged while an 
asset is in service.
    Response: The Circular now provides that a reasonable use allowance 
may be negotiated for fully depreciated assets; therefore, OMB believes 
a reasonable use allowance could be negotiated for an asset for as long 
as the asset is in service.
    Comment: It is not clear whether accelerated depreciation is 
allowed.
    Response: The preferred method of depreciation is the straight line 
method. However, other methods may be used when there is evidence that 
an asset will be used up faster in the earlier portion of its useful 
life.
    Comment: The estimated useful lives of equipment and buildings used 
to compute use allowances should be shortened.
    Response: No changes were made. Governmental units have the option 
of claiming depreciation which is usually based on the actual life of 
the asset.
    Comment: It is not clear why classes of assets needed to be 
determined on a State-wide, local-wide, or Tribal-wide basis.
    Response: This section was amended to say classes of assets shall 
be determined on the same bases used for the governmental unit's 
financial statements.
Equipment and Other Capital Expenditures
    Comment: The capitalization level for equipment seems to be 
arbitrarily low. The criterion of $25,000, which is recognized by the 
Department of Health and Human Services (HHS), might be more 
appropriate.
    Response: The $5000 criterion is in line with capitalization levels 
used by government contractors and others. The HHS criterion is limited 
to equipment used on a few very large programs where equipment 
purchases are a very small percentage of total program costs. For CAS-
covered contracts subject to ``full coverage'', the threshold for 
equipment is $1500 as established under CAS 404.
    Comment: Clarify the term ``article'' as used in the definition of 
equipment. The Circular defines equipment ``as [[Page 26486]] being an 
article of nonexpendable property.''
    Response: The definition of ``capital expenditure'' was added to 
further define the term ``equipment.'' However, if further guidance is 
needed in this area, governmental units should follow their own 
accounting practices when defining equipment.
    Comment: It is not clear what is meant by ``The total acquisition 
costs are not allowable as indirect costs during the period acquired.''
    Response: This section was clarified. It now says that capital 
expenditures which are not authorized to be charged directly to an 
award may be recovered through use allowances or depreciation.
    Comment: The impact of depreciation as proposed in the Circular 
would shift costs to the governmental unit, not make any provision for 
the time value of money, increase administrative costs to track 
resulting depreciation schedules, and erode the partner relationship 
between Federal agencies and governmental units.
    Response: The accounting treatment for depreciation as prescribed 
by the Circular is based on GAAP. Further, the provisions ensure that 
the Federal Government pays its fair share of costs, including interest 
on financing.
Fund Raising and Investment Management Costs
    Comment: It is not clear whether costs related to raising funds 
from employees within an organization for charitable activities, such 
as the United Way, would be allowable since the Circular disallows fund 
raising costs.
    Response: Generally, the prohibition on fund raising activities 
covered by the Circular is for those activities where the governmental 
unit raises funds for its own use. Incidental fund raising from an 
organization's own employees for charitable organizations, such as the 
United Way, is considered part of normal operating expenses and, 
therefore, allowable.
Gains and Losses on Disposition of Depreciable Property and Other 
Capital Assets and Substantial Relocation of Federal Programs
    Comment: The provisions which would require governmental units to 
reimburse the Federal Government when Federal awards were relocated 
from facilities where the Federal Government participated in the 
financing is inappropriate.
    Response: This section was amended. It now requires governmental 
units to obtain prior approval from the cognizant agency for 
substantial relocations of Federal awards from buildings for which the 
Federal Government participated in the financing.
Insurance and Indemnification
    Comment: It is not apparent why provisions for liabilities, which 
do not become payable for more than one year after a self insurance 
provision is made, are limited to the discounted value of the 
liability.
    Response: This requirement is designed to cover only those cases 
where the amount of the liability is firm or reasonably certain. This 
provision helps to avoid excessive reserve balances for the current 
fiscal year. It limits current year premiums to the present value of 
the future (known or reasonably certain) liability. When that future 
liability becomes due, prior years premiums plus earnings (i.e., 
interest or investment income) from those premiums will be available to 
satisfy that debt.
    Comment: The Circular states that self-insurance reserves must be 
based on sound actuarial principles using the most likely assumptions. 
This seems to be an attempt to limit sound actuarial principles.
    Response: This language was not intended to restrict sound 
actuarial principles. The language was changed to clarify that sound 
actuarial assumptions should recognize actual past, as well as probable 
future, events when determining premiums and reserve levels.
Interest
    Comment: Interest expense should be allowable not only for building 
modifications, as provided in the 1981 revision of Circular A-87, but 
also for acquisitions of equipment made prior to the issuance date of 
the revised Circular. The proposed provision is objectionable because 
it would require dual records and impose an unreasonable and 
unnecessary administrative burden on State and local governments.
    Response: The provision was rewritten to allow interest expense 
paid or incurred on or after the revised Circular's effective date to 
be charged to Federal awards for existing as well as newly-acquired 
equipment.
    Historically, OMB has not allowed interest on debt issued prior to 
the effective date of an interest policy revision (pre-revision debt). 
In 1980, OMB allowed State and local governments interest on debt 
issued to acquire buildings, but not on pre-revision debt (45 FR 
27363). In 1982, in a revision to Circular A-21, ``Cost Principles for 
Educational Institutions,'' OMB allowed interest on debt issued to 
acquire buildings and equipment, but not on pre-revision debt (47 FR 
33658). In 1994, in a proposed revision to Circular A-122, ``Cost 
Principles for Non-Profit Organizations,'' OMB proposed to allow 
interest debt issued to acquire buildings and equipment, but not on 
pre-revision debt (59 FR 49091).
    In view of the fact that pre-revision debt was incurred with full 
knowledge of the cost policy that was in effect at that time, OMB does 
not believe that grantees should expect the Federal Government to allow 
interest on this debt without such a decision being cost-justified from 
the Federal Government's perspective. OMB believes the Federal 
Government should only allow interest on pre-revision debt when the 
cost of maintaining dual records on pre-revision and post-revision 
assets and related debt (all or a portion of these recordkeeping costs 
are chargeable to the Federal programs as administrative costs) is less 
than the interest cost on pre-revision debt.
    With respect to debt incurred to purchase buildings, OMB believes 
that the cost of maintaining dual records is cost-justified in view of 
the limited number of buildings and debt issues for which separate 
records would have to be maintained, and the substantial interest cost 
associated with long term debt used to finance buildings. Thus, as OMB 
has previously explained, ``[a]applying the new rules to old buildings 
would appear to provide a windfall recovery, and might drive up 
overhead costs of federally assisted programs'' (47 FR 33658, also see 
45 FR 27363).
    Equipment acquired by State and local governments (except 
computers), while substantial in terms of the number of pieces, is 
relatively nominal in cost and has a relatively short life span. As a 
result, the outstanding interest on debt issued to finance this 
equipment is relatively nominal. Moreover, State and local governments 
would still bear the major share of the financing costs, even if pre-
revision debt were allowable. By contrast, the cost of maintaining dual 
records for a large number of items and related debt would likely be 
substantial. Given the different balance between administrative and 
interest costs, OMB has decided that, in this instance, the 
administrative costs associated with maintaining separate records to 
track pre-revision and post-revision debt is not cost-justifiable from 
the Federal Government's perspective.
    The basis for the allowance of pre-revision debt for equipment of 
State and local governments is consistent with the basis for OMB's 
treatment of such debt for educational institutions (in 1982) and OMB's 
proposed treatment of such [[Page 26487]] debt for non-profit 
organizations (in 1994). The cost of equipment acquired by educational 
institutions and non-profit organizations through debt financing can be 
significant (e.g., over $650,000 for x-ray crystallography equipment, 
$348,000 for a vantage flow cytometer for high speed cell analysis, and 
$265,000 for an electron microscope). Equipment of this type and 
related debt has a longer life, and in turn, significantly higher 
interest cost. Moreover, as with buildings, there are only a limited 
number of pieces of such equipment, which reduces the administrative 
costs of dual records. Given the amount of interest involved in the 
financing of these assets compared with the relatively nominal 
administrative burden associated with maintaining dual records, OMB 
believes the cost of maintaining dual records is justifiable.
    Comment: The requirement for a governmental unit to document, as 
part of its decisionmaking process, that capital leasing is the most 
economical option does not belong in Circular A-87.
    Response: The requirement for lease analysis as part of the 
governmental unit's decisionmaking process and its proper documentation 
is addressed in the Grants Management Common Rule under Section 
____.36(b)(4). This requirement is not addressed in Circular A-87.
    Comment: Governmental units would not recover their full costs 
because of provisions in the Circular which provide that a credit is 
due the Federal Government when Federal payments for interest, 
depreciation, use charges and other contributions for building use 
exceed the interest and principal payments made by the government 
(positive cash flow).
    Response: OMB deleted the provisions in the Circular which would 
require credits under the conditions described above. However, 
governmental units will be required to negotiate the amount of 
allowable interest whenever cash payments (interest, use allowances, 
depreciation and contributions) exceed governmental unit cash payments 
and other governmental unit contributions. OMB will study this matter 
further to ensure fair and equitable policies are established for the 
States and the Federal Government.
Memberships, Subscriptions, and Professional Activities
    Comment: Membership costs in some civic and community organizations 
should be allowable when the purpose is to promote services provided by 
the Federal award.
    Response: The language has been revised to allow memberships in 
civic and community organizations as a direct cost with the prior 
approval of the Federal awarding agency.
Professional Service Costs
    Comment: Simplify the section on professional service costs by 
eliminating the factors to consider in determining the allowability of 
professional service costs.
    Response: Eight subsections listing the factors were deleted.
Proposal Costs
    Comment: It is not clear why proposal costs should normally be 
treated as indirect costs and allocated to all activities. Such costs 
should be treated as direct costs if they can be identified with a 
specific award.
    Response: OMB added a provision to allow governmental units to 
charge proposal costs directly to a Federal award with the prior 
approval of the Federal awarding agency.
Taxes
    Comment: If OMB adopts the proposed revision affecting sales tax 
reimbursement, the revision should become effective at some later date 
to allow time to change State and local laws.
    Response: OMB agrees that there should be a phase-in period. The 
Circular allows governmental units three years to phase-in the change.
    Comment: If the sales tax proposal were adopted, it would become a 
burden to separately account for State sales taxes paid on Federal 
grant purchases.
    Response: The Circular allows reasonable approximations to be used 
where the identification of the actual amount of unallowed taxes would 
require an inordinate amount of effort.
    Comment: State sales taxes should be allowable when a governmental 
unit is in a position that makes exclusion administratively impossible, 
i.e., when employees in travel status must pay sales taxes upon receipt 
of goods and services.
    Response: States should attempt a reasonable approximation.
    Comment: Some State and local governments and Indian Tribal 
governments would lose substantial amounts of revenue if sales taxes 
were not chargeable to purchases made in connection with federally-
funded programs.
    Response: The intention of the tax provision is to address State or 
local government taxes, or changes in tax policy, that 
disproportionately affect a federally-funded program. Under the 
Circular, such taxes are unallowable. (As explained in the next 
comment-and-response, where a Federal statute prescribes a different 
treatment for taxes, that statute controls.)
    For example, a tax would disproportionately affect a Federal 
program if the tax were defined or applied so that it was imposed only 
in connection with that program, or only in connection with Federal 
programs generally. Another example would be if a sales tax were 
imposed on a good or service that in practice is used solely or 
disproportionately in connection with Federal programs. These examples 
are for illustration, and are not meant to be exclusive. Whether a 
particular tax, or change in tax policy, would disproportionately 
affect a Federal program will have to be determined based on a review 
of the tax and the Federal programs in question.
    When a governmental unit pays a tax to itself, that self-assessed 
tax is not a true cost to the governmental unit. Especially where a 
self-assessed tax disproportionately affects a Federal program, it is 
not appropriate for the governmental unit to be able to characterize 
that tax as a ``cost'' of its participation in the Federal program. If 
such disproportionate, self-assessed taxes were treated as allowable, 
even though they disproportionately affect Federal programs, 
governmental units could define or apply taxes in such a way that their 
net impact would largely be to increase the Federal Government's 
contribution, rather than to raise revenues from the taxpayer. To the 
extent that making such taxes unallowable would result in a loss of 
Federal assistance awards, the Circular allows three years for 
governmental units to phase-out any existing taxes that 
disproportionately affect Federal programs. (For the larger formula 
grant programs, the disallowance of such taxes would not result in any 
loss of Federal assistance awards; the funds which are now used to pay 
self-assessed taxes could be used to further the objectives of the 
Federal assistance.)
    Comment: The proposed revision on sales taxes is directly contrary 
to the legislative intent of Public Law 102-234, ``Medicaid Voluntary 
Contributions and Provider Specific Tax Amendments of 1991.'' The 
proposal should be revised to preclude its application to broad-based 
health care related taxes paid by public entities.
    Response: The Circular would not take precedence over a statute. If 
any statute specifically prescribes policies [[Page 26488]] and 
specific requirements that differ from the Circular, the statute will 
govern.
    Comment: State sales taxes collected by another level of government 
should be exempt from the provisions of the Circular.
    Response: As noted above, the Circular's disallowance is directed 
at self-assessed taxes. Thus, if a local government receives an award 
directly from the Federal Government, and pays a State sales tax on 
purchases made in connection with that award, the tax is an allowable 
cost. (However, as previously noted, the Circular does not restrict the 
authority of Federal agencies to identify taxes where Federal 
participation is inappropriate.)
    However, if the local government does not receive the award 
directly from the Federal Government, but instead receives the award 
indirectly by virtue of a State pass-through, then the sales tax that 
the local government pays the State is in reality a self-assessed tax, 
which would be unallowable if the tax disproportionately affects a 
Federal program.
    Comment: It is not clear whether the prohibition on payment of 
sales taxes applies to out-of-state sales tax.
    Response: Since they are not self-assessed, taxes assessed by other 
States, or political subdivisions of other States, are not unallowable 
under the Circular. (However, as previously noted, the Circular does 
not restrict the authority of Federal agencies to identify taxes where 
Federal participation is inappropriate.)
Travel Costs
    Comment: Airfare costs in excess of the lowest available commercial 
discount fare are unallowable. With today's confusing array of super 
savers and fare wars, the burden involved in proving the lowest airfare 
would be considerable.
    Response: The travel provisions were changed to say travel costs in 
excess of the customary standard (coach or equivalent) airfare are 
unallowable.

State/Local-Wide Central Service Cost Allocation Plans--Attachment C

    Comment: Working capital reserves in many cases should not be 
limited to 60 days cash expenses. Time consuming collections, uneven 
usage levels, and unanticipated demand for services are some of the 
reasons for authorizing a larger reserve.
    Response: OMB believes the 60 day reserve should provide the 
flexibility required by most funds to operate from one billing cycle to 
the next. However, the Circular was amended to provide for a larger 
reserve in exceptional cases when approved by the cognizant Federal 
agency.
    Comment: The Circular should not restrict governmental units from 
engaging an accounting firm to prepare an indirect cost proposal and 
then engaging the same firm to make subsequent audits.
    Response: This provision was deleted from the Circular. This issue 
will be addressed as part of OMB policy changes to other OMB grants 
management circulars.
    Comment: What are the criteria OMB uses for making cognizant 
assignments and for defining ``major governments''?
    Response:  OMB is in the process of reviewing the cognizant 
assignments for governmental units. Only governmental units receiving 
substantial amounts of direct Federal assistance will be assigned a 
Federal cognizant agency and be required to submit plans to those 
cognizant agencies. Because the mix of Federal awards has changed so 
much since the last list was issued, OMB needs to develop a new dollar 
criterion for defining ``major.''
    Comment: States and other prime grantees should not be required to 
monitor subrecipient cost allocation plans and/or negotiate sub-
recipient indirect costs.
    Response:  The grants management common rule requires governmental 
units to monitor subawards to assure compliance with applicable Federal 
requirements. These requirements include compliance with the cost 
principles. In those cases where the subrecipient does not receive any 
Federal awards directly from the Federal Government, Federal agencies 
would not have any direct responsibility for negotiating indirect 
costs.
    Comment: Attachment C, Section E states that ``The documentation 
requirements in this section may be modified, expanded, or reduced by 
the cognizant agency on a case-by-case basis.'' This specific sentence 
might allow a Federal cognizant agency to unreasonably and unilaterally 
expand the documentation requirements.
    Response:  Federal agencies should have the flexibility to obtain 
additional data, when necessary. However, OMB agrees that this type of 
request should be the exception rather than the rule.
    Comment: Documentation for internal service funds seems excessive 
since these areas are audited. This documentation is more appropriately 
included in a State or local government's financial statements and work 
papers for the fiscal year rather than in the entity's cost allocation 
plan.
    Response:  OMB amended this section to require only the largest 
funds to submit data. If the required data are included in the 
governmental unit's financial statements, submission of the financial 
statements to the Federal cognizant agency will meet the requirements 
of the Circular.
    Comment: OMB proposed to add provisions requiring the certification 
of cost allocation plans and of indirect cost rates (see preamble (58 
FR 44218); Attachment C, Section E.4 (58 FR 44229); Attachment D, 
Section D.3 (58 FR 44230-31); and Attachment E, Section D.3 (58 FR 
44233)). States objected to the inclusion of the phrase ``under penalty 
of perjury'' in the proposed certification. They contended that the 
phrase is unnecessary.
    Response: OMB has decided to amend the Circular to add the proposed 
certifications, but OMB has accepted the commenters' suggestion that 
the phrase ``under penalty of perjury'' not be included in the 
certifications. OMB believes that, when the Federal Government is 
dealing with State and local governments, it is unnecessary to require 
that the certifying government official sign a certification stating 
that it is made ``under penalty of perjury.'' State and local officials 
should not conclude, however, that the omission of the phrase ``under 
penalty of perjury'' means that no potential legal liability is 
associated with a certification's submission. In this regard, note the 
provision in Federal law imposing criminal penalties for ``false, 
fictitious or fraudulent statements or representations'' (18 U.S.C. 
1001). The Department of Justice is responsible for enforcing this 
provision (and other laws regarding false statements and claims). OMB 
expresses no opinion concerning the potential legal liabilities that 
are associated with making the certifications in the revised Circular.
    Comment: Restricting the authority to reopen Central Service Plans 
to the Federal cognizant agency is inequitable.
    Response: This section was changed to state that agreements may be 
subject to reopening only if the agreement is subsequently found to 
violate a statute or the information upon which the plan was negotiated 
is later found to be materially incomplete or inaccurate.
    Comment: GAAP for State and local governments do not require 
internal service activities to be accounted for and reported in 
proprietary accounts.
    Response: The requirement for internal service activities to be 
accounted for in proprietary accounts was deleted.
    Comment: Remove the requirement that a carry forward adjustment is 
not [[Page 26489]] permitted for a central service activity that was 
not included in the approved plan.

    Response: The carry forward technique was intended to permit 
adjustments for differences between actual and estimated costs of 
services included in a cost allocation plan. It was not intended to 
shift the entire cost of an activity excluded from the year of the plan 
to a future year. There may be circumstances where a change to the plan 
should be considered (e.g., the service did not exist when the plan was 
established and was initiated during the year covered by the plan). 
This type of amendment should modify the plan itself and would not be 
handled through a carry forward adjustment.

    Comment: Adjustments of billed services do not provide a workable 
solution for the larger central services of the States. The dollar 
limitation of $50,000 for making adjustments through allocated central 
services is too low.

    Response: This section was rewritten to provide governmental units 
more options and flexibility in making adjustments to Federal awards.

Public Assistance Cost Allocation Plans--Attachment D

    Comment: The public assistance cost allocation plans are narrative 
descriptions of cost allocation procedures rather than allocations of 
actual costs. The provisions dealing with refunds or adjustments 
related to unallowable costs and the certification of cost allowability 
do not appear appropriate.

    Response: The certification and the provisions dealing with refunds 
and adjustments were deleted.

State and Local Indirect Cost Rate Proposals--Attachment E

    Comment: The Circular is silent on the time period for use of 
predetermined rates.

    Response: The Circular was amended to encourage the use of indirect 
cost rates for a period of two to four years.

    Comment: Governmental units should notify the Federal Government of 
any accounting changes that might make it necessary to renegotiate the 
predetermined rate.

    Response: A provision was added to the certification which requires 
the governmental unit to notify the Federal Government of any 
accounting changes that would effect the application of the 
predetermined rate.

C. Procurement Issues

    Several procurement issues arose during the Federal Government's 
internal review process. This section clarifies the procurement issues.

Effective Date for Governmental Units With Predetermined Rates Beyond 
September 1, 1995

    For a governmental unit that already has established indirect cost 
rates beyond September 1, 1995, the effective date of the revised 
Circular shall be at the start of the next accounting period beginning 
on or after September 1, 1995, for which the governmental unit has not 
yet established a predetermined indirect cost rate.

Depreciation Method(s) for CAS-Covered Contracts

    CAS-covered contracts subject to ``full coverage'' under CASB shall 
follow the standards promulgated by CASB in the computation of 
depreciation.

Allowability of Interest Expenses for CAS-Covered Contracts

    For contracts subject to CAS 414 (48 CFR 9903.414, cost of money as 
an element of the cost of capital), and CAS 417 (48 CFR 9903.417, cost 
of money as an element of the cost of capital assets under 
construction), the imputed cost of money determined allocable in 
accordance with CAS 414 and 417 may be claimed as an allowable cost. 
When cost of money is claimed, interest shall not be an allowable 
direct or indirect cost under such contracts.

D. Federal Acquisition Streamline Act

    The Federal Acquisition Streamlining Act (FASA) of 1994, enacted on 
October 13, 1994, amended Section 306(e) of the Federal Property and 
Administrative Services Act of 1949 (41 U.S.C. 256, Public Law 103-355, 
Section 2151, 108 Stat. 3309-12), to specify certain items of costs as 
not allowable under Federal covered contracts. OMB is undertaking a 
review of these FASA provisions, for the purpose of determining whether 
the unallowable cost provisions of Circular A-87, and of OMB's other 
cost principles circulars, should be amended in light of the FASA 
provisions on unallowable costs. If OMB ultimately concludes that 
amendments may be appropriate, OMB will issue a proposal seeking public 
comment on the proposed revisions.
John B. Arthur,
Associate Director for Administration.

Executive Office of The President

Office of Management and Budget

Washington, DC 20503

May 4, 1995.

Circular No. A-87 Revised

To the Heads of Executive Departments and Establishments

From: Alice M. Rivlin, Director
Subject: Cost Principles for State, Local, and Indian Tribal 
Governments

    1. Purpose. This Circular establishes principles and standards 
for determining costs for Federal awards carried out through grants, 
cost reimbursement contracts, and other agreements with State and 
local governments and federally-recognized Indian tribal governments 
(governmental units).
    2. Authority. This Circular is issued under the authority of the 
Budget and Accounting Act of 1921, as amended; the Budget and 
Accounting Procedures Act of 1950, as amended; the Chief Financial 
Officers Act of 1990; Reorganization Plan No. 2 of 1970; and 
Executive Order No. 11541 (``Prescribing the Duties of the Office of 
Management and Budget and the Domestic Policy Council in the 
Executive Office of the President'').
    3. Background. An interagency task force was established in 1987 
to review existing cost principles for Federal awards to State, 
local, and Indian tribal governments. The task force studied 
Inspector General reports and recommendations, solicited suggestions 
for changes to the Circular from governmental units, and compared 
for consistency the provisions of other OMB cost principles 
circulars covering non-profit organizations and universities. A 
proposed revised Circular reflecting the results of those efforts 
was issued on October 12, 1988, and August 19, 1993. Extensive 
comments on the proposed revisions, discussions with interest 
groups, and related developments were considered in developing this 
revision.
    4. Rescissions. This Circular rescinds and supersedes Circular 
A-87, issued January 15, 1981.
    5. Policy. This Circular establishes principles and standards to 
provide a uniform approach for determining costs and to promote 
effective program delivery, efficiency, and better relationships 
between governmental units and the Federal Government. The 
principles are for determining allowable costs only. They are not 
intended to identify the circumstances or to dictate the extent of 
Federal and governmental unit participation in the financing of a 
particular Federal award. Provision for profit or other increment 
above cost is outside the scope of this Circular.
    6. Definitions. Definitions of key terms used in this Circular 
are contained in Attachment A, Section B.
    7. Required Action. Agencies responsible for administering 
programs that involve cost reimbursement contracts, grants, and 
other agreements with governmental units shall [[Page 26490]] issue 
codified regulations to implement the provisions of this Circular 
and its Attachments by September 1, 1995.
    8. OMB Responsibilities. The Office of Management and Budget 
(OMB) will review agency regulations and implementation of this 
Circular, and will provide policy interpretations and assistance to 
insure effective and efficient implementation. Any exceptions will 
be subject to approval by OMB. Exceptions will only be made in 
particular cases where adequate justification is presented.
    9. Information Contact. Further information concerning this 
Circular may be obtained by contacting the Office of Federal 
Financial Management, Financial Standards and Reporting Branch, 
Office of Management and Budget, Washington, DC 20503, telephone 
202-395-3993.
    10. Policy Review Date. OMB Circular A-87 will have a policy 
review three years from the date of issuance.
    11. Effective Date. This Circular is effective as follows:

--For costs charged indirectly or otherwise covered by the cost 
allocation plans described in Attachments C, D and E, this revision 
shall be applied to cost allocation plans and indirect cost 
proposals submitted or prepared for a governmental unit's fiscal 
year that begins on or after September 1, 1995.
--For other costs, this revision shall be applied to all awards or 
amendments, including continuation or renewal awards, made on or 
after September 1, 1995.
OMB Circular No. A-87--Cost Principles for State, Local and Indian 
Tribal Governments

Table of Contents

Attachment A--General Principles for Determining Allowable Costs
Attachment B--Selected Items of Cost
Attachment C--State/Local-Wide Central Service Cost Allocation Plans
Attachment D--Public Assistance Cost Allocation Plans
Attachment E--State and Local Indirect Cost Rate Proposals

Attachment A--General Principles for Determining Allowable Costs

Table of Contents

A. Purpose and Scope
    1. Objectives
    2. Policy guides
    3. Application
B. Definitions
    1. Approval or authorization of the awarding or cognizant 
Federal agency
    2. Award
    3. Awarding agency
    4. Central service cost allocation plan
    5. Claim
    6. Cognizant agency
    7. Common rule
    8. Contract
    9. Cost
    10. Cost allocation plan
    11. Cost objective
    12. Federally-recognized Indian tribal government
    13. Governmental unit
    14. Grantee department or agency
    15. Indirect cost rate proposal
    16. Local government
    17. Public assistance cost allocation plan
    18. State
C. Basic Guidelines
    1. Factors affecting allowability of costs
    2. Reasonable costs
    3. Allocable costs
    4. Applicable credits
D. Composition of Cost
    1. Total cost
    2. Classification of costs
E. Direct Costs
    1. General
    2. Application
    3. Minor items
F. Indirect Costs
    1. General
    2. Cost allocation plans and indirect cost proposals
    3. Limitation on indirect or administrative costs
G. Interagency Services
H. Required Certifications

A. Purpose and Scope

    1. Objectives. This Attachment establishes principles for 
determining the allowable costs incurred by State, local, and 
federally-recognized Indian tribal governments (governmental units) 
under grants, cost reimbursement contracts, and other agreements with 
the Federal Government (collectively referred to in this Circular as 
``Federal awards''). The principles are for the purpose of cost 
determination and are not intended to identify the circumstances or 
dictate the extent of Federal or governmental unit participation in the 
financing of a particular program or project. The principles are 
designed to provide that Federal awards bear their fair share of cost 
recognized under these principles except where restricted or prohibited 
by law. Provision for profit or other increment above cost is outside 
the scope of this Circular.
    2. Policy guides.
    a. The application of these principles is based on the fundamental 
premises that:
    (1) Governmental units are responsible for the efficient and 
effective administration of Federal awards through the application of 
sound management practices.
    (2) Governmental units assume responsibility for administering 
Federal funds in a manner consistent with underlying agreements, 
program objectives, and the terms and conditions of the Federal award.
    (3) Each governmental unit, in recognition of its own unique 
combination of staff, facilities, and experience, will have the primary 
responsibility for employing whatever form of organization and 
management techniques may be necessary to assure proper and efficient 
administration of Federal awards.
    b. Federal agencies should work with States or localities which 
wish to test alternative mechanisms for paying costs for administering 
Federal programs. The Office of Management and Budget (OMB) encourages 
Federal agencies to test fee-for-service alternatives as a replacement 
for current cost-reimbursement payment methods in response to the 
National Performance Review's (NPR) recommendation. The NPR recommended 
the fee-for-service approach to reduce the burden associated with 
maintaining systems for charging administrative costs to Federal 
programs and preparing and approving cost allocation plans. This 
approach should also increase incentives for administrative 
efficiencies and improve outcomes.
    3. Application.
    a. These principles will be applied by all Federal agencies in 
determining costs incurred by governmental units under Federal awards 
(including subawards) except those with (1) Publicly-financed 
educational institutions subject to OMB Circular A-21, ``Cost 
Principles for Educational Institutions,'' and (2) programs 
administered by publicly-owned hospitals and other providers of medical 
care that are subject to requirements promulgated by the sponsoring 
Federal agencies. However, this Circular does apply to all central 
service and department/agency costs that are allocated or billed to 
those educational institutions, hospitals, and other providers of 
medical care or services by other State and local government 
departments and agencies.
    b. All subawards are subject to those Federal cost principles 
applicable to the particular organization concerned. Thus, if a 
subaward is to a governmental unit (other than a college, university or 
hospital), this Circular shall apply; if a subaward is to a commercial 
organization, the cost principles applicable to commercial 
organizations shall apply; if a subaward is to a college or university, 
Circular A-21 shall apply; if a subaward is to a hospital, the cost 
principles used by the Federal awarding agency for awards to hospitals 
shall apply, subject to the provisions of subsection A.3.a. of this 
Attachment; if a subaward is to some other non-profit organization, 
Circular A-122, ``Cost Principles for Non-Profit Organizations,'' shall 
apply.
    c. These principles shall be used as a guide in the pricing of 
fixed price arrangements where costs are used in determining the 
appropriate price. [[Page 26491]] 
    d. Where a Federal contract awarded to a governmental unit 
incorporates a Cost Accounting Standards (CAS) clause, the requirements 
of that clause shall apply. In such cases, the governmental unit and 
the cognizant Federal agency shall establish an appropriate advance 
agreement on how the governmental unit will comply with applicable CAS 
requirements when estimating, accumulating and reporting costs under 
CAS-covered contracts. The agreement shall indicate that OMB Circular 
A-87 requirements will be applied to other Federal awards. In all 
cases, only one set of records needs to be maintained by the 
governmental unit.
B. Definitions

    1. ``Approval or authorization of the awarding or cognizant Federal 
agency'' means documentation evidencing consent prior to incurring a 
specific cost. If such costs are specifically identified in a Federal 
award document, approval of the document constitutes approval of the 
costs. If the costs are covered by a State/local-wide cost allocation 
plan or an indirect cost proposal, approval of the plan constitutes the 
approval.
    2. ``Award'' means grants, cost reimbursement contracts and other 
agreements between a State, local and Indian tribal government and the 
Federal Government.
    3. ``Awarding agency'' means (a) with respect to a grant, 
cooperative agreement, or cost reimbursement contract, the Federal 
agency, and (b) with respect to a subaward, the party that awarded the 
subaward.
    4. ``Central service cost allocation plan'' means the documentation 
identifying, accumulating, and allocating or developing billing rates 
based on the allowable costs of services provided by a governmental 
unit on a centralized basis to its departments and agencies. The costs 
of these services may be allocated or billed to users.
    5. ``Claim'' means a written demand or written assertion by the 
governmental unit or grantor seeking, as a matter of right, the payment 
of money in a sum certain, the adjustment or interpretation of award 
terms, or other relief arising under or relating to the award. A 
voucher, invoice or other routine request for payment that is not a 
dispute when submitted is not a claim. Appeals, such as those filed by 
a governmental unit in response to questioned audit costs, are not 
considered claims until a final management decision is made by the 
Federal awarding agency.
    6. ``Cognizant agency'' means the Federal agency responsible for 
reviewing, negotiating, and approving cost allocation plans or indirect 
cost proposals developed under this Circular on behalf of all Federal 
agencies. OMB publishes a listing of cognizant agencies.
    7. ``Common Rule'' means the ``Uniform Administrative Requirements 
for Grants and Cooperative Agreements to State and Local Governments; 
Final Rule'' originally issued at 53 FR 8034-8103 (March 11, 1988). 
Other common rules will be referred to by their specific titles.
    8. ``Contract'' means a mutually binding legal relationship 
obligating the seller to furnish the supplies or services (including 
construction) and the buyer to pay for them. It includes all types of 
commitments that obligate the government to an expenditure of 
appropriated funds and that, except as otherwise authorized, are in 
writing. In addition to bilateral instruments, contracts include (but 
are not limited to): awards and notices of awards; job orders or task 
orders issued under basic ordering agreements; letter contracts; 
orders, such as purchase orders, under which the contract becomes 
effective by written acceptance or performance; and, bilateral contract 
modifications. Contracts do not include grants and cooperative 
agreements covered by 31 U.S.C. 6301 et seq.
    9. ``Cost'' means an amount as determined on a cash, accrual, or 
other basis acceptable to the Federal awarding or cognizant agency. It 
does not include transfers to a general or similar fund.
    10. ``Cost allocation plan'' means central service cost allocation 
plan, public assistance cost allocation plan, and indirect cost rate 
proposal. Each of these terms are further defined in this section.
    11. ``Cost objective'' means a function, organizational 
subdivision, contract, grant, or other activity for which cost data are 
needed and for which costs are incurred.
    12. ``Federally-recognized Indian tribal government'' means the 
governing body or a governmental agency of any Indian tribe, band, 
nation, or other organized group or community (including any native 
village as defined in Section 3 of the Alaska Native Claims Settlement 
Act, 85 Stat. 688) certified by the Secretary of the Interior as 
eligible for the special programs and services provided through the 
Bureau of Indian Affairs.
    13. ``Governmental unit'' means the entire State, local, or 
federally-recognized Indian tribal government, including any component 
thereof. Components of governmental units may function independently of 
the governmental unit in accordance with the term of the award.
    14. ``Grantee department or agency'' means the component of a 
State, local, or federally-recognized Indian tribal government which is 
responsible for the performance or administration of all or some part 
of a Federal award.
    15. ``Indirect cost rate proposal'' means the documentation 
prepared by a governmental unit or component thereof to substantiate 
its request for the establishment of an indirect cost rate as described 
in Attachment E of this Circular.
    16. ``Local government'' means a county, municipality, city, town, 
township, local public authority, school district, special district, 
intrastate district, council of governments (whether or not 
incorporated as a non-profit corporation under State law), any other 
regional or interstate government entity, or any agency or 
instrumentality of a local government.
    17. ``Public assistance cost allocation plan'' means a narrative 
description of the procedures that will be used in identifying, 
measuring and allocating all administrative costs to all of the 
programs administered or supervised by State public assistance agencies 
as described in Attachment D of this Circular.
    18. ``State'' means any of the several States of the United States, 
the District of Columbia, the Commonwealth of Puerto Rico, any 
territory or possession of the United States, or any agency or 
instrumentality of a State exclusive of local governments.

C. Basic Guidelines

    1. Factors affecting allowability of costs. To be allowable under 
Federal awards, costs must meet the following general criteria:
    a. Be necessary and reasonable for proper and efficient performance 
and administration of Federal awards.
    b. Be allocable to Federal awards under the provisions of this 
Circular.
    c. Be authorized or not prohibited under State or local laws or 
regulations.
    d. Conform to any limitations or exclusions set forth in these 
principles, Federal laws, terms and conditions of the Federal award, or 
other governing regulations as to types or amounts of cost items.
    e. Be consistent with policies, regulations, and procedures that 
apply uniformly to both Federal awards and other activities of the 
governmental unit.
    f. Be accorded consistent treatment. A cost may not be assigned to 
a Federal award as a direct cost if any other cost incurred for the 
same purpose in like [[Page 26492]] circumstances has been allocated to 
the Federal award as an indirect cost.
    g. Except as otherwise provided for in this Circular, be determined 
in accordance with generally accepted accounting principles.
    h. Not be included as a cost or used to meet cost sharing or 
matching requirements of any other Federal award in either the current 
or a prior period, except as specifically provided by Federal law or 
regulation.
    i. Be the net of all applicable credits.
    j. Be adequately documented.
    2. Reasonable costs. 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. The question of reasonableness is particularly 
important when governmental units or components are predominately 
federally-funded. In determining reasonableness of a given cost, 
consideration shall be given to:
    a. 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.
    b. The restraints or requirements imposed by such factors as: sound 
business practices; arms length bargaining; Federal, State and other 
laws and regulations; and, terms and conditions of the Federal award.
    c. Market prices for comparable goods or services.
    d. 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.
    e. Significant deviations from the established practices of the 
governmental unit which may unjustifiably increase the Federal award's 
cost.
    3. Allocable costs.
    a. A cost is allocable to a particular cost objective if the goods 
or services involved are chargeable or assignable to such cost 
objective in accordance with relative benefits received.
    b. All activities which benefit from the governmental unit's 
indirect cost, including unallowable activities and services donated to 
the governmental unit by third parties, will receive an appropriate 
allocation of indirect costs.
    c. Any cost allocable to a particular Federal award or cost 
objective under the principles provided for in this Circular may not be 
charged to other Federal awards to overcome fund deficiencies, to avoid 
restrictions imposed by law or terms of the Federal awards, or for 
other reasons. However, this prohibition would not preclude 
governmental units from shifting costs that are allowable under two or 
more awards in accordance with existing program agreements.
    d. Where an accumulation of indirect costs will ultimately result 
in charges to a Federal award, a cost allocation plan will be required 
as described in Attachments C, D, and E.
    4. Applicable credits.
    a. Applicable credits refer to those receipts or reduction of 
expenditure-type transactions that offset or reduce expense items 
allocable to Federal awards as direct or indirect costs. Examples of 
such transactions are: purchase discounts, rebates or allowances, 
recoveries or indemnities on losses, insurance refunds or rebates, and 
adjustments of overpayments or erroneous charges. To the extent that 
such credits accruing to or received by the governmental unit relate to 
allowable costs, they shall be credited to the Federal award either as 
a cost reduction or cash refund, as appropriate.
    b. In some instances, the amounts received from the Federal 
Government to finance activities or service operations of the 
governmental unit should be treated as applicable credits. 
Specifically, the concept of netting such credit items (including any 
amounts used to meet cost sharing or matching requirements) should be 
recognized in determining the rates or amounts to be charged to Federal 
awards. (See Attachment B, item 15, ``Depreciation and use 
allowances,'' for areas of potential application in the matter of 
Federal financing of activities.)

D. Composition of Cost

    1. Total cost. The total cost of Federal awards is comprised of the 
allowable direct cost of the program, plus its allocable portion of 
allowable indirect costs, less applicable credits.
    2. Classification of costs. There is no universal rule for 
classifying certain costs as either direct or indirect under every 
accounting system. A cost may be direct with respect to some specific 
service or function, but indirect with respect to the Federal award or 
other final cost objective. Therefore, it is essential that each item 
of cost be treated consistently in like circumstances either as a 
direct or an indirect cost. Guidelines for determining direct and 
indirect costs charged to Federal awards are provided in the sections 
that follow.
E. Direct Costs

    1. General. Direct costs are those that can be identified 
specifically with a particular final cost objective.
    2. Application. Typical direct costs chargeable to Federal awards 
are:
    a. Compensation of employees for the time devoted and identified 
specifically to the performance of those awards.
    b. Cost of materials acquired, consumed, or expended specifically 
for the purpose of those awards.
    c. Equipment and other approved capital expenditures.
    d. Travel expenses incurred specifically to carry out the award.
    3. Minor items. 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.

F. Indirect Costs

    1. General. Indirect costs are those: (a) incurred for a common or 
joint purpose benefiting more than one cost objective, and (b) not 
readily assignable to the cost objectives specifically benefitted, 
without effort disproportionate to the results achieved. The term 
``indirect costs,'' as used herein, applies to costs of this type 
originating in the grantee department, as well as those incurred by 
other departments in supplying goods, services, and facilities. To 
facilitate equitable distribution of indirect expenses to the cost 
objectives served, it may be necessary to establish a number of pools 
of indirect costs within a governmental unit department or in other 
agencies providing services to a governmental unit department. Indirect 
cost pools should be distributed to benefitted cost objectives on bases 
that will produce an equitable result in consideration of relative 
benefits derived.
    2. Cost allocation plans and indirect cost proposals. Requirements 
for development and submission of cost allocation plans and indirect 
cost rate proposals are contained in Attachments C, D, and E.
    3. Limitation on indirect or administrative costs.
    a. In addition to restrictions contained in this Circular, there 
may be laws that further limit the amount of administrative or indirect 
cost allowed.
    b. Amounts not recoverable as indirect costs or administrative 
costs under one Federal award may not be shifted to another Federal 
award, unless specifically authorized by Federal legislation or 
regulation. [[Page 26493]] 

G. Interagency Services

    The cost of services provided by one agency to another within the 
governmental unit may include allowable direct costs of the service 
plus a pro rate share of indirect costs. A standard indirect cost 
allowance equal to ten percent of the direct salary and wage cost of 
providing the service (excluding overtime, shift premiums, and fringe 
benefits) may be used in lieu of determining the actual indirect costs 
of the service. These services do not include centralized services 
included in central service cost allocation plans as described in 
Attachment C.

H. Required Certifications

    Each cost allocation plan or indirect cost rate proposal required 
by Attachments C and E must comply with the following:
    1. No proposal to establish a cost allocation plan or an indirect 
cost rate, whether submitted to a Federal cognizant agency or 
maintained on file by the governmental unit, shall be acceptable unless 
such costs have been certified by the governmental unit using the 
Certificate of Cost Allocation Plan or Certificate of Indirect Costs as 
set forth in Attachments C and E. The certificate must be signed on 
behalf of the governmental unit by an individual at a level no lower 
than chief financial officer of the governmental unit that submits the 
proposal or component covered by the proposal.
    2. No cost allocation plan or indirect cost rate shall be approved 
by the Federal Government unless the plan or rate proposal has been 
certified. Where it is necessary to establish a cost allocation plan or 
an indirect cost rate and the governmental unit has not submitted a 
certified proposal for establishing such a plan or rate in accordance 
with the requirements, the Federal Government may either disallow all 
indirect costs or unilaterally establish such a plan or rate. Such a 
plan or rate may be based upon audited historical data or such other 
data that have been furnished to the cognizant Federal agency and for 
which it can be demonstrated that all unallowable costs have been 
excluded. When a cost allocation plan or indirect cost rate is 
unilaterally established by the Federal Government because of failure 
of the governmental unit to submit a certified proposal, the plan or 
rate established will be set to ensure that potentially unallowable 
costs will not be reimbursed.

Attachment B--Selected Items of Cost

Table of Contents

1. Accounting
2. Advertising and public relations costs
3. Advisory councils
4. Alcoholic beverages
5. Audit services
6. Automatic electronic data processing
7. Bad debts
8. Bonding costs
9. Budgeting
10. Communications
11. Compensation for personnel services
    a. General
    b. Reasonableness
    c. Unallowable costs
    d. Fringe benefits
    e. Pension plan costs
    f. Post-retirement health benefits
    g. Severance pay
    h. Support of salaries and wages
    i. Donated services
12. Contingencies
13. Contributions and donations
14. Defense and prosecution of criminal and civil proceedings, and 
claims
15. Depreciation and use allowances
16. Disbursing service
17. Employee morale, health, and welfare costs
18. Entertainment
19. Equipment and other capital expenditures
20. Fines and penalties
21. Fund raising and investment management costs
22. Gains and losses on disposition of depreciable property and 
other capital assets and substantial relocation of Federal programs
23. General government expenses
24. Idle facilities and idle capacity
25. Insurance and indemnification
26. Interest
27. Lobbying
28. Maintenance, operations, and repairs
29. Materials and supplies
30. Memberships, subscriptions, and professional activities
31. Motor pools
32. Pre-award costs
33. Professional service costs
34. Proposal costs
35. Publication and printing costs
36. Rearrangements and alterations
37. Reconversion costs
38. Rental costs
39. Taxes
40. Training
41. Travel costs
42. Underrecovery of costs under Federal agreements

    Sections 1 through 42 provide principles to be applied in 
establishing the allowability or unallowability of certain items of 
cost. These principles apply whether a cost is treated as direct or 
indirect. A cost is allowable for Federal reimbursement only to the 
extent of benefits received by Federal awards and its conformance with 
the general policies and principles stated in Attachment A to this 
Circular. Failure to mention a particular item of cost in these 
sections is not intended to imply that it is either allowable or 
unallowable; rather, determination of allowability in each case should 
be based on the treatment or standards provided for similar or related 
items of cost.
    1. Accounting. The cost of establishing and maintaining accounting 
and other information systems is allowable.
    2. Advertising and public relations costs.
    a. The term ``advertising costs'' means the costs of advertising 
media and corollary administrative costs. Advertising media include 
magazines, newspapers, radio and television programs, direct mail, 
exhibits, and the like.
    b. The term ``public relations'' includes community relations and 
means those activities dedicated to maintaining the image of the 
governmental unit or maintaining or promoting understanding and 
favorable relations with the community or public at large or any 
segment of the public.
    c. Advertising costs are allowable only when incurred for the 
recruitment of personnel, the procurement of goods and services, the 
disposal of surplus materials, and any other specific purposes 
necessary to meet the requirements of the Federal award. Advertising 
costs associated with the disposal of surplus materials are not 
allowable where all disposal costs are reimbursed based on a standard 
rate as specified in the grants management common rule.
    d. Public relations costs are allowable when:
    (1) Specifically required by the Federal award and then only as a 
direct cost;
    (2) Incurred to communicate with the public and press pertaining to 
specific activities or accomplishments that result from performance of 
the Federal award and then only as a direct cost; or
    (3) Necessary to conduct general liaison with news media and 
government public relations officers, to the extent that such 
activities are limited to communication and liaison necessary to keep 
the public informed on matters of public concern, such as notices of 
Federal contract/grant awards, financial matters, etc.
    e. Unallowable advertising and public relations costs include the 
following:
    (1) All advertising and public relations costs other than as 
specified in subsections c. and d.;
    (2) Except as otherwise permitted by these cost principles, costs 
of conventions, meetings, or other events [[Page 26494]] related to 
other activities of the governmental unit including:
     (a) Costs of displays, demonstrations, and exhibits;
     (b) Costs of meeting rooms, hospitality suites, and other special 
facilities used in conjunction with shows and other special events; and
     (c) Salaries and wages of employees engaged in setting up and 
displaying exhibits, making demonstrations, and providing briefings;
    (3) Costs of promotional items and memorabilia, including models, 
gifts, and souvenirs; and
    (4) Costs of advertising and public relations designed solely to 
promote the governmental unit.
    3. Advisory councils. Costs incurred by advisory councils or 
committees are allowable as a direct cost where authorized by the 
Federal awarding agency or as an indirect cost where allocable to 
Federal awards.
    4. Alcoholic beverages. Costs of alcoholic beverages are 
unallowable.
    5. Audit services. The costs of audits are allowable provided that 
the audits were performed in accordance with the Single Audit Act, as 
implemented by Circular A-128, ``Audits of State and Local 
Governments.'' Generally, the percentage of costs charged to Federal 
awards for a single audit shall not exceed the percentage derived by 
dividing Federal funds expended by total funds expended by the 
recipient or subrecipient (including program matching funds) during the 
fiscal year. The percentage may be exceeded only if appropriate 
documentation demonstrates higher actual costs.
    Other audit costs are allowable if specifically approved by the 
awarding or cognizant agency as a direct cost to an award or included 
as an indirect cost in a cost allocation plan or rate.
    6. Automatic electronic data processing. The cost of data 
processing services is allowable (but see section 19, Equipment and 
other capital expenditures).
    7. Bad debts. Any losses arising from uncollectible accounts and 
other claims, and related costs, are unallowable unless provided for in 
Federal program award regulations.
    8. Bonding costs. Costs of bonding employees and officials are 
allowable to the extent that such bonding is in accordance with sound 
business practice.
    9. Budgeting. Costs incurred for the development, preparation, 
presentation, and execution of budgets are allowable.
    10. Communications. Costs of telephone, mail, messenger, and 
similar communication services are allowable.
    11. Compensation for personnel services.
    a. General. Compensation for personnel services includes all 
remuneration, paid currently or accrued, for services rendered during 
the period of performance under Federal awards, including but not 
necessarily limited to wages, salaries, and fringe benefits. The costs 
of such compensation are allowable to the extent that they satisfy the 
specific requirements of this Circular, and that the total compensation 
for individual employees:
    (1) Is reasonable for the services rendered and conforms to the 
established policy of the governmental unit consistently applied to 
both Federal and non-Federal activities;
    (2) Follows an appointment made in accordance with a governmental 
unit's laws and rules and meets merit system or other requirements 
required by Federal law, where applicable; and
    (3) Is determined and supported as provided in subsection h.
    b. Reasonableness. Compensation for employees engaged in work on 
Federal awards will be considered reasonable to the extent that it is 
consistent with that paid for similar work in other activities of the 
governmental unit. In cases where the kinds of employees required for 
Federal awards are not found in the other activities of the 
governmental unit, compensation will be considered reasonable to the 
extent that it is comparable to that paid for similar work in the labor 
market in which the employing government competes for the kind of 
employees involved. Compensation surveys providing data representative 
of the labor market involved will be an acceptable basis for evaluating 
reasonableness.
    c. Unallowable costs. Costs which are unallowable under other 
sections of these principles shall not be allowable under this section 
solely on the basis that they constitute personnel compensation.
    d. Fringe benefits.
    (1) Fringe benefits are allowances and services provided by 
employers to their employees as compensation in addition to regular 
salaries and wages. Fringe benefits include, but are not limited to, 
the costs of leave, employee insurance, pensions, and unemployment 
benefit plans. Except as provided elsewhere in these principles, the 
costs of fringe benefits are allowable to the extent that the benefits 
are reasonable and are required by law, governmental unit-employee 
agreement, or an established policy of the governmental unit.
    (2) The cost of fringe benefits in the form of regular compensation 
paid to employees during periods of authorized absences from the job, 
such as for annual leave, sick leave, holidays, court leave, military 
leave, and other similar benefits, are allowable if: (a) they are 
provided under established written leave policies; (b) the costs are 
equitably allocated to all related activities, including Federal 
awards; and, (c) the accounting basis (cash or accrual) selected for 
costing each type of leave is consistently followed by the governmental 
unit.
    (3) When a governmental unit uses the cash basis of accounting, the 
cost of leave is recognized in the period that the leave is taken and 
paid for. Payments for unused leave when an employee retires or 
terminates employment are allowable in the year of payment provided 
they are allocated as a general administrative expense to all 
activities of the governmental unit or component.
    (4) The accrual basis may be only used for those types of leave for 
which a liability as defined by Generally Accepted Accounting 
Principles (GAAP) exists when the leave is earned. When a governmental 
unit uses the accrual basis of accounting, in accordance with GAAP, 
allowable leave costs are the lesser of the amount accrued or funded.
    (5) The cost of fringe benefits in the form of employer 
contributions or expenses for social security; employee life, health, 
unemployment, and worker's compensation insurance (except as indicated 
in section 25, Insurance and indemnification); pension plan costs (see 
subsection e.); and other similar benefits are allowable, provided such 
benefits are granted under established written policies. Such benefits, 
whether treated as indirect costs or as direct costs, shall be 
allocated to Federal awards and all other activities in a manner 
consistent with the pattern of benefits attributable to the individuals 
or group(s) of employees whose salaries and wages are chargeable to 
such Federal awards and other activities.
    e. Pension plan costs. Pension plan costs may be computed using a 
pay-as-you-go method or an acceptable actuarial cost method in 
accordance with established written policies of the governmental unit.
    (1) For pension plans financed on a pay-as-you-go method, allowable 
costs will be limited to those representing actual payments to retirees 
or their beneficiaries.
    (2) Pension costs calculated using an actuarial cost-based method 
recognized by GAAP are allowable for a given fiscal year if they are 
funded for that year [[Page 26495]] within six months after the end of 
that year. Costs funded after the six month period (or a later period 
agreed to by the cognizant agency) are allowable in the year funded. 
The cognizant agency may agree to an extension of the six month period 
if an appropriate adjustment is made to compensate for the timing of 
the charges to the Federal Government and related Federal reimbursement 
and the governmental unit's contribution to the pension fund. 
Adjustments may be made by cash refund or other equitable procedures to 
compensate the Federal Government for the time value of Federal 
reimbursements in excess of contributions to the pension fund.
    (3) Amounts funded by the governmental unit in excess of the 
actuarially determined amount for a fiscal year may be used as the 
governmental unit's contribution in future periods.
    (4) When a governmental unit converts to an acceptable actuarial 
cost method, as defined by GAAP, and funds pension costs in accordance 
with this method, the unfunded liability at the time of conversion 
shall be allowable if amortized over a period of years in accordance 
with GAAP.
    (5) The Federal Government shall receive an equitable share of any 
previously allowed pension costs (including earnings thereon) which 
revert or inure to the governmental unit in the form of a refund, 
withdrawal, or other credit.
    f. Post-retirement health benefits. Post-retirement health benefits 
(PRHB) refers to costs of health insurance or health services not 
included in a pension plan covered by subsection e. for retirees and 
their spouses, dependents, and survivors. PRHB costs may be computed 
using a pay-as-you-go method or an acceptable actuarial cost method in 
accordance with established written polices of the governmental unit.
    (1) For PRHB financed on a pay as-you-go method, allowable costs 
will be limited to those representing actual payments to retirees or 
their beneficiaries.
    (2) PRHB costs calculated using an actuarial cost method recognized 
by GAAP are allowable if they are funded for that year within six 
months after the end of that year. Costs funded after the six month 
period (or a later period agreed to by the cognizant agency) are 
allowable in the year funded. The cognizant agency may agree to an 
extension of the six month period if an appropriate adjustment is made 
to compensate for the timing of the charges to the Federal Government 
and related Federal reimbursements and the governmental unit's 
contributions to the PRHB fund. Adjustments may be made by cash refund, 
reduction in current year's PRHB costs, or other equitable procedures 
to compensate the Federal Government for the time value of Federal 
reimbursements in excess of contributions to the PRHB fund.
    (3) Amounts funded in excess of the actuarially determined amount 
for a fiscal year may be used as the government's contribution in a 
future period.
    (4) When a governmental unit converts to an acceptable actuarial 
cost method and funds PRHB costs in accordance with this method, the 
initial unfunded liability attributable to prior years shall be 
allowable if amortized over a period of years in accordance with GAAP, 
or, if no such GAAP period exists, over a period negotiated with the 
cognizant agency.
    (5) To be allowable in the current year, the PRHB costs must be 
paid either to:
     (a) An insurer or other benefit provider as current year costs or 
premiums, or
     (b) An insurer or trustee to maintain a trust fund or reserve for 
the sole purpose of providing post-retirement benefits to retirees and 
other beneficiaries.
    (6) The Federal Government shall receive an equitable share of any 
amounts of previously allowed post-retirement benefit costs (including 
earnings thereon) which revert or inure to the governmental unit in the 
form of a refund, withdrawal, or other credit.
    g. Severance pay.
    (1) Payments in addition to regular salaries and wages made to 
workers whose employment is being terminated are allowable to the 
extent that, in each case, they are required by (a) law, (b) employer-
employee agreement, or (c) established written policy.
    (2) Severance payments (but not accruals) associated with normal 
turnover are allowable. Such payments shall be allocated to all 
activities of the governmental unit as an indirect cost.
    (3) Abnormal or mass severance pay will be considered on a case-by-
case basis and is allowable only if approved by the cognizant Federal 
agency.
    h. Support of salaries and wages. These standards regarding time 
distribution are in addition to the standards for payroll 
documentation.
    (1) Charges to Federal awards for salaries and wages, whether 
treated as direct or indirect costs, will be based on payrolls 
documented in accordance with generally accepted practice of the 
governmental unit and approved by a responsible official(s) of the 
governmental unit.
    (2) No further documentation is required for the salaries and wages 
of employees who work in a single indirect cost activity.
    (3) Where employees are expected to work solely on a single Federal 
award or cost objective, charges for their salaries and wages will be 
supported by periodic certifications that the employees worked solely 
on that program for the period covered by the certification. These 
certifications will be prepared at least semi-annually and will be 
signed by the employee or supervisory official having first hand 
knowledge of the work performed by the employee.
    (4) Where employees work on multiple activities or cost objectives, 
a distribution of their salaries or wages will be supported by 
personnel activity reports or equivalent documentation which meets the 
standards in subsection (5) unless a statistical sampling system (see 
subsection (6)) or other substitute system has been approved by the 
cognizant Federal agency. Such documentary support will be required 
where employees work on:
     (a) More than one Federal award,
     (b) A Federal award and a non-Federal award,
     (c) An indirect cost activity and a direct cost activity,
     (d) Two or more indirect activities which are allocated using 
different allocation bases, or
     (e) An unallowable activity and a direct or indirect cost 
activity.
    (5) Personnel activity reports or equivalent documentation must 
meet the following standards:
     (a) They must reflect an after-the-fact distribution of the actual 
activity of each employee,
     (b) They must account for the total activity for which each 
employee is compensated,
     (c) They must be prepared at least monthly and must coincide with 
one or more pay periods, and
     (d) They must be signed by the employee.
     (e) Budget estimates or other distribution percentages determined 
before the services are performed do not qualify as support for charges 
to Federal awards but may be used for interim accounting purposes, 
provided that:
     (i) The governmental unit's system for establishing the estimates 
produces reasonable approximations of the activity actually performed;
     (ii) At least quarterly, comparisons of actual costs to budgeted 
distributions based on the monthly activity reports are made. Costs 
charged to Federal [[Page 26496]] awards to reflect adjustments made as 
a result of the activity actually performed may be recorded annually if 
the quarterly comparisons show the differences between budgeted and 
actual costs are less than ten percent; and
     (iii) The budget estimates or other distribution percentages are 
revised at least quarterly, if necessary, to reflect changed 
circumstances.
    (6) Substitute systems for allocating salaries and wages to Federal 
awards may be used in place of activity reports. These systems are 
subject to approval if required by the cognizant agency. Such systems 
may include, but are not limited to, random moment sampling, case 
counts, or other quantifiable measures of employee effort.
     (a) Substitute systems which use sampling methods (primarily for 
Aid to Families with Dependent Children (AFDC), Medicaid, and other 
public assistance programs) must meet acceptable statistical sampling 
standards including:
     (i) The sampling universe must include all of the employees whose 
salaries and wages are to be allocated based on sample results except 
as provided in subsection (c);
     (ii) The entire time period involved must be covered by the 
sample; and
     (iii) The results must be statistically valid and applied to the 
period being sampled.
     (b) Allocating charges for the sampled employees' supervisors, 
clerical and support staffs, based on the results of the sampled 
employees, will be acceptable.
     (c) Less than full compliance with the statistical sampling 
standards noted in subsection (a) may be accepted by the cognizant 
agency if it concludes that the amounts to be allocated to Federal 
awards will be minimal, or if it concludes that the system proposed by 
the governmental unit will result in lower costs to Federal awards than 
a system which complies with the standards.
    (7) Salaries and wages of employees used in meeting cost sharing or 
matching requirements of Federal awards must be supported in the same 
manner as those claimed as allowable costs under Federal awards.
    i. Donated services.
    (1) Donated or volunteer services may be furnished to a 
governmental unit by professional and technical personnel, consultants, 
and other skilled and unskilled labor. The value of these services is 
not reimbursable either as a direct or indirect cost. However, the 
value of donated services may be used to meet cost sharing or matching 
requirements in accordance with the provisions of the Common Rule.
    (2) The value of donated services utilized in the performance of a 
direct cost activity shall, when material in amount, be considered in 
the determination of the governmental unit's indirect costs or rate(s) 
and, accordingly, shall be allocated a proportionate share of 
applicable indirect costs.
    (3) To the extent feasible, donated services will be supported by 
the same methods used by the governmental unit to support the 
allocability of regular personnel services.
    12. Contingencies. Contributions to a contingency reserve or any 
similar provision made for events the occurrence of which cannot be 
foretold with certainty as to time, or intensity, or with an assurance 
of their happening, are unallowable. The term ``contingency reserve'' 
excludes self-insurance reserves (see subsection 25.c.), pension plan 
reserves (see subsection 11.e.), and post-retirement health and other 
benefit reserves (see subsection 11.f.) computed using acceptable 
actuarial cost methods.
    13. Contributions and donations. Contributions and donations, 
including cash, property, and services, by governmental units to 
others, regardless of the recipient, are unallowable.
    14. Defense and prosecution of criminal and civil proceedings, and 
claims.
    a. The following costs are unallowable for contracts covered by 10 
U.S.C. 2324(k), ``Allowable costs under defense contracts.''
    (1) Costs incurred in defense of any civil or criminal fraud 
proceeding or similar proceeding (including filing of false 
certification brought by the United States where the contractor is 
found liable or has pleaded nolo contendere to a charge of fraud or 
similar proceeding (including filing of a false certification).
    (2) Costs incurred by a contractor in connection with any criminal, 
civil or administrative proceedings commenced by the United States or a 
State to the extent provided in 10 U.S.C. 2324(k).
    b. Legal expenses required in the administration of Federal 
programs are allowable. Legal expenses for prosecution of claims 
against the Federal Government are unallowable.
    15. Depreciation and use allowances.
    a. Depreciation and use allowances are means of allocating the cost 
of fixed assets to periods benefitting from asset use. Compensation for 
the use of fixed assets on hand may be made through depreciation or use 
allowances. A combination of the two methods may not be used in 
connection with a single class of fixed assets (e.g., buildings, office 
equipment, computer equipment, etc.) except as provided in subsection 
g. Except for enterprise funds and internal service funds that are 
included as part of a State/local cost allocation plan, classes of 
assets shall be determined on the same basis used for the government-
wide financial statements.
    b. The computation of depreciation or use allowances shall be based 
on the acquisition cost of the assets involved. Where actual cost 
records have not been maintained, a reasonable estimate of the original 
acquisition cost may be used. The value of an asset donated to the 
governmental unit by an unrelated third party shall be its fair market 
value at the time of donation. Governmental or quasi-governmental 
organizations located within the same State shall not be considered 
unrelated third parties for this purpose.
    c. The computation of depreciation or use allowances will exclude:
    (1) The cost of land;
    (2) Any portion of the cost of buildings and equipment borne by or 
donated by the Federal Government irrespective of where title was 
originally vested or where it presently resides; and
    (3) Any portion of the cost of buildings and equipment contributed 
by or for the governmental unit, or a related donor organization, in 
satisfaction of a matching requirement.
    d. Where the use allowance method is followed, the use allowance 
for buildings and improvements (including land improvements, such as 
paved parking areas, fences, and sidewalks) will be computed at an 
annual rate not exceeding two percent of acquisition costs. The use 
allowance for equipment will be computed at an annual rate not 
exceeding 6\2/3\ percent of acquisition cost. When the use allowance 
method is used for buildings, the entire building must be treated as a 
single asset; the building's components (e.g., plumbing system, heating 
and air condition, etc.) cannot be segregated from the building's 
shell. The two percent limitation, however, need not be applied to 
equipment which is merely attached or fastened to the building but not 
permanently fixed to it and which is used as furnishings or decorations 
or for specialized purposes (e.g., dentist chairs and dental treatment 
units, counters, laboratory benches bolted to the floor, dishwashers, 
modular furniture, carpeting, etc.). Such equipment will be considered 
as not being permanently fixed to the building if it can be removed 
without the destruction of, or need for costly or extensive alterations 
or repairs, to the building or the equipment. Equipment that meets 
these [[Page 26497]] criteria will be subject to the 6\2/3\ percent 
equipment use allowance limitation.
    e. Where the depreciation method is followed, the period of useful 
service (useful life) established in each case for usable capital 
assets must take into consideration such factors as type of 
construction, nature of the equipment used, historical usage patterns, 
technological developments, and the renewal and replacement policies of 
the governmental unit followed for the individual items or classes of 
assets involved. In the absence of clear evidence indicating that the 
expected consumption of the asset will be significantly greater in the 
early portions than in the later portions of its useful life, the 
straight line method of depreciation shall be used. Depreciation 
methods once used shall not be changed unless approved by the Federal 
cognizant or awarding agency. When the depreciation method is 
introduced for application to an asset previously subject to a use 
allowance, the annual depreciation charge thereon may not exceed the 
amount that would have resulted had the depreciation method been in 
effect from the date of acquisition of the asset. The combination of 
use allowances and depreciation applicable to the asset shall not 
exceed the total acquisition cost of the asset or fair market value at 
time of donation.
    f. When the depreciation method is used for buildings, a building's 
shell may be segregated from the major component of the building (e.g., 
plumbing system, heating, and air conditioning system, etc.) and each 
major component depreciated over its estimated useful life, or the 
entire building (i.e., the shell and all components) may be treated as 
a single asset and depreciated over a single useful life.
    g. A reasonable use allowance may be negotiated for any assets that 
are considered to be fully depreciated, after taking into consideration 
the amount of depreciation previously charged to the government, the 
estimated useful life remaining at the time of negotiation, the effect 
of any increased maintenance charges, decreased efficiency due to age, 
and any other factors pertinent to the utilization of the asset for the 
purpose contemplated.
    h. Charges for use allowances or depreciation must be supported by 
adequate property records. Physical inventories must be taken at least 
once every two years (a statistical sampling approach is acceptable) to 
ensure that assets exist, and are in use. Governmental units will 
manage equipment in accordance with State laws and procedures. When the 
depreciation method is followed, depreciation records indicating the 
amount of depreciation taken each period must also be maintained.
    16. Disbursing service. The cost of disbursing funds by the 
Treasurer or other designated officer is allowable.
    17. Employee morale, health, and welfare costs. The costs of health 
or first-aid clinics and/or infirmaries, recreational facilities, 
employee counseling services, employee information publications, and 
any related expenses incurred in accordance with a governmental unit's 
policy are allowable. Income generated from any of these activities 
will be offset against expenses.
    18. Entertainment. Costs of entertainment, including amusement, 
diversion, and social activities and any costs directly associated with 
such costs (such as tickets to shows or sports events, meals, lodging, 
rentals, transportation, and gratuities) are unallowable.
    19. Equipment and other capital expenditures.
    a. As used in this section the following terms have the meanings as 
set forth below:
    (1) ``Capital expenditure'' means the cost of the asset including 
the cost to put it in place. Capital expenditure for equipment means 
the net invoice price of the equipment, including the cost of any 
modifications, attachments, accessories, or auxiliary apparatus 
necessary to make it usable for the purpose for which it is acquired. 
Ancillary charges, such as taxes, duty, protective in transit 
insurance, freight, and installation may be included in, or excluded 
from, capital expenditure cost in accordance with the governmental 
unit's regular accounting practices.
    (2) ``Equipment'' means an article of nonexpendable, tangible 
personal property having a useful life of more than one year and an 
acquisition cost which equals the lesser of (a) the capitalization 
level established by the governmental unit for financial statement 
purposes, or (b) $5000.
    (3) ``Other capital assets'' mean buildings, land, and improvements 
to buildings or land that materially increase their value or useful 
life.
    b. Capital expenditures which are not charged directly to a Federal 
award may be recovered through use allowances or depreciation on 
buildings, capital improvements, and equipment (see section 15). See 
also section 38 for allowability of rental costs for buildings and 
equipment.
    c. Capital expenditures for equipment, including replacement 
equipment, other capital assets, and improvements which materially 
increase the value or useful life of equipment or other capital assets 
are allowable as a direct cost when approved by the awarding agency. 
Federal awarding agencies are authorized at their option to waive or 
delegate this approval requirement.
    d. Items of equipment with an acquisition cost of less than $5000 
are considered to be supplies and are allowable as direct costs of 
Federal awards without specific awarding agency approval.
    e. The unamortized portion of any equipment written off as a result 
of a change in capitalization levels may be recovered by (1) continuing 
to claim the otherwise allowable use allowances or depreciation charges 
on the equipment or by (2) amortizing the amount to be written off over 
a period of years negotiated with the cognizant agency.
    f. When replacing equipment purchased in whole or in part with 
Federal funds, the governmental unit may use the equipment to be 
replaced as a trade-in or sell the property and use the proceeds to 
offset the cost of the replacement property.
    20. Fines and penalties. Fines, penalties, damages, and other 
settlements resulting from violations (or alleged violations) of, or 
failure of the governmental unit to comply with, Federal, State, local, 
or Indian tribal laws and regulations are unallowable except when 
incurred as a result of compliance with specific provisions of the 
Federal award or written instructions by the awarding agency 
authorizing in advance such payments.
    21. Fund raising and investment management costs.
    a. Costs of organized fund raising, including financial campaigns, 
solicitation of gifts and bequests, and similar expenses incurred to 
raise capital or obtain contributions are unallowable, regardless of 
the purpose for which the funds will be used.
    b. Costs of investment counsel and staff and similar expenses 
incurred to enhance income from investments are unallowable. However, 
such costs associated with investments covering pension, self-
insurance, or other funds which include Federal participation allowed 
by this Circular are allowable.
    c. Fund raising and investment activities shall be allocated an 
appropriate share of indirect costs under the conditions described in 
subsection C.3.b. of Attachment A.
    22. Gains and losses on disposition of depreciable property and 
other capital assets and substantial relocation of Federal programs. 
[[Page 26498]] 
    a. (1) Gains and losses on the sale, retirement, or other 
disposition of depreciable property shall be included in the year in 
which they occur as credits or charges to the asset cost grouping(s) in 
which the property was included. The amount of the gain or loss to be 
included as a credit or charge to the appropriate asset cost 
grouping(s) shall be the difference between the amount realized on the 
property and the undepreciated basis of the property.
    (2) Gains and losses on the disposition of depreciable property 
shall not be recognized as a separate credit or charge under the 
following conditions:
    (a) The gain or loss is processed through a depreciation account 
and is reflected in the depreciation allowable under sections 15 and 
19.
    (b) The property is given in exchange as part of the purchase price 
of a similar item and the gain or loss is taken into account in 
determining the depreciation cost basis of the new item.
    (c) A loss results from the failure to maintain permissible 
insurance, except as otherwise provided in subsection 25.d.
    (d) Compensation for the use of the property was provided through 
use allowances in lieu of depreciation.
    b. Substantial relocation of Federal awards from a facility where 
the Federal Government participated in the financing to another 
facility prior to the expiration of the useful life of the financed 
facility requires Federal agency approval. The extent of the 
relocation, the amount of the Federal participation in the financing, 
and the depreciation charged to date may require negotiation of space 
charges for Federal awards.
    c. Gains or losses of any nature arising from the sale or exchange 
of property other than the property covered in subsection a., e.g., 
land or included in the fair market value used in any adjustment 
resulting from a relocation of Federal awards covered in subsection b. 
shall be excluded in computing Federal award costs.
    23. General government expenses.
    a. The general costs of government are unallowable (except as 
provided in section 41). These include:
    (1) Salaries and expenses of the Office of the Governor of a State 
or the chief executive of a political subdivision or the chief 
executives of federally-recognized Indian tribal governments;
    (2) Salaries and other expenses of State legislatures, tribal 
councils, or similar local governmental bodies, such as county 
supervisors, city councils, school boards, etc., whether incurred for 
purposes of legislation or executive direction;
    (3) Cost of the judiciary branch of a government;
    (4) Cost of prosecutorial activities unless treated as a direct 
cost to a specific program when authorized by program regulations 
(however, this does not preclude the allowability of other legal 
activities of the Attorney General); and
    (5) Other general types of government services normally provided to 
the general public, such as fire and police, unless provided for as a 
direct cost in program regulations.
    b. For federally-recognized Indian tribal governments and Councils 
Of Governments (COGs), the portion of salaries and expenses directly 
attributable to managing and operating Federal programs by the chief 
executive and his staff is allowable.
    24. Idle facilities and idle capacity.
    a. As used in this section the following terms have the meanings 
set forth below:
    (1) ``Facilities'' means land and buildings or any portion thereof, 
equipment individually or collectively, or any other tangible capital 
asset, wherever located, and whether owned or leased by the 
governmental unit.
    (2) ``Idle facilities'' means completely unused facilities that are 
excess to the governmental unit's current needs.
    (3) ``Idle capacity'' means the unused capacity of partially used 
facilities. It is the difference between (a) that which a facility 
could achieve under 100 percent operating time on a one-shift basis 
less operating interruptions resulting from time lost for repairs, 
setups, unsatisfactory materials, and other normal delays and (b) the 
extent to which the facility was actually used to meet demands during 
the accounting period. A multi-shift basis should be used if it can be 
shown that this amount of usage would normally be expected for the type 
of facility involved.
    (4) ``Cost of idle facilities or idle capacity'' means costs such 
as maintenance, repair, housing, rent, and other related costs, e.g., 
insurance, interest, and depreciation or use allowances.
    b. The costs of idle facilities are unallowable except to the 
extent that:
    (1) They are necessary to meet fluctuations in workload; or
    (2) Although not necessary to meet fluctuations in workload, they 
were necessary when acquired and are now idle because of changes in 
program requirements, efforts to achieve more economical operations, 
reorganization, termination, or other causes which could not have been 
reasonably foreseen. Under the exception stated in this subsection, 
costs of idle facilities are allowable for a reasonable period of time, 
ordinarily not to exceed one year, depending on the initiative taken to 
use, lease, or dispose of such facilities.
    c. The costs of idle capacity are normal costs of doing business 
and are a factor in the normal fluctuations of usage or indirect cost 
rates from period to period. Such costs are allowable, provided that 
the capacity is reasonably anticipated to be necessary or was 
originally reasonable and is not subject to reduction or elimination by 
use on other Federal awards, subletting, renting, or sale, in 
accordance with sound business, economic, or security practices. 
Widespread idle capacity throughout an entire facility or among a group 
of assets having substantially the same function may be considered idle 
facilities.
    25. Insurance and indemnification.
    a. Costs of insurance required or approved and maintained, pursuant 
to the Federal award, are allowable.
    b. Costs of other insurance in connection with the general conduct 
of activities are allowable subject to the following limitations:
    (1) Types and extent and cost of coverage are in accordance with 
the governmental unit's policy and sound business practice.
    (2) Costs of insurance or of contributions to any reserve covering 
the risk of loss of, or damage to, Federal Government property are 
unallowable except to the extent that the awarding agency has 
specifically required or approved such costs.
    c. Actual losses which could have been covered by permissible 
insurance (through a self-insurance program or otherwise) are 
unallowable, unless expressly provided for in the Federal award or as 
described below. However, the Federal Government will participate in 
actual losses of a self insurance fund that are in excess of reserves. 
Costs incurred because of losses not covered under nominal deductible 
insurance coverage provided in keeping with sound management practice, 
and minor losses not covered by insurance, such as spoilage, breakage, 
and disappearance of small hand tools, which occur in the ordinary 
course of operations, are allowable.
    d. Contributions to a reserve for certain self-insurance programs 
including workers compensation, unemployment compensation, and 
severance pay are allowable subject to the following provisions:
    (1) The 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. [[Page 26499]] However, 
provision for known or reasonably estimated self-insured liabilities, 
which do not become payable for more than one year after the provision 
is made, shall not exceed the discounted present value of the 
liability. The rate used for discounting the liability must be 
determined by giving consideration to such factors as the governmental 
unit's settlement rate for those liabilities and its investment rate of 
return.
    (2) Earnings or investment income on reserves must be credited to 
those reserves.
    (3) Contributions to reserves must be based on sound actuarial 
principles using historical experience and reasonable assumptions. 
Reserve levels must be analyzed and updated at least biennially for 
each major risk being insured and take into account any reinsurance, 
coinsurance, etc. Reserve levels related to employee-related coverages 
will normally be limited to the value of claims (a) submitted and 
adjudicated but not paid, (b) submitted but not adjudicated, and (c) 
incurred but not submitted. Reserve levels in excess of the amounts 
based on the above must be identified and justified in the cost 
allocation plan or indirect cost rate proposal.
    (4) Accounting records, actuarial studies, and cost allocations (or 
billings) must recognize any significant differences due to types of 
insured risk and losses generated by the various insured activities or 
agencies of the governmental unit. If individual departments or 
agencies of the governmental unit experience significantly different 
levels of claims for a particular risk, those differences are to be 
recognized by the use of separate allocations or other techniques 
resulting in an equitable allocation.
    (5) Whenever funds are transferred from a self-insurance reserve to 
other accounts (e.g., general fund), refunds shall be made to the 
Federal Government for its share of funds transferred, including earned 
or imputed interest from the date of transfer.
    e. Actual claims paid to or on behalf of employees or former 
employees for workers' compensation, unemployment compensation, 
severance pay, and similar employee benefits (e.g., subsection 11.f. 
for post retirement health benefits), are allowable in the year of 
payment provided (1) the governmental unit follows a consistent costing 
policy and (2) they are allocated as a general administrative expense 
to all activities of the governmental unit.
    f. Insurance refunds shall be credited against insurance costs in 
the year the refund is received.
    g. Indemnification includes securing the governmental unit against 
liabilities to third persons and other losses not compensated by 
insurance or otherwise. The Federal Government is obligated to 
indemnify the governmental unit only to the extent expressly provided 
for in the Federal award, except as provided in subsection d.
    h. Costs of commercial insurance that protects against the costs of 
the contractor for correction of the contractor's own defects in 
materials or workmanship are unallowable.
    26. Interest.
    a. Costs incurred for interest on borrowed capital or the use of a 
governmental unit's own funds, however represented, are unallowable 
except as specifically provided in subsection b. or authorized by 
Federal legislation.
    b. Financing costs (including interest) paid or incurred on or 
after the effective date of this Circular associated with the otherwise 
allowable costs of building acquisition, construction, or fabrication, 
reconstruction or remodeling completed on or after October 1, 1980 is 
allowable, subject to the conditions in (1)-(4). Financing costs 
(including interest) paid or incurred on or after the effective date of 
this Circular associated with otherwise allowable costs of equipment is 
allowable, subject to the conditions in (1)-(4).
    (1) The financing is provided (from other than tax or user fee 
sources) by a bona fide third party external to the governmental unit;
    (2) The assets are used in support of Federal awards;
    (3) Earnings on debt service reserve funds or interest earned on 
borrowed funds pending payment of the construction or acquisition costs 
are used to offset the current period's cost or the capitalized 
interest, as appropriate. Earnings subject to being reported to the 
Federal Internal Revenue Service under arbitrage requirements are 
excludable.
    (4) Governmental units will negotiate the amount of allowable 
interest whenever cash payments (interest, depreciation, use 
allowances, and contributions) exceed the governmental unit's cash 
payments and other contributions attributable to that portion of real 
property used for Federal awards.
    27. Lobbying. The cost of certain influencing activities associated 
with obtaining grants, contracts, cooperative agreements, or loans is 
an unallowable cost. Lobbying with respect to certain grants, 
contracts, cooperative agreements, and loans shall be governed by the 
common rule, ``New Restrictions on Lobbying'' published at 55 FR 6736 
(February 26, 1990), including definitions, and the Office of 
Management and Budget ``Government-wide Guidance for New Restrictions 
on Lobbying'' and notices published at 54 FR 52306 (December 20, 1989), 
55 FR 24540 (June 15, 1990), and 57 FR 1772 (January 15, 1992), 
respectively.
    28. Maintenance, operations, and repairs. Unless prohibited by law, 
the cost of utilities, insurance, security, janitorial services, 
elevator service, upkeep of grounds, necessary maintenance, normal 
repairs and alterations, and the like are allowable to the extent that 
they: (1) keep property (including Federal property, unless otherwise 
provided for) in an efficient operating condition, (2) do not add to 
the permanent value of property or appreciably prolong its intended 
life, and (3) are not otherwise included in rental or other charges for 
space. Costs which add to the permanent value of property or 
appreciably prolong its intended life shall be treated as capital 
expenditures (see sections 15 and 19).
    29. Materials and supplies. The cost of materials and supplies is 
allowable. Purchases should be charged at their actual prices after 
deducting all cash discounts, trade discounts, rebates, and allowances 
received. Withdrawals from general stores or stockrooms should be 
charged at cost under any recognized method of pricing, consistently 
applied. Incoming transportation charges are a proper part of materials 
and supply costs.
    30. Memberships, subscriptions, and professional activities.
    a. Costs of the governmental unit's memberships in business, 
technical, and professional organizations are allowable.
    b. Costs of the governmental unit's subscriptions to business, 
professional, and technical periodicals are allowable.
    c. Costs of meetings and conferences where the primary purpose is 
the dissemination of technical information, including meals, 
transportation, rental of meeting facilities, and other incidental 
costs are allowable.
    d. Costs of membership in civic and community, social organizations 
are allowable as a direct cost with the approval of the Federal 
awarding agency.
    e. Costs of membership in organizations substantially engaged in 
lobbying are unallowable.
    31. Motor pools. The costs of a service organization which provides 
automobiles to user governmental units at a mileage or fixed rate and/
or [[Page 26500]] provides vehicle maintenance, inspection, and repair 
services are allowable.
    32. Pre-award costs. Pre-award costs are those incurred prior to 
the effective date of the award directly pursuant to the negotiation 
and in anticipation of the award where such costs are necessary to 
comply with the proposed delivery schedule or period of performance. 
Such costs are allowable only to the extent that they would have been 
allowable if incurred after the date of the award and only with the 
written approval of the awarding agency.
    33. Professional service costs.
    a. Cost of professional and consultant services rendered by persons 
or organizations that are members of a particular profession or possess 
a special skill, whether or not officers or employees of the 
governmental unit, are allowable, subject to section 14 when reasonable 
in relation to the services rendered and when not contingent upon 
recovery of the costs from the Federal Government.
    b. Retainer fees supported by evidence of bona fide services 
available or rendered are allowable.
    34. Proposal costs. Costs of preparing proposals for potential 
Federal awards are allowable. Proposal costs should normally be treated 
as indirect costs and should be allocated to all activities of the 
governmental unit utilizing the cost allocation plan and indirect cost 
rate proposal. However, proposal costs may be charged directly to 
Federal awards with the prior approval of the Federal awarding agency.
    35. Publication and printing costs. Publication costs, including 
the costs of printing (including the processes of composition, plate-
making, press work, and binding, and the end products produced by such 
processes), distribution, promotion, mailing, and general handling are 
allowable.
    36. Rearrangements and alterations. Costs incurred for ordinary and 
normal rearrangement and alteration of facilities are allowable. 
Special arrangements and alterations costs incurred specifically for a 
Federal award are allowable with the prior approval of the Federal 
awarding agency.
    37. Reconversion costs. Costs incurred in the restoration or 
rehabilitation of the governmental unit's facilities to approximately 
the same condition existing immediately prior to commencement of 
Federal awards, less costs related to normal wear and tear, are 
allowable.
    38. Rental costs.
    a. Subject to the limitations described in subsections b. through 
d. of this section, rental costs are allowable to the extent that the 
rates are reasonable in light of such factors as: rental costs of 
comparable property, if any; market conditions in the area; 
alternatives available; and, the type, life expectancy, condition, and 
value of the property leased.
    b. Rental costs under sale and leaseback arrangements are allowable 
only up to the amount that would be allowed had the governmental unit 
continued to own the property.
    c. Rental costs under less-than-arms-length leases are allowable 
only up to the amount that would be allowed had title to the property 
vested in the governmental unit. For this purpose, less-than-arms-
length leases include, but are not limited to, those where:
    (1) One party to the lease is able to control or substantially 
influence the actions of the other;
    (2) Both parties are parts of the same governmental unit; or
    (3) The governmental unit creates an authority or similar entity to 
acquire and lease the facilities to the governmental unit and other 
parties.
    d. Rental costs under leases which are required to be treated as 
capital leases under GAAP are allowable only up to the amount that 
would be allowed had the governmental unit purchased the property on 
the date the lease agreement was executed. This amount would include 
expenses such as depreciation or use allowance, maintenance, and 
insurance. The provisions of Financial Accounting Standards Board 
Statement 13 shall be used to determine whether a lease is a capital 
lease. Interest costs related to capital leases are allowable to the 
extent they meet the criteria in section 26.
    39. Taxes.
    a. Taxes that a governmental unit is legally required to pay are 
allowable, except for self-assessed taxes that disproportionately 
affect Federal programs or changes in tax policies that 
disproportionately affect Federal programs. This provision becomes 
effective for taxes paid during the governmental unit's first fiscal 
year that begins on or after January 1, 1998, and applies thereafter.
    b. Gasoline taxes, motor vehicle fees, and other taxes that are in 
effect user fees for benefits provided to the Federal Government are 
allowable.
    c. This provision does not restrict the authority of Federal 
agencies to identify taxes where Federal participation is 
inappropriate. Where the identification of the amount of unallowable 
taxes would require an inordinate amount of effort, the cognizant 
agency may accept a reasonable approximation thereof.
    40. Training. The cost of training provided for employee 
development is allowable.
    41. Travel costs.
    a. General. Travel costs are allowable for expenses for 
transportation, lodging, subsistence, and related items incurred by 
employees traveling on official business. Such costs may be charged on 
an actual cost basis, on a per diem or mileage basis in lieu of actual 
costs incurred, or on a combination of the two, provided the method 
used is applied to an entire trip, and results in charges consistent 
with those normally allowed in like circumstances in non-federally-
sponsored activities. Notwithstanding the provisions of section 23, 
travel costs of officials covered by that section, when specifically 
related to Federal awards, are allowable with the prior approval of a 
grantor agency.
    b. Lodging and subsistence. Costs incurred by employees and 
officers for travel, including costs of lodging, other subsistence, and 
incidental expenses, shall be considered reasonable and allowable only 
to the extent such costs do not exceed charges normally allowed by the 
governmental unit in its regular operations as a result of the 
governmental unit's policy. In the absence of a written governmental 
unit policy regarding travel costs, the rates and amounts established 
under subchapter I of Chapter 57 of Title 5, United States Code 
``Travel and Subsistence Expenses; Mileage Allowances,'' or by the 
Administrator of General Services, or the President (or his designee) 
pursuant to any provisions of such subchapter shall be used as guidance 
for travel under Federal awards (41 U.S.C. 420, ``Travel Expenses of 
Government Contractors'').
    c. Commercial air travel. Airfare costs in excess of the customary 
standard (coach or equivalent) airfare, are unallowable except when 
such accommodations would: require circuitous routing, require travel 
during unreasonable hours, excessively prolong travel, greatly increase 
the duration of the flight, result in increased cost that would offset 
transportation savings, or offer accommodations not reasonably adequate 
for the medical needs of the traveler. Where a governmental unit can 
reasonably demonstrate to the awarding agency either the 
nonavailability of customary standard airfare or Federal Government 
contract airfare for individual trips or, on an overall basis, that it 
is the governmental unit's practice to make routine use of such 
airfare, specific determinations of nonavailability will generally not 
be questioned by the Federal Government, [[Page 26501]] unless a 
pattern of avoidance is detected. However, in order for airfare costs 
in excess of the customary standard commercial airfare to be allowable, 
e.g., use of first-class airfare, the governmental unit must justify 
and document on a case-by-case basis the applicable condition(s) set 
forth above.
    d. Air travel by other than commercial carrier. Cost of travel by 
governmental unit-owned, -leased, or -chartered aircraft, as used in 
this section, includes the cost of lease, charter, operation (including 
personnel costs), maintenance, depreciation, interest, insurance, and 
other related costs. Costs of travel via governmental unit-owned, -
leased, or -chartered aircraft are unallowable to the extent they 
exceed the cost of allowable commercial air travel, as provided for in 
subsection c.
    42. Underrecovery of costs under Federal agreements. Any excess 
costs over the Federal contribution under one award agreement are 
unallowable under other award agreements.
Table of Contents

A. General
B. Definitions
    1. Billed central services
    2. Allocated central services
    3. Agency or operating agency
C. Scope of the Central Service Cost Allocation Plans
D. Submission Requirements
E. Documentation Requirements for Submitted Plans
    1. General
    2. Allocated central services
    3. Billed services
    a. General
    b. Internal service funds
    c. Self-insurance funds
    d. Fringe benefits
    44. Required certification
F. Negotiation and Approval of Central Service Plans
G. Other Policies
    1. Billed central service activities
    2. Working capital reserves
    3. Carry-forward adjustments of allocated central service costs
    4. Adjustments of billed central services
    5. Records retention
    6. Appeals
    7. OMB assistance

A. General

    1. 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 whereby these central service costs can be identified and 
assigned to benefitted activities on a reasonable and consistent basis. 
The central service cost allocation plan provides that process. All 
costs and other data used to distribute the costs included in the plan 
should be supported by formal accounting and other records that will 
support the propriety of the costs assigned to Federal awards.
    2. Guidelines and illustrations of central service cost allocation 
plans are provided in a brochure published by the Department of Health 
and Human Services entitled ``A Guide for State and Local Government 
Agencies: Cost Principles and Procedures for Establishing Cost 
Allocation Plans and Indirect Cost Rates for Grants and Contracts with 
the Federal Government.'' A copy of this brochure may be obtained from 
the Superintendent of Documents, U.S. Government Printing Office.

B. Definitions

    1. ``Billed central services'' means central services that are 
billed to benefitted agencies and/or programs on an individual fee-for-
service or similar basis. Typical examples of billed central services 
include computer services, transportation services, insurance, and 
fringe benefits.
    2. ``Allocated central services'' means central services that 
benefit operating agencies but are not billed to the agencies on a fee-
for-service or similar basis. These costs are allocated to benefitted 
agencies on some reasonable basis. Examples of such services might 
include general accounting, personnel administration, purchasing, etc.
    3. ``Agency or operating agency'' means an organizational unit or 
sub-division within a governmental unit that is responsible for the 
performance or administration of awards or activities of the 
governmental unit.

C. Scope of the Central Service Cost Allocation Plans

    The central service cost allocation plan will include all central 
service costs that will be claimed (either as a billed or an allocated 
cost) under Federal awards and will be documented as described in 
section E. Costs of central services omitted from the plan will not be 
reimbursed.

D. Submission Requirements

    1. Each State will submit a plan to the Department of Health and 
Human Services for each year in which it claims central service costs 
under Federal awards. The plan should include (a) a projection of the 
next year's allocated central service cost (based either on actual 
costs for the most recently completed year or the budget projection for 
the coming year), and (b) a reconciliation of actual allocated central 
service costs to the estimated costs used for either the most recently 
completed year or the year immediately preceding the most recently 
completed year.
    2. Each local government that has been designated as a ``major 
local government'' by the Office of Management and Budget (OMB) is also 
required to submit a plan to its cognizant agency annually. OMB 
periodically lists major local governments in the Federal Register.
    3. All other local governments claiming central service costs must 
develop a plan in accordance with the requirements described in this 
Circular and maintain the plan and related supporting documentation for 
audit. These local governments are not required to submit their plans 
for Federal approval unless they are specifically requested to do so by 
the cognizant agency. Where a local government only receives funds as a 
sub-recipient, the primary recipient will be responsible for 
negotiating indirect cost rates and/or monitoring the sub-recipient's 
plan.
    4. All central service cost allocation plans will be prepared and, 
when required, submitted within six months prior to the beginning of 
each of the governmental unit's fiscal years in which it proposes to 
claim central service costs. Extensions may be granted by the cognizant 
agency on a case-by-case basis.

E. Documentation Requirements for Submitted Plans

    The documentation requirements described in this section may be 
modified, expanded, or reduced by the cognizant agency on a case-by-
case basis. For example, the requirements may be reduced for those 
central services which have little or no impact on Federal awards. 
Conversely, if a review of a plan indicates that certain additional 
information is needed, and will likely be needed in future years, it 
may be routinely requested in future plan submissions. Items marked 
with an asterisk (*) should be submitted only once; subsequent plans 
should merely indicate any changes since the last plan.
    1. General. All proposed plans must be accompanied by the 
following: an organization chart sufficiently detailed to show 
operations including the central service activities of the State/local 
government whether or not they are shown as benefiting from central 
service functions; a copy of the Comprehensive Annual Financial Report 
(or a copy of the Executive Budget if budgeted costs are being 
proposed) to support the allowable costs of each central service 
activity included in the plan; and, a [[Page 26502]] certification (see 
subsection 4.) that the plan was prepared in accordance with this 
Circular, contains only allowable costs, and was prepared in a manner 
that treated similar costs consistently among the various Federal 
awards and between Federal and non-Federal awards/activities.
    2. Allocated central services. For each allocated central service, 
the plan must also include the following: a brief description of the 
service*, an identification of the unit rendering the service and the 
operating agencies receiving the service, the items of expense included 
in the cost of the service, the method used to distribute the cost of 
the service to benefitted agencies, and a summary schedule showing the 
allocation of each service to the specific benefitted agencies. If any 
self-insurance funds or fringe benefits costs are treated as allocated 
(rather than billed) central services, documentation discussed in 
subsections 3.b. and c. shall also be included.
    3. Billed services.
    a. General. The information described below shall be provided for 
all billed central services, including internal service funds, self-
insurance funds, and fringe benefit funds.
     b. Internal service funds.
     (1) For each internal service fund or similar activity with an 
operating budget of $5 million or more, the plan shall include: a brief 
description of each service; a balance sheet for each fund based on 
individual accounts contained in the governmental unit's accounting 
system; a revenue/expenses statement, with revenues broken out by 
source, e.g., regular billings, interest earned, etc.; a listing of all 
non-operating transfers (as defined by Generally Accepted Accounting 
Principles (GAAP)) into and out of the fund; a description of the 
procedures (methodology) used to charge the costs of each service to 
users, including how billing rates are determined; a schedule of 
current rates; and, a schedule comparing total revenues (including 
imputed revenues) generated by the service to the allowable costs of 
the service, as determined under this Circular, with an explanation of 
how variances will be handled.
    (2) Revenues shall consist of all revenues generated by the 
service, including unbilled and uncollected revenues. If some users 
were not billed for the services (or were not billed at the full rate 
for that class of users), a schedule showing the full imputed revenues 
associated with these users shall be provided. Expenses shall be broken 
out by object cost categories (e.g., salaries, supplies, etc.).
    c. Self-insurance funds. For each self-insurance fund, the plan 
shall include: the fund balance sheet; a statement of revenue and 
expenses including a summary of billings and claims paid by agency; a 
listing of all non-operating transfers into and out of the fund; the 
type(s) of risk(s) covered by the fund (e.g., automobile liability, 
workers' compensation, etc.); an explanation of how the level of fund 
contributions are determined, including a copy of the current actuarial 
report (with the actuarial assumptions used) if the contributions are 
determined on an actuarial basis; and, a description of the procedures 
used to charge or allocate fund contributions to benefitted activities. 
Reserve levels in excess of claims (1) submitted and adjudicated but 
not paid, (2) submitted but not adjudicated, and (3) incurred but not 
submitted must be identified and explained.
    d. Fringe benefits. For fringe benefit costs, the plan shall 
include: a listing of fringe benefits provided to covered employees, 
and the overall annual cost of each type of benefit; current fringe 
benefit policies*; and procedures used to charge or allocate the costs 
of the benefits to benefitted activities. In addition, for pension and 
post-retirement health insurance plans, the following information shall 
be provided: the governmental unit's funding policies, e.g., 
legislative bills, trust agreements, or State-mandated contribution 
rules, if different from actuarially determined rates; the pension 
plan's costs accrued for the year; the amount funded, and date(s) of 
funding; a copy of the current actuarial report (including the 
actuarial assumptions); the plan trustee's report; and, a schedule from 
the activity showing the value of the interest cost associated with 
late funding.
    4. Required certification. Each central service cost allocation 
plan will be accompanied by a certification in the following form:
Certificate of Cost Allocation Plan

    This is to certify that I have reviewed the cost allocation plan 
submitted herewith and to the best of my knowledge and belief:
    (1) All costs included in this proposal [identify date] to 
establish cost allocations or billings for [identify period covered 
by plan] are allowable in accordance with the requirements of OMB 
Circular A-87, ``Cost Principles for State and Local Governments,'' 
and the Federal award(s) to which they apply. Unallowable costs have 
been adjusted for in allocating costs as indicated in the cost 
allocation plan.
    (2) All costs included in this proposal are properly allocable 
to Federal awards on the basis of a beneficial or causal 
relationship between the expenses incurred and the awards to which 
they are allocated in accordance with applicable requirements. 
Further, the same costs that have been treated as indirect costs 
have not been claimed as direct costs. Similar types of costs have 
been accounted for consistently.
    I declare that the foregoing is true and correct.

Governmental Unit ----------------------------------------------------

Signature ------------------------------------------------------------

Name of Official -----------------------------------------------------

Title ----------------------------------------------------------------

Date of Execution ----------------------------------------------------

F. Negotiation and Approval of Central Service Plans

    1. All proposed central service cost allocation plans that are 
required to be submitted will be reviewed, negotiated, and approved by 
the Federal cognizant agency on a timely basis. The cognizant agency 
will review the proposal within six months of receipt of the proposal 
and either negotiate/approve the proposal or advise the governmental 
unit of the additional documentation needed to support/evaluate the 
proposed plan or the changes required to make the proposal acceptable. 
Once an agreement with the governmental unit has been reached, the 
agreement will be accepted and used by all Federal agencies, unless 
prohibited or limited by statute. Where a Federal funding agency has 
reason to believe that special operating factors affecting its awards 
necessitate special consideration, the funding agency will, prior to 
the time the plans are negotiated, notify the cognizant agency.
    2. The results of each negotiation shall be formalized in a written 
agreement between the cognizant agency and the governmental unit. This 
agreement will be subject to re-opening if the agreement is 
subsequently found to violate a statute or the information upon which 
the plan was negotiated is later found to be materially incomplete or 
inaccurate. The results of the negotiation shall be made available to 
all Federal agencies for their use.
    3. Negotiated cost allocation plans based on a proposal later found 
to have included costs that: (a) are unallowable (i) as specified by 
law or regulation, (ii) as identified in Attachment B of this Circular, 
or (iii) by the terms and conditions of Federal awards, or (b) are 
unallowable because they are clearly not allocable to Federal awards, 
shall be adjusted, or a refund shall be made at the option of the 
Federal cognizant agency. These adjustments or refunds are designed to 
correct the plans and do not constitute a reopening of the negotiation. 
[[Page 26503]] 

G. Other Policies

    1. Billed central service activities. Each billed central service 
activity must separately account for all revenues (including imputed 
revenues) generated by the service, expenses incurred to furnish the 
service, and profit/loss.
    2. Working capital reserves. Internal service funds are dependent 
upon a reasonable level of working capital reserve to operate from one 
billing cycle to the next. Charges by an internal service activity to 
provide for the establishment and maintenance of a reasonable level of 
working capital reserve, in addition to the full recovery of costs, are 
allowable. A working capital reserve as part of retained earnings of up 
to 60 days cash expenses for normal operating purposes is considered 
reasonable. A working capital reserve exceeding 60 days may be approved 
by the cognizant Federal agency in exceptional cases.
    3. Carry-forward adjustments of allocated central service costs. 
Allocated central service costs are usually negotiated and approved for 
a future fiscal year on a ``fixed with carry-forward'' basis. Under 
this procedure, the fixed amounts for the future year covered by 
agreement are not subject to adjustment for that year. However, when 
the actual costs of the year involved become known, the differences 
between the fixed amounts previously approved and the actual costs will 
be carried forward and used as an adjustment to the fixed amounts 
established for a later year. This ``carry-forward'' procedure applies 
to all central services whose costs were fixed in the approved plan. 
However, a carry-forward adjustment is not permitted, for a central 
service activity that was not included in the approved plan, or for 
unallowable costs that must be reimbursed immediately.
    4. Adjustments of billed central services. Billing rates used to 
charge Federal awards shall be based on the estimated costs of 
providing the services, including an estimate of the allocable central 
service costs. A comparison of the revenue generated by each billed 
service (including total revenues whether or not billed or collected) 
to the actual allowable costs of the service will be made at least 
annually, and an adjustment will be made for the difference between the 
revenue and the allowable costs. These adjustments will be made through 
one of the following adjustment methods: (a) a cash refund to the 
Federal Government for the Federal share of the adjustment, (b) credits 
to the amounts charged to the individual programs, (c) adjustments to 
future billing rates, or (d) adjustments to allocated central service 
costs. Adjustments to allocated central services will not be permitted 
where the total amount of the adjustment for a particular service 
(Federal share and non-Federal) share exceeds $500,000.
    5. Records retention. All central service cost allocation plans and 
related documentation used as a basis for claiming costs under Federal 
awards must be retained for audit in accordance with the records 
retention requirements contained in the Common Rule.
    6. Appeals. If a dispute arises in the negotiation of a plan 
between the cognizant agency and the governmental unit, the dispute 
shall be resolved in accordance with the appeals procedures of the 
cognizant agency.
    7. OMB assistance. To the extent that problems are encountered 
among the Federal agencies and/or governmental units in connection with 
the negotiation and approval process, OMB will lend assistance, as 
required, to resolve such problems in a timely manner.

Attachment D--Public Assistance Cost Allocation Plans

Table of Contents

A. General
B. Definitions
    1. State public assistance agency
    2. State public assistance agency costs
C. Policy
D. Submission, Documentation, and Approval of Public Assistance Cost 
Allocation Plans
E. Review of Implementation of Approved Plans
F. Unallowable Costs

A. General

    Federally-financed programs administered by State public assistance 
agencies are funded predominately by the Department of Health and Human 
Services (HHS). In support of its stewardship requirements, HHS has 
published requirements for the development, documentation, submission, 
negotiation, and approval of public assistance cost allocation plans in 
Subpart E of 45 CFR Part 95. All administrative costs (direct and 
indirect) are normally charged to Federal awards by implementing the 
public assistance cost allocation plan. This Attachment extends these 
requirements to all Federal agencies whose programs are administered by 
a State public assistance agency. Major federally-financed programs 
typically administered by State public assistance agencies include: Aid 
to Families with Dependent Children, Medicaid, Food Stamps, Child 
Support Enforcement, Adoption Assistance and Foster Care, and Social 
Services Block Grant.

B. Definitions

    1. ``State public assistance agency'' means a State agency 
administering or supervising the administration of one or more public 
assistance programs operated by the State as identified in Subpart E of 
45 CFR Part 95. For the purpose of this Attachment, these programs 
include all programs administered by the State public assistance 
agency.
    2. ``State public assistance agency costs'' means all costs 
incurred by, or allocable to, the State public assistance agency, 
except expenditures for financial assistance, medical vendor payments, 
food stamps, and payments for services and goods provided directly to 
program recipients.

C. Policy

    State public assistance agencies will develop, document and 
implement, and the Federal Government will review, negotiate, and 
approve, public assistance cost allocation plans in accordance with 
Subpart E of 45 CFR Part 95. The plan will include all programs 
administered by the State public assistance agency. Where a letter of 
approval or disapproval is transmitted to a State public assistance 
agency in accordance with Subpart E, the letter will apply to all 
Federal agencies and programs. The remaining sections of this 
Attachment (except for the requirement for certification) summarize the 
provisions of Subpart E of 45 CFR Part 95.

D. Submission, Documentation, and Approval of Public Assistance Cost 
Allocation Plans

    1. State public assistance agencies are required to promptly submit 
amendments to the cost allocation plan to HHS for review and approval.
    2. Under the coordination process outlined in subsection E, 
affected Federal agencies will review all new plans and plan amendments 
and provide comments, as appropriate, to HHS. The effective date of the 
plan or plan amendment will be the first day of the quarter following 
the submission of the plan or amendment, unless another date is 
specifically approved by HHS. HHS, as the cognizant agency acting on 
behalf of all affected Federal agencies, will, as necessary, conduct 
negotiations with the State public assistance agency and will inform 
the State agency of the action taken on the plan or plan amendment.

E. Review of Implementation of Approved Plans

    1. Since public assistance cost allocation plans are of a narrative 
[[Page 26504]] nature, the review during the plan approval process 
consists of evaluating the appropriateness of the proposed groupings of 
costs (cost centers) and the related allocation bases. As such, the 
Federal Government needs some assurance that the cost allocation plan 
has been implemented as approved. This is accomplished by reviews by 
the funding agencies, single audits, or audits conducted by the 
cognizant audit agency.
    2. Where inappropriate charges affecting more than one funding 
agency are identified, the cognizant HHS cost negotiation office will 
be advised and will take the lead in resolving the issue(s) as provided 
for in Subpart E of 45 CFR Part 95.
    3. If a dispute arises in the negotiation of a plan or from a 
disallowance involving two or more funding agencies, the dispute shall 
be resolved in accordance with the appeals procedures set out in 45 CFR 
Part 75. Disputes involving only one funding agency will be resolved in 
accordance with the funding agency's appeal process.
    4. To the extent that problems are encountered among the Federal 
agencies and/or governmental units in connection with the negotiation 
and approval process, the Office of Management and Budget will lend 
assistance, as required, to resolve such problems in a timely manner.

F. Unallowable Costs

    Claims developed under approved cost allocation plans will be based 
on allowable costs as identified in this Circular. Where unallowable 
costs have been claimed and reimbursed, they will be refunded to the 
program that reimbursed the unallowable cost using one of the following 
methods: (a) a cash refund, (b) offset to a subsequent claim, or (c) 
credits to the amounts charged to individual awards.

Attachment E--State and Local Indirect Cost Rate Proposals

Table of Contents

A. General
B. Definitions
    1. Indirect cost rate proposal
    2. Indirect cost rate
    3. Indirect cost pool
    4. Base
    5. Predetermined rate
    6. Fixed rate
    7. Provisional rate
    8. Final rate
    9. Base period
C. Allocation of Indirect Costs and Determination of Indirect Cost 
Rates
    1. General
    2. Simplified method
    3. Multiple allocation base method
    4. Special indirect cost rates
D. Submission and Documentation of Proposals
    1. Submission of indirect cost rate proposals
    2. Documentation of proposals
    3. Required certification
E. Negotiation and Approval of Rates
F. Other Policies
    1. Fringe benefit rates
    2. Billed services provided by the grantee agency
    3. Indirect cost allocations not using rates
    4. Appeals
    5. Collections of unallowable costs and erroneous payments
    6. OMB assistance

A. General

    1. Indirect costs are those that have been incurred for common or 
joint purposes. These costs benefit more than one cost objective and 
cannot be readily identified with a particular final cost objective 
without effort disproportionate to the results achieved. After direct 
costs have been determined and assigned directly to Federal awards and 
other activities as appropriate, indirect costs are those remaining to 
be allocated to benefitted cost objectives. A cost may not be allocated 
to a Federal award as an indirect cost if any other cost incurred for 
the same purpose, in like circumstances, has been assigned to a Federal 
award as a direct cost.
    2. Indirect costs include (a) the indirect costs originating in 
each department or agency of the governmental unit carrying out Federal 
awards and (b) the costs of central governmental services distributed 
through the central service cost allocation plan (as described in 
Attachment C) and not otherwise treated as direct costs.
    3. Indirect costs are normally charged to Federal awards by the use 
of an indirect cost rate. A separate indirect cost rate(s) is usually 
necessary for each department or agency of the governmental unit 
claiming indirect costs under Federal awards. Guidelines and 
illustrations of indirect cost proposals are provided in a brochure 
published by the Department of Health and Human Services entitled ``A 
Guide for State and Local Government Agencies: Cost Principles and 
Procedures for Establishing Cost Allocation Plans and Indirect Cost 
Rates for Grants and Contracts with the Federal Government.'' A copy of 
this brochure may be obtained from the Superintendent of Documents, 
U.S. Government Printing Office.
    4. Because of the diverse characteristics and accounting practices 
of governmental units, the types of costs which may be classified as 
indirect costs cannot be specified in all situations. However, typical 
examples of indirect costs may include certain State/local-wide central 
service costs, general administration of the grantee department or 
agency, accounting and personnel services performed within the grantee 
department or agency, depreciation or use allowances on buildings and 
equipment, the costs of operating and maintaining facilities, etc.
    5. This Attachment does not apply to State public assistance 
agencies. These agencies should refer instead to Attachment D.

B. Definitions

    1. ``Indirect cost rate proposal'' means the documentation prepared 
by a governmental unit or subdivision thereof to substantiate its 
request for the establishment of an indirect cost rate.
    2. ``Indirect cost rate'' is a device for determining in a 
reasonable manner the proportion of indirect costs each program should 
bear. It is the ratio (expressed as a percentage) of the indirect costs 
to a direct cost base.
    3. ``Indirect cost pool'' is the accumulated costs that jointly 
benefit two or more programs or other cost objectives.
    4. ``Base'' means the accumulated direct costs (normally either 
total direct salaries and wages or total direct costs exclusive of any 
extraordinary or distorting expenditures) used to distribute indirect 
costs to individual Federal awards. The direct cost base selected 
should result in each award bearing a fair share of the indirect costs 
in reasonable relation to the benefits received from the costs.
    5. ``Predetermined rate'' means an indirect cost rate, applicable 
to a specified current or future period, usually the governmental 
unit's fiscal year. This rate is based on an estimate of the costs to 
be incurred during the period. Except under very unusual circumstances, 
a predetermined rate is not subject to adjustment. (Because of legal 
constraints, predetermined rates are not permitted for Federal 
contracts; they may, however, be used for grants or cooperative 
agreements.) Predetermined rates may not be used by governmental units 
that have not submitted and negotiated the rate with the cognizant 
agency. In view of the potential advantages offered by this procedure, 
negotiation of predetermined rates for indirect costs for a period of 
two to four years should be the norm in those situations where the cost 
experience and other pertinent facts available are deemed sufficient to 
enable the parties involved to reach an informed judgment as to the 
probable [[Page 26505]] level of indirect costs during the ensuing 
accounting periods.
    6. ``Fixed rate'' means an indirect cost rate which has the same 
characteristics as a predetermined rate, except that the difference 
between the estimated costs and the actual, allowable costs of the 
period covered by the rate is carried forward as an adjustment to the 
rate computation of a subsequent period.
    7. ``Provisional rate'' means a temporary indirect cost rate 
applicable to a specified period which is used for funding, interim 
reimbursement, and reporting indirect costs on Federal awards pending 
the establishment of a ``final'' rate for that period.
    8. ``Final rate'' means an indirect cost rate applicable to a 
specified past period which is based on the actual allowable costs of 
the period. A final audited rate is not subject to adjustment.
    9. ``Base period'' for the allocation of indirect costs is the 
period in which such costs are incurred and accumulated for allocation 
to activities performed in that period. The base period normally should 
coincide with the governmental unit's fiscal year, but in any event, 
shall be so selected as to avoid inequities in the allocation of costs.

C. Allocation of Indirect Costs and Determination of Indirect Cost 
Rates

    1. General.
    a. Where a governmental unit's department or agency has only one 
major function, or where all its major functions benefit from the 
indirect costs to approximately the same degree, the allocation of 
indirect costs and the computation of an indirect cost rate may be 
accomplished through simplified allocation procedures as described in 
subsection 2.
    b. Where a governmental unit's department or agency has several 
major functions which benefit from its indirect costs in varying 
degrees, the allocation of indirect costs may require the accumulation 
of such costs into separate cost groupings which then are allocated 
individually to benefitted functions by means of a base which best 
measures the relative degree of benefit. The indirect costs allocated 
to each function are then distributed to individual awards and other 
activities included in that function by means of an indirect cost 
rate(s).
    c. Specific methods for allocating indirect costs and computing 
indirect cost rates along with the conditions under which each method 
should be used are described in subsections 2, 3 and 4.
    2. Simplified method.
    a. Where a grantee agency's major functions benefit from its 
indirect costs to approximately the same degree, the allocation of 
indirect costs may be accomplished by (1) classifying the grantee 
agency's total costs for the base period as either direct or indirect, 
and (2) 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 Federal awards. The rate should be expressed as the 
percentage which the total amount of allowable indirect costs bears to 
the base selected. This method should also be used where a governmental 
unit's department or agency has only one major function encompassing a 
number of individual projects or activities, and may be used where the 
level of Federal awards to that department or agency is relatively 
small.
    b. Both the direct costs and the indirect costs shall exclude 
capital expenditures and unallowable costs. However, unallowable costs 
must be included in the direct costs if they represent activities to 
which indirect costs are properly allocable.
    c. The distribution base may be (1) total direct costs (excluding 
capital expenditures and other distorting items, such as pass-through 
funds, major subcontracts, etc.), (2) direct salaries and wages, or (3) 
another base which results in an equitable distribution.
    3. Multiple allocation base method.
    a. Where a grantee agency's indirect costs benefit its major 
functions in varying degrees, such costs shall be accumulated into 
separate cost groupings. Each grouping shall then be allocated 
individually to benefitted functions by means of a base which best 
measures the relative benefits.
    b. The cost groupings should be established so as to permit the 
allocation of each grouping on the basis of benefits provided to the 
major functions. Each grouping should constitute a pool of expenses 
that are of like character in terms of the functions they benefit and 
in terms of the allocation base which best measures the relative 
benefits provided to each function. The number of separate groupings 
should be held within practical limits, taking into consideration the 
materiality of the amounts involved and the degree of precision needed.
    c. Actual conditions must be taken into account in selecting the 
base to be used in allocating the expenses in each grouping to 
benefitted functions. When an allocation can be made by assignment of a 
cost grouping directly to the function benefitted, the allocation shall 
be made in that manner. When the expenses in a grouping are more 
general in nature, the allocation should be made through the use of a 
selected base which produces results that are equitable to both the 
Federal Government and the governmental unit. In general, any cost 
element or related factor associated with the governmental unit's 
activities is potentially adaptable for use as an allocation base 
provided that: (1) it can readily be expressed in terms of dollars or 
other quantitative measures (total direct costs, direct salaries and 
wages, staff hours applied, square feet used, hours of usage, number of 
documents processed, population served, and the like), and (2) it is 
common to the benefitted functions during the base period.
    d. Except where a special indirect cost rate(s) is required in 
accordance with subsection 4, 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 Federal awards included in that function 
by use of a single indirect cost rate.
    e. The distribution base used in computing the indirect cost rate 
for each function may be (1) total direct costs (excluding capital 
expenditures and other distorting items such as pass-through funds, 
major subcontracts, etc.), (2) direct salaries and wages, or (3) 
another base which results in an equitable distribution. An indirect 
cost rate should be developed for each separate indirect cost pool 
developed. The rate in each case should be stated as the percentage 
relationship between the particular indirect cost pool and the 
distribution base identified with that pool.
    4. Special indirect cost rates.
    a. In some instances, a single indirect cost rate for all 
activities of a grantee department or agency or for each major function 
of the agency may not be appropriate. It may not take into account 
those different factors which may substantially affect the indirect 
costs applicable to a particular program or group of programs. The 
factors may include the physical location of the work, the level of 
administrative support required, the nature of the facilities or other 
resources employed, the organizational arrangements used, or any 
combination thereof. When a particular award is carried out in an 
environment which appears to generate a significantly different level 
of indirect costs, provisions should be made for a separate indirect 
cost pool applicable to that award. The separate indirect cost 
[[Page 26506]] pool should be developed during the course of the 
regular allocation process, and the separate indirect cost rate 
resulting therefrom should be used, provided that: (1) the rate differs 
significantly from the rate which would have been developed under 
subsections 2. and 3., and (2) the award to which the rate would apply 
is material in amount.
    b. Although this Circular adopts the concept of the full allocation 
of indirect costs, there are some Federal statutes which restrict the 
reimbursement of certain indirect costs. Where such restrictions exist, 
it may be necessary to develop a special rate for the affected award. 
Where a ``restricted rate'' is required, the procedure for developing a 
non-restricted rate will be used except for the additional step of the 
elimination from the indirect cost pool those costs for which the law 
prohibits reimbursement.

D. Submission and Documentation of Proposals

    1. Submission of indirect cost rate proposals.
    a. All departments or agencies of the governmental unit desiring to 
claim indirect costs under Federal awards must prepare an indirect cost 
rate proposal and related documentation to support those costs. The 
proposal and related documentation must be retained for audit in 
accordance with the records retention requirements contained in the 
Common Rule.
    b. A governmental unit for which a cognizant agency assignment has 
been specifically designated must submit its indirect cost rate 
proposal to its cognizant agency. The Office of Management and Budget 
(OMB) will periodically publish lists of governmental units identifying 
the appropriate Federal cognizant agencies. The cognizant agency for 
all governmental units or agencies not identified by OMB will be 
determined based on the Federal agency providing the largest amount of 
Federal funds. In these cases, a governmental unit must develop an 
indirect cost proposal in accordance with the requirements of this 
Circular and maintain the proposal and related supporting documentation 
for audit. These governmental units are not required to submit their 
proposals unless they are specifically requested to do so by the 
cognizant agency. Where a local government only receives funds as a 
sub-recipient, the primary recipient will be responsible for 
negotiating and/or monitoring the sub-recipient's plan.
    c. Each Indian tribal government desiring reimbursement of indirect 
costs must submit its indirect cost proposal to the Department of the 
Interior (its cognizant Federal agency).
    d. Indirect cost proposals must be developed (and, when required, 
submitted) within six months after the close of the governmental unit's 
fiscal year, unless an exception is approved by the cognizant Federal 
agency. If the proposed central service cost allocation plan for the 
same period has not been approved by that time, the indirect cost 
proposal may be prepared including an amount for central services that 
is based on the latest federally-approved central service cost 
allocation plan. The difference between these central service amounts 
and the amounts ultimately approved will be compensated for by an 
adjustment in a subsequent period.
    2. Documentation of proposals. The following shall be included with 
each indirect cost proposal:
    a. The rates proposed, including subsidiary work sheets and other 
relevant data, cross referenced and reconciled to the financial data 
noted in subsection b. Allocated central service costs will be 
supported by the summary table included in the approved central service 
cost allocation plan. This summary table is not required to be 
submitted with the indirect cost proposal if the central service cost 
allocation plan for the same fiscal year has been approved by the 
cognizant agency and is available to the funding agency.
    b. A copy of the financial data (financial statements, 
comprehensive annual financial report, executive budgets, accounting 
reports, etc.) upon which the rate is based. Adjustments resulting from 
the use of unaudited data will be recognized, where appropriate, by the 
Federal cognizant agency in a subsequent proposal.
    c. 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.
    d. A chart showing the organizational structure of the agency 
during the period for which the proposal applies, along with a 
functional statement(s) noting the duties and/or responsibilities of 
all units that comprise the agency. (Once this is submitted, only 
revisions need be submitted with subsequent proposals.)
    3. Required certification. Each indirect cost rate proposal shall 
be accompanied by a certification in the following form:
Certificate of Indirect Costs

    This is to certify that I have reviewed the indirect cost rate 
proposal submitted herewith and to the best of my knowledge and 
belief:
    (1) All costs included in this proposal [identify date] to 
establish billing or final indirect costs rates for [identify period 
covered by rate] are allowable in accordance with the requirements 
of the Federal award(s) to which they apply and OMB Circular A-87, 
``Cost Principles for State and Local Governments.'' Unallowable 
costs have been adjusted for in allocating costs as indicated in the 
cost allocation plan.
    (2) All costs included in this proposal are properly allocable 
to Federal awards on the basis of a beneficial or causal 
relationship between the expenses incurred and the agreements to 
which they are allocated in accordance with applicable requirements. 
Further, the same costs that have been treated as indirect costs 
have not been claimed as direct costs. Similar types of costs have 
been accounted for consistently and the Federal Government will be 
notified of any accounting changes that would affect the 
predetermined rate.
    I declare that the foregoing is true and correct.

Governmental Unit------------------------------------------------------

Signature--------------------------------------------------------------

Name of Official-------------------------------------------------------

Title------------------------------------------------------------------

Date of Execution:-----------------------------------------------------

E. Negotiation and Approval of Rates

    1. Indirect cost rates will be reviewed, negotiated, and approved 
by the cognizant Federal agency on a timely basis. Once a rate has been 
agreed upon, it will be accepted and used by all Federal agencies 
unless prohibited or limited by statute. Where a Federal funding agency 
has reason to believe that special operating factors affecting its 
awards necessitate special indirect cost rates, the funding agency 
will, prior to the time the rates are negotiated, notify the cognizant 
Federal agency.
    2. The use of predetermined rates, if allowed, is encouraged where 
the cognizant agency has reasonable assurance based on past experience 
and reliable projection of the grantee agency's costs, that the rate is 
not likely to exceed a rate based on actual costs. Long-term agreements 
utilizing predetermined rates extending over two or more years are 
encouraged, where appropriate.
    3. The results of each negotiation shall be formalized in a written 
agreement between the cognizant agency and the governmental unit. This 
agreement will be subject to re-opening if the agreement is 
subsequently found to violate a statute, or the information upon which 
the plan was negotiated is later found to be materially incomplete or 
inaccurate. The agreed upon rates shall be made available to all 
Federal agencies for their use.
    4. Refunds shall be made if proposals are later found to have 
included costs that (a) are unallowable (i) as specified 
[[Page 26507]] by law or regulation, (ii) as identified in Attachment B 
of this Circular, or (iii) by the terms and conditions of Federal 
awards, or (b) are unallowable because they are clearly not allocable 
to Federal awards. These adjustments or refunds will be made regardless 
of the type of rate negotiated (predetermined, final, fixed, or 
provisional).

F. Other Policies

    1. Fringe benefit rates. If overall fringe benefit rates are not 
approved for the governmental unit as part of the central service cost 
allocation plan, these rates will be reviewed, negotiated and approved 
for individual grantee agencies during the indirect cost negotiation 
process. In these cases, a proposed fringe benefit rate computation 
should accompany the indirect cost proposal. If fringe benefit rates 
are not used at the grantee agency level (i.e., the agency specifically 
identifies fringe benefit costs to individual employees), the 
governmental unit should so advise the cognizant agency.
    2. Billed services provided by the grantee agency. In some cases, 
governmental units provide and bill for services similar to those 
covered by central service cost allocation plans (e.g., computer 
centers). Where this occurs, the governmental unit should be guided by 
the requirements in Attachment C relating to the development of billing 
rates and documentation requirements, and should advise the cognizant 
agency of any billed services. Reviews of these types of services 
(including reviews of costing/billing methodology, profits or losses, 
etc.) will be made on a case-by-case basis as warranted by the 
circumstances involved.
    3. Indirect cost allocations not using rates. In certain 
situations, a governmental unit, because of the nature of its awards, 
may be required to develop a cost allocation plan that distributes 
indirect (and, in some cases, direct) costs to the specific funding 
sources. In these cases, a narrative cost allocation methodology should 
be developed, documented, maintained for audit, or submitted, as 
appropriate, to the cognizant agency for review, negotiation, and 
approval.
    4. Appeals. If a dispute arises in a negotiation of an indirect 
cost rate (or other rate) between the cognizant agency and the 
governmental unit, the dispute shall be resolved in accordance with the 
appeals procedures of the cognizant agency.
    5. Collection of unallowable costs and erroneous payments. Costs 
specifically identified as unallowable and charged to Federal awards 
either directly or indirectly will be refunded (including interest 
chargeable in accordance with applicable Federal agency regulations).
    6. OMB assistance. To the extent that problems are encountered 
among the Federal agencies and/or governmental units in connection with 
the negotiation and approval process, OMB will lend assistance, as 
required, to resolve such problems in a timely manner.

[FR Doc. 95-11658 Filed 5-16-95; 8:45 am]
BILLING CODE 3110-01-P