What Everyone Should Know About Indirect Costs
Guest blog by Cindy Hope
Director, Costing and Financial Compliance
Council on Government Relations (COGR)
I’ve been explaining the indirect/facilities and administrative costs of universities for 30 years. The topic first came to my attention as an auditor, but that was just a toe in the water. When I was hired as the indirect cost specialist for the University of Alabama at Birmingham, I found myself in the middle of the deep end. Fortunately, I had access to experts who spent months explaining to me what I’m going to attempt to summarize for you in just three minutes.
Indirect Costs Are Not That Complicated
In concept, it isn’t that hard.
Certainly, the costs that are easy to assign to individual research projects are not hard, and we call those direct costs. Typical direct costs include researcher salaries, lab supplies, and equipment needed specifically for a project.
Other costs are difficult to assign directly to a particular project with any degree of accuracy, so they are called indirect costs. Those include utilities, depreciation of buildings and equipment used for research, and maintenance. They also include administrative costs like purchasing, lab safety, human and animal subject protections, research security, and data management and sharing.
“Indirect” is the same term used in the federal commercial cost principles, but the terminology seems to create confusion when applied to universities and other nonprofit research institutions. Years ago, to clarify the true nature of indirect costs, the federal government, universities, and other nonprofit research performers agreed to use the term “facilities and administrative” (F&A) costs. While this term is more descriptive, the government recently switched back from F&A to “indirect” costs.
Indirect Costs Only Include Actual Costs of Supporting Research
Just like industry performers of federally funded research, universities and other nonprofits calculate an indirect cost reimbursement rate by collecting, organizing, and reporting on massive amounts of cost, space usage, and other data. This results in an allocation of indirect costs to benefiting activities, such as research. The indirect costs allocated to research are then divided by a subset of the direct costs of research to arrive at an indirect cost rate. This subset of direct cost, modified total direct cost (MTDC), excludes several types of costs, like equipment and graduate student researcher tuition, to avoid inequitable allocations of indirect costs.
The federally dictated procedures for arriving at the rate are detailed and prescriptive, and the federal government spends significant time extensively scrutinizing the institution’s proposal. Site visits and other procedures are conducted at institutions with large federal research portfolios. These include inspecting space and equipment and interviewing principal investigators. Anything not fully supported as reasonable, allowable, and allocable to research is eliminated from the indirect costs (the numerator in the indirect cost divided by MTDC calculation), and the parties arrive at a negotiated indirect cost rate.
No profit, no fee, and nothing else is included in the indirect cost rate, only the allocable cost of housing and supporting research.
Changing Indirect Cost Rates
To receive reimbursement for any of the investments the institution made to support research, it applies the negotiated indirect cost rate to awards as it does the research and charges the direct cost. So, when the project is charged for direct costs, the expenses included in MTDC are multiplied by the indirect cost reimbursement rate and the result is added to the charges to the project.
The Indirect Cost Reimbursement System Is Not Perfect
While simple in concept, the indirect cost reimbursement process does have complications, which lead to additional misunderstandings. For example, if an institution were able to negotiate and apply its full indirect cost rate to all federally funded research projects, it would recover all the indirect costs allocable to that research. It cannot, due to caps on indirect cost components and the rate negotiation process, and it does not, because of agency decisions not to pay the negotiated rate.
Despite significantly sharing in the cost of research, including under-reimbursement of indirect costs, some perceive inequities in how indirect cost rates are applied. Because the rate is intended to be simple, it applies to all on-campus research across all types of research projects. So, on average and in total, the institution never receives more than it spent to support sponsored research. Importantly, an institution charges the same rate whether a particular project costs less or more than the average to support. In other words, an institution can’t accept less than the average for a less expensive project because it can’t charge more for a more expensive project – it charges them the same rate.
Additionally, some academic institutions remove the federal limits from their indirect cost rates prior to charging industry sponsors but still recover no more than their cost. Most, meanwhile, accept lower rates from nonprofit sponsors with rate cap policies. While this may appear unfair to federal and other sponsors paying a higher rate, institutions subsidize this small portion of their research portfolio to further specific research interests, and the sponsors paying higher rates are still paying no more than cost.
The System Is Simple but Flexible
The indirect cost reimbursement system is simple in concept but accommodates differences in cost between regions of the country and the types of research in which an institution specializes. While we should pursue improvements, we should note that the system is practical, efficient, and effective. Further details on indirect costs can be found on COGR’s Facilities and Administrative Cost Reimbursement Materials webpage.
Cindy Hope leads COGR’s efforts to address federal policies impacting the financial management of research programs. Learn more about Cindy and connect with Cindy on LinkedIn.