July 9, 2010
Dear County and District Chief Business Officials and Charter School Administrators:
We are pleased to announce that the United States Department of Education (ED) has approved an updated indirect cost plan for California. This plan governs the methodology by which indirect cost rates for California local educational agencies (LEAs) are determined. The revised plan coincides with the expiration of California's previous plan, and is the result of negotiations between ED and the California Department of Education (CDE). The new plan has as its basis California's previous indirect cost plan, and again establishes the CDE as the cognizant agency for approval of kindergarten through twelfth grade LEA indirect cost rates. The new plan takes effect for indirect cost rates approved for use in 2011–12.
As before, the type of indirect cost rate is a fixed-with-carry-forward restricted rate. The indirect cost rate is computed and "fixed" in advance for a specific future period on the basis of an estimate of that period's ratio of indirect costs and operating costs. Once the actual indirect and operating costs of that period are known, the difference between the estimated and actual indirect costs is "carried forward" as an adjustment to the calculation of a future rate. This places any adjustments to the rate in a future period, allowing LEAs to avoid having to file amended federal or state program reports when actual indirect costs vary from estimated indirect costs.
The primary cost principles which guide the indirect cost plan are found in the Office of Management and Budget (OMB) Circular A-87, Cost Principles for State, Local, and Indian Tribal Governments. 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. OMB Circular A-87 provides guidance as to what types of costs are allowable charges to federal programs, and whether these costs are allowable as direct charges or as indirect charges.
Other guidance used in the development of the indirect cost plan is found in a variety of federally recognized sources, including:
Generally, consistent with past practice, all school districts and county offices of education, and those joint powers agencies (JPAs) that request it, are annually assigned an indirect cost rate based on the indirect costs reflected in their unaudited actual data submission. The ratio of indirect costs incurred in the current year serves as an estimate of the ratio of indirect costs that the LEA will incur in the future year during which the approved rate will be used.
Once approved by the CDE, the rate will be used by the LEA to recover indirect costs in the second subsequent fiscal year. For example, the following is a time line of how 2009–10 data produces rates for use with programs:
Most provisions of the indirect cost calculation remain the same as in recent years. The new provisions affect only how the carry-forward adjustment is calculated and applied. The new provisions are designed to limit and smooth the effects of the carry-forward adjustment on the LEA’s approved rate, enabling LEAs to plan more effectively and to recover indirect costs in a more predictable manner.
The new provisions are the result of the collaborative efforts of an indirect cost work group, consisting of LEA representatives and CDE staff, that was convened by the CDE and which met over a period of months to explore solutions to those aspects of the previous plan that LEAs have most frequently found problematic. The CDE extends its appreciation to the members of that group for their contributions in helping to shape the CDE’s subsequent negotiations with the ED.
The new provisions are described below, with discussion of their benefit to LEAs and how those LEAs that wish to can make use of them to manage their recovery of indirect costs. The new provisions do not require any LEA to change its current practices.
Example: If an LEA’s approved rate was based on estimated indirect costs of 8 percent, and the LEA actually incurred indirect costs of only 5 percent, there would exist a potential over-recovery of 3 percent. However, if the highest rate the LEA actually used to recover costs from any program was 6 percent, the over-recovery would be calculated based on that 6 percent, yielding a calculated over-recovery of 2 percent.
If this same LEA consistently used 6 percent to recover costs from programs except for one instance in which the LEA used 7 percent, the calculation of the carry-forward adjustment would use 7 percent, yielding a calculated over-recovery of 1 percent. LEAs should consider whether charging a particular program at a higher rate than most other programs will be beneficial.The distinction between the approved rate and the highest rate used is meaningful only where a potential over-recovery exists, that is, when the amount of indirect costs recoverable using the approved rate is greater than the estimated indirect costs that were used to establish that rate. Where the opposite is true, that is, where the amount of indirect costs recoverable using the approved rate is less than the estimated indirect costs used to establish that rate, an under-recovery exists and the calculation of that under-recovery is based on the approved rate.
Example: If an LEA's approved rate was based on estimated indirect costs of 8 percent, and the LEA actually incurred indirect costs of 9 percent, there would exist an under-recovery. The carry-forward adjustment for the under-recovery would still be calculated based on the approved rate of 8 percent.
The CDE recognizes that because some programs have indirect cost caps or allow no indirect costs at all, using the highest rate the LEA actually used in any program to calculate the carry-forward adjustment for over-recovery is not a perfectly equitable solution in every case. However, this new provision represents a compromise that significantly benefits the interests of LEAs while protecting the interest of the federal government that unallowable costs in certain programs may not be shifted to other programs.
Example: An LEA with a negative carry-forward adjustment may request that all, one-half, or one-third of the negative carry-forward adjustment be applied in the current year calculation and that the remainder be deferred. The entire deferred portion will be incorporated into the calculation of the indirect cost rate in the following year. If the carry-forward adjustment in the following year is again negative, the LEA may again request that the carry-forward adjustment be allocated over more than one year.
The assessment of whether an LEA would sustain significant fiscal harm if its negative carry-forward adjustment were applied entirely in the current year calculation is subjective. This assessment is the responsibility of the LEA. The LEA should take into consideration that deferring a portion of its negative carry-forward adjustment to a future year will affect the rate calculated in that year.In the event that applying a carry-forward adjustment over more than one year does not resolve a negative rate, the CDE will establish an equitable means of resolution on a case-by-case basis, involving the ED as needed.
Example: If an LEA’s operating costs increase significantly over their historic level because the LEA takes on new programs or expands its existing programs, the ratio of indirect costs to operating costs incurred by the LEA in that year is likely to decrease from its historic level. If the LEA were to use its approved rate to recover costs in that year, a significant over-recovery of costs could result, creating a negative carry-forward adjustment that might substantially reduce the rate for a future year.
If the CDE were to approve a revised rate closer to the ratio of costs the LEA actually expected to incur, the LEA would avoid the over-recovery and the resulting negative carry-forward adjustment.
As a practical matter, the LEA in this example could accomplish the same thing by recovering costs from programs using a rate less than its approved rate and closer to the costs it actually expects to incur. Since the carry-forward adjustment for over-recovery is now based on the highest rate the LEA actually used, an LEA can effectively minimize any negative carry-forward adjustment by using a rate very close to the ratio of costs incurred.
Consistent with past practice, in no case may an LEA use a rate higher than its approved rate.
These new provisions have been incorporated into the automated indirect cost rate calculations contained in the 2010ALL release of the CDE’s Standardized Account Code Structure (SACS) Financial Reporting Software. The functionality relating to these new provisions is described in the user guide, which is downloaded along with the software. The software can be downloaded from our Web page at http://www.cde.ca.gov/fg/sf/fr/.
Consistent with current practice, charter schools are annually assigned an indirect cost rate based on one of the following criteria:
The CDE may assign an indirect cost rate to a non-LEA that receives funding from the CDE but receives little or no funding directly from any federal agency. A non-LEA that receives funding directly from a federal agency would apply to that agency for a rate. Examples of non-LEAs are private schools, consortia, not-for-profit entities other than charter schools, and other public or private organizations.
Non-LEAs requesting a rate from the CDE will be assigned a rate based on the statewide average rate. As mentioned previously, over the last five years this rate has been between 5.00 percent and 4.44 percent. This option is used on a case-by-case basis and is subject to the CDE's approval.
For additional information about the indirect cost rate calculation or indirect cost issues in general, please refer to Procedure 915, Indirect Cost Rate, of the California School Accounting Manual (CSAM ). The 2008 edition can be accessed on the CDE's Web page at http://www.cde.ca.gov/fg/ac/sa/. Changes relating to the topics in this letter will be incorporated into the next edition, which we anticipate will be released in 2011.
Also available on our Web page at http://www.cde.ca.gov/fg/ac/ic/ is an indirect cost Frequently Asked Questions (FAQ) document and the current lists of approved indirect cost rates. The FAQ document will be updated to reflect the new provisions described in this letter.
If you have questions or need assistance with the new provisions of the indirect cost plan, please contact the Office of Financial Accountability and Information Services at 916-322-1770 or by e-mail at firstname.lastname@example.org.
Scott Hannan, Director
School Fiscal Services Division