Direct vs. Indirect Costs: the need for consistency and limited administrative charges

This is the fourth in a series of CAS-related articles focused on the recommendations from issue-specific working groups. Because implementing these recommendations will affect faculty directly, the working group and steering committee seek your comments.

by Thomas B. Higerd, Ph.D. Professor and Associate Dean, College of Medicine Preparation of a budget to accompany a grant or contract proposal is a two-step process. The first step involves estimating those expenses which contribute to the direct costs, such as personnel salaries, laboratory supplies, scientific equipment, and travel. The sum of all these costs is the “total direct costs” and is the basis for calculating “indirect costs” (overhead). The last step in preparing the budget is to tack on the indirect cost.

If the proposal describes a typical laboratory-based investigation, then an equivalent of 44 percent of the total direct costs is added. (Actually, MUSC's official rate is based on “modified total direct cost.” See the full report for details.) If the proposal involves a clinical trial, the rate of 23 percent is used. The sum of the direct costs and the indirect costs constitutes the total financial request and, if accepted by the sponsor without modification, becomes the sponsor’s financial obligation.

Investigators add indirect costs to the budgets of most proposals. This addition has become so routine that the only energy expended is a phone call to the Research Office for the latest indirect cost rate. Unfortunately, few investigators and business managers understand the basis for calculating indirect cost rates. More grant and contract management responsibilities are moving into departments, and departments are sharing more of the indirect costs. A better understanding of the use of indirect costs will help avoid audit difficulties.

By complying with CAS standards, MUSC accepts responsibility for developing a set of operating principles and guidelines which, among other things, clearly delineate those research-related expenses identified as direct costs vs. indirect costs. MUSC also accepts responsibility for disseminating this information to all university research faculty. The most egregious violation may be the situation of double billing: where an expense that had been negotiated as an indirect cost is also charged as a direct cost. A more thorough understanding of indirect costs will be helpful in appreciating subsequent articles in this series.

What are the criteria for determining direct costs?

Direct costs are those costs that can be identified specifically with and assigned to a specific research project in support of that project’s activity. The federal regulations require that the direct costs be reasonable, that they benefit the project’s stated goals, and that similar items be treated consistently as direct costs on other projects. Typically, direct costs should be itemized in the awarded budget or permitted within rebudgeting authority. One important aspect of complying with this CAS requirement is that MUSC’s written policies and practices will have precedence over sponsor-approved budgets or statements.

Examples of acceptable direct cost items are listed in the accompanying table. Salaries and fringe benefits for researchers and technicians, laboratory supplies, long-distance telephone charges, photocopy costs, animal care costs, computer costs, and specialized shop costs are allowable direct costs. Itemizing direct costs in the budget readily identifies the expenses with an activity in the sponsored project.

What goes into calculating our Indirect Cost Rate?

Federal Circular A-21 defines indirect costs as “those that are incurred for common or joint objectives and therefore cannot be identified readily and specifically to a particular sponsored project, an instructional activity or any other institutional activity.” Indirect costs are often referred to in the private sector as “overhead” or in government jargon, “facilities and administrative costs (F&A).” It is important to understand and differentiate the facilities portion from the administrative portion of indirect costs. Facilities costs include depreciation of buildings, interest on debt, capital improvements, operations and maintenance, and library expenses, to name a few. Administrative costs include such things as general administration, related department administration, sponsored programs administration, and student services. It is important to delineate the elements: the administrative portion has a ceiling which limits our return on indirect costs (listed below).

Written policies or guidelines regarding the expensing of elements composing our current, 1993-negotiated MUSC indirect cost rate do not exist. This statement, however, does not necessarily reflect adversely on the team that negotiated the rate, nor does it imply that the current rate is without merit.

To begin the daunting task of creating policies and practices for defining direct and indirect cost elements, a CAS working group was formed. This group, headed by Velma Graham from Grants and Contracts Accounting, was charged with determining which cost items should be charged as a direct cost and which should be charged as an indirect cost. Issues such as allowability, reasonableness, and consistency must be considered in the determination. Fringe benefit rates charged to sponsored programs are also a key element and require attention.

The accompanying table, listed below, illustrates the types of expenses which will be negotiated as a basis for establishing the indirect-cost rate. Once approved, we will be reviewed periodically for consistency in allocating these expenses as direct and indirect costs across all university projects. It should be recognized, however, that for special purposes and circumstances, costs normally charged as an indirect cost may be charged as a direct cost. These special-purpose situations require reasoned documentation.

So how does the cap on administrative costs affect MUSC?

By federal mandate, universities cannot charge more than 26 percent of total direct costs for the administrative portion of the indirect cost rate. A recent review of our current administrative rate was undertaken and our rate is approximately 33 percent, well above the 26 percent cap. This translates into a loss of eight cents on every direct dollar awarded, or about $2.5 million annually. The working group’s task was to review the elements of the administrative portion and move items appropriate as direct costs or move items that belong legitimately under the uncapped facilities portion. In either event, moving into a reimbursed area should provide additional revenue to the university.

Recommended Direct and Indirect Cost Elements

Direct Costs

Salaries & Related Fringe Benefits

• principal/co-investigator
• postdoctoral fellow
• lab technician
• college work study student
• consultant/specialist

Contractual Services

• freight/express deliveries
• special contract employees
• advertisement
• software
• patient travel
• film badge service

Service Center Charges

• animals and animal care
• laboratory testing services

Equipment, scientific

• dedicated
• maintenance contracts
• rental agreements

Telephone, project related

• long distance
• cellular

Supplies and Materials

• pharmaceutical
• medical, scientific, laboratory
• educational

Trainee Costs

• stipend
• tuition and fees
• other related expenses (i.e., travel)

Travel

Indirect Costs

Salaries and Related Fringe Benefits

• fiscal officer
• secretary
• department administrator
• administrative staff officer
• clerical assistant

Computer Software

• routine word processing programs
• basic data storage software
• standard statistical analysis
• software under $500, in general
• computer diskettes

Computer Hardware

• general administrative use
• portable laptops

Equipment, general purpose

• photocopier
• office furniture
• fax machines

Telephone, general

• local calls - voice mail
• basic line charges
• pagers

Office Supplies

• pens, pencils - transparencies
• paper, tablets - staples
• files, folders, binders

Postage

• general charges

Subscriptions / memberships Meals and refreshments

Working Group: Direct and Indirect Costs

Chair: Velma Graham (GCA)

Members: Carl Brown (Fiscal Affairs); Jerry Garza (Medicine); Jeanine Mathews (GCA); Lawrence Moser (Pathology); Janet Scarborough (ORSP); Maurice Snook (COM); Mike Bull (GCA); Beth Hansell (Pathology); Kathryn Meier, Ph.D. (Pharmacology); John Raymond, M.D. (Medicine); Marc Silverstein, M.D. (CHCR) Marie Townsend (ORSP)

This working group has met on numerous occasions with partners from Coopers and Lybrand to construct their written report. The report includes recommendations for adoption by the steering committee. You are invited to communicate your thoughts on this or any other CAS-related topic.