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Indirect Cost and Accounting Changes

Letter Head: Jack O'Connell, State Superintendent of Public Instruction, Phone number 916-319-0800

December 15, 2006

Dear County and District Chief Business Officials and Charter School Administrators:


This letter is a follow up to our letter dated November 7, 2005, titled "Indirect Cost Plan for Local Educational Agencies," in which we announced that the California Department of Education (CDE) had renegotiated an indirect cost plan with the United States Department of Education (ED) and had entered into a Memorandum of Understanding (MOU) to commit to writing some indirect cost and related issues that ED was specifically interested in addressing. That November 7 letter can be found on the internet at

The CDE has completed its review of the pending indirect cost issues discussed in the previous letter and we are now ready to share the resolution of those issues and the resulting changes to our guidance. All changes referenced in this letter will be effective beginning with fiscal year 2007–08, which will produce indirect cost rates for use in fiscal year 2009–10.


The CDE periodically renegotiates an indirect cost plan with the federal government. This plan is the basis by which California kindergarten through grade twelve (K–12) local educational agencies (LEAs) are allowed to charge indirect costs to federal and state programs.

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 and MOU is found in a variety of federally recognized sources, including:

  • 34 CFR. Education Department General Administrative Regulations (EDGAR), Parts 75 and 76, of Title 34 of the Code of Federal Regulations (CFR). California's indirect cost rates are calculated in accordance with 34 CFR Parts 75 and 76.

  • ASMB C-10. Department of Health and Human Services (DHHS), ASMB C-10, Cost Principles and Procedures for Developing Cost Allocation Plans and Indirect Cost Rates for Agreements with the Federal Governments.

Changes related to the topics in this letter will be incorporated into the 2007 edition of the California School Accounting Manual (CSAM) which will go to the State Board of Education for approval in January, 2007. After approval, the manual will be available on the CDE Web site at


Subagreements for services (which include subawards) are indicated when a part or all of an instructional or support activity for which the LEA is responsible is conducted by a third party rather than by the LEA. The LEA's responsibility for the activity may originate from any grant, award, or entitlement. It is necessary to track subagreements separately from other agreements for reasons directly related to the indirect cost process.

Federal cost principles require that subagreements be excluded from the indirect cost rate calculation and from eligible program costs on which indirect costs are charged. The rationale for this is to prevent indirect costs from being charged twice against the same program expenditures, once by the original grant recipient and again by the subrecipient. Additional rationale for this approach is that subcontracted expenditures generally do not generate or benefit from indirect costs to the same extent as other expenditures.

To facilitate the accounting for this new requirement, the CDE has created Object 5100, Subagreements for Services. (See Attachment A for the definition of Object 5100.) Costs in Object 5100 will be excluded from the indirect cost calculation and must also be excluded from the costs on which indirect costs are charged.

In recognition that subagreements do require some level of administrative services, federal guidelines provide that up to $25,000 of each subagreement may be included in the indirect cost calculation and may be included in the costs on which indirect costs are charged. This is accomplished by charging up to $25,000 per subagreement to Object 5800, Professional/Consulting Services and Operating Expenditures.

Because of the timing and interaction between the rate calculated based on 2005–06 data and the 2007–08 expenditures to which that rate will be applied, it may be necessary to adjust some LEAs' 2007–08 rates before CDE approves them. Typically, this adjustment will increase the rate and will correct for the potential under-recovery of indirect costs in 2007–08 if subagreement expenditures were included in the calculation of the rate but excluded from the eligible expenditures to which that rate could be applied.

Therefore, if your LEA had material expenditures for subagreements in 2005–06 you should submit Attachment B, Addendum to 2005–06 Unaudited Actual Data, Subagreements for Services (see attached), to your county office of education by January 19, 2007. The form must then be forwarded by the county office to the CDE by January 31, 2007. CDE will review the data and modify the indirect cost calculations prior to approving and publishing the indirect cost rates to be used in fiscal year 2007–08.


When an employee separates from service (e.g., retires or terminates), the LEA may incur costs associated with the separation in addition to the employee's regular salary and benefits for the final pay period. These additional separation costs can be categorized either as "normal" or "abnormal or mass" costs.

Normal Separation Costs

Examples of normal separation costs include pay for accumulated unused leave or severance pay offered pursuant to the LEA’s policy. Federal guidelines prohibit charging normal separation costs directly to a federal program. State programs may have similar restrictions. Consequently, in these cases an unrestricted resource must be used. Federal guidelines and California's indirect cost plan allow for these normal separation costs that would have been charged to a restricted resource to be included in the LEA's indirect cost pool. LEAs that choose to do this will have the opportunity to manually identify and enter the costs in the indirect cost rate work sheet.

Abnormal or Mass Separation Costs

Examples of abnormal separation costs include early retirement incentives such as a golden handshake or a contract buyout. Abnormal or mass separation costs may not be charged to a federal program as either direct or indirect costs. State programs may have similar restrictions. In these cases, an unrestricted resource must be used.  Because these costs are unallowable charges to federal programs, any such costs in Function 7200, General Administration, or Function 7700, Centralized Data Processing, must be manually identified in the indirect cost rate work sheet and deleted from the indirect cost pool.


During negotiations with ED, as well as in separate discussions with the National Center for Education Statistics (NCES) to whom we report LEA financial data, CDE discussed the appropriate coding of legal, audit, and negotiations costs and the allowability of those costs to federal programs. As a result of those discussions, the CDE is now able to provide more specific guidance relating to these costs.

Legal Costs

Our discussions with ED have confirmed that, consistent with past practice, in cases where legal counsel is working on agencywide policies or is specifically representing the board or superintendent, those costs should be charged to Function 7100, Board and Superintendent. However, new guidance now allows that certain other legal costs may be charged to the function that necessitates or benefits from the legal activity. For example, legal costs necessitated by a specific program may be charged to Function 2100, Instructional Administration; legal costs related to specific business-office, purchasing or personnel matters may be charged to Function 7200, Other General Administration; and legal costs related to facilities acquisition and construction may be charged to Function 8700.

External Financial Audit

NCES requires that external audit costs be reported as an activity of the board, which by definition would exclude them from the indirect cost pool. However, this differs from the accounting treatment permitted by OMB Circular A-87, which allows that costs incurred for audits required and conducted in accordance with OMB Circular A-133, the Single Audit Act, may be charged indirectly to federal programs. Conversely, OMB Circular A-133 prohibits costs of the external audit to be charged to federal programs when a single audit is not required or conducted.

Accordingly, the CDE has added two new function codes for external financial audits, one for the single audit conducted pursuant to OMB Circular A-133 for LEAs that expend more than $500,000 in federal funds (Function 7190, External Financial Audit—Single Audit), and one for an external financial audit for LEAs that expend less than $500,000 in federal funds and for whom a single audit is not required (Function 7191, External Financial Audit—Other). Function 7190 will be added to the indirect cost pool and Function 7191 will remain part of the base.

Staff Relations and Negotiations

Incremental costs of activities concerned with staff relations systemwide and the responsibilities for contractual negotiations with both instructional and noninstructional personnel can generally be charged indirectly to federal programs. Accordingly, the CDE has added an optional new code (Function 7120, Staff Relations and Negotiations) and any costs charged to this function with an unrestricted resource will be included in the indirect cost pool.


In general terms, an indirect cost rate is the ratio of total indirect costs to total direct costs. While indirect costs are usually limited to the General Fund, direct costs are typically recorded in both the general fund and in certain other funds. Federal indirect cost guidelines require that the indirect cost rate calculation include all funds that have activities that would reasonably benefit from the services performed by the general administrative offices.

Under the previous indirect cost plan, the indirect cost rate calculation included the following funds: General/County School Service (Fund 01), Adult Education (Fund 11), Child Development (Fund 12), Cafeteria Special Revenue (Fund 13), and Cafeteria Enterprise (Fund 61). Pursuant to the new plan, the Foundation Special Revenue Fund (Fund 19) and the Foundation Permanent Fund (Fund 57) were added to the indirect cost calculation in fiscal year 2005–06.

The Charter Schools Special Revenue Fund (Fund 09) and the Charter Schools Enterprise Fund (Fund 62) will be added to the indirect cost rate calculation beginning with the 2007–08 unaudited actual data. This means that for those school districts and county offices of education that include charter school data in Fund 09 or Fund 62 of their unaudited actual submissions, the charter school’s data will be included in the calculation of the LEA's indirect cost rate. If a charter school reports its data to CDE separately under its own county-district-school (CDS) code, it will receive its own separate indirect cost rate. Charter schools using the alternative form will continue to receive a statewide average indirect cost rate.

For school districts or county offices that include charter data in their submissions, we recommend that you reevaluate whether the charter school should be part of your LEA’s reporting entity. Among other things, the inclusion of the charter school’s data will affect your indirect cost rate. You may want to discuss this with your auditor.


To provide for consistency in reporting, and to allow for further automation of the indirect cost process, ED has agreed to allow the percentage of administrative salaries and benefits rather than the percentage of administrative classroom units (CUs) to be used as the basis for determining the portion of plant services costs to include in the indirect cost pool. Because there is a correlation between administrative salaries and administrative space usage, for many LEAs the results will be similar by either method.

For those LEAs that contract for administrative services rather than employ personnel in these positions, the CDE will allow a manual adjustment to the indirect cost worksheet so that these costs are included in the calculation.

  • To ensure consistency and compliance with federal cost principles, when calculating the percentage of administrative salaries and benefits, salaries and benefits relating to Plant Services will now be categorized as "other" costs (rather than administrative) and salaries and benefits relating to Instruction-Related Services and Pupil Services will be added to the base costs (previously they were mostly excluded). Further, to prevent the potential double-charging of costs, Facilities Rents and Leases paid with a restricted resource will be excluded from the pool of facility costs split between indirect and base costs; these costs will instead be automatically assigned to the base.

  • The CDE has identified three circumstances where costs charged to the general administration function typically have a specific funding source. These are Nonagency (Goals 7110 and 7150); County Services to School Districts (Goal 8600); and resource-specific indirect costs (e.g., CSIS, Resource 6020, and Teacher Recruitment, Resource 6255). In the indirect cost rate calculation, County Services to School Districts are already correctly recorded as base costs rather than indirect costs. For the nonagency goals and resource-specific indirect costs, since the services are paid for by a particular funding source, they will be removed from the pool of indirect costs and instead be put in the base.

    The net result of this change will be to include only costs in Resources 0000–1999, Unrestricted, and Goals 0000 and 9000, Undistributed, in the pool of indirect costs. (Note: There may be exceptions to this for LEAs that are funded by a single restricted resource, such as some joint powers agencies.)

  • Costs in Function 6000, Enterprise, have been treated inconsistently in the indirect cost rate calculation in that enterprise costs in Fund 01 have been excluded from the calculation but enterprise costs in other funds (11, 12, 13, and 61) have been included. Since it is reasonable to assume that enterprise activities benefit from the services provided by general administrative activities (e.g., fiscal services, personnel/human resources, centralized data processing), then it is correct that they be included in the base. Therefore, Function 6000 costs for the other funds will remain in the base and the indirect cost rate calculation will be updated to include Function 6000 costs with Fund 01. (Note: If an enterprise activity is significant and is entirely self-supporting, the activity should normally be accounted for in Fund 63, Enterprise, which will exclude it from the calculation.)

As a result of significant research and negotiation with ED, and also as a result of the new Governmental Accounting Standards Board Statement 45 regarding postemployment benefits other than pensions (OPEB), the CDE has developed new guidance on the allowability and proper accounting for OPEB costs. Because there are no changes to the indirect cost process due to OPEB, and because OPEB is a separate and complex topic, the CDE will be sending a separate detailed letter soon that will provide explicit explanation and guidance on this subject.


Both CDE and ED recognize that the changes outlined in this letter may have a noticeable effect on an LEA's distribution of costs between the indirect cost pool and base costs. Given this, application of the carry-forward adjustment, which involves amounts calculated prior to implementation of our new indirect cost plan, may be inappropriate during the transition to the revised calculation. CDE and ED are negotiating an alternative to the regular application of the carry-forward adjustment to use during the transition; you will be notified when a resolution has been agreed upon.

If you have any questions or need assistance with the accounting guidance in this letter, please contact the Office of Financial Accountability and Information Services at 916-322-1770 or by email at


Scott Hannan, Director
School Fiscal Services Division

Attachment A

Last Reviewed: Friday, February 2, 2024

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