Department of Health and Human Services (H.H.S.)
Departmental Appeals Board
DAB Decision
MCLEAN HOSPITAL
Docket No. 81-38
Decision No. 0288
April 30, 1982
DECISION
This appeal by McLean Hospital (Appellant) involves a determination that
volunteers who worked on research projects conducted by Appellant but were
paid by other sources benefitted from space-related indirect costs incurred
by
Appellant, and that an adjustment in Appellant's proposed indirect cost rate
for fiscal year 1981 should be made in recognition of that benefit. The
determination was made by the Principal Regional Official, Region I
(Respondent), sustaining the position of the Director, Division of Cost
Allocation, on an appeal by Appellant under 45 CFR Part 75. As discussed
below, we find that no adjustment for volunteer services in Appellant's
proposed indirect cost rate for fiscal year 1981 is justified since Respondent
failed to show that a distortion in the distribution of indirect costs among
research projects would otherwise occur.
How the Adverse Determination Arose
Appellant, a psychiatric hospital, receives grant awards from various
constituent agencies of the Department of Health and Human Services, as well
as from private sources, to support research projects in areas pertaining to
mental health and related subjects. Federal grant awards account for
approximately 80% of Appellant's total research funding. In carrying out both
its federal and non-federal research projects, Appellant relies to some extent
upon volunteers. The volunteers fall into three categories: (1) "strict"
volunteers who receive no compensation for their services; (2) college
students on work-study, who receive stipends paid in part by Appellant and in
part by their respective schools; and (3) "supported" volunteers,
who receive
no salary from the grant project on which they work but are funded by sources
other than Appellant, such as universities. In fiscal year 1979 (the year for
which actual cost data in support of the indirect cost proposal was supplied),
18.1 percent of the persons (measured in full-time equivalents--FTE's) working
on the research projects were volunteers. "Supported" volunteers constituted
11.88 FTE's. Most of the "supported" volunteers working on federal
research
projects were identified in the grant applications, some as principal or
coprincipal investigators.
(Application for review, Exhibit G) Respondent acknowledged that the
volunteers were essential to the performance of the federally funded projects.
(Transcript of Conference held February 26, 1982, pp. 8, 108)
By letter dated March 31, 1980, Appellant submitted to the Director,
Division of Cost Allocation, an indirect cost proposal for fiscal year 1981
based on actual cost data for fiscal year 1979. (Response to appeal, dated
August 3, 1981, p. 1; Transcript, p. 62) Appellant's proposal requested a
research indirect cost rate of 61.31%, computed using a direct cost base of
total direct costs. (Application for review, Exhibit A)
In negotiations on the proposal, Respondent took the position that
Appellant should include in the direct cost base the imputed value of the
services of the volunteers. In response to arguments made by Appellant,
however, Respondent later agreed that it would be inequitable to include the
value of these services in the base "(b) ecause many of the indirect cost
elements do not seem to benefit these individuals . . ." (Application for
review, Exhibit B) Respondent further stated, however, that ". . . there
is no
doubt that space related costs such as operation and maintenance of plant and
building depreciation do benefit the 'non-paid' people . . .," and proposed
to
exclude from the indirect cost pool an amount equal to certain space-related
costs times the percentage of volunteers. Since an indirect cost rate is the
ratio of indirect costs to a direct cost base, the effect of excluding certain
indirect costs was to reduce the rate to 56.22%. (Application for review,
Exhibit B) The alternative of the inclusion of the value of the services of
the volunteers in the direct cost base would also result in a reduction of the
proposed rate, although no figure is given in the record. When no other
suggestions regarding the treatment of the volunteers were made by Appellant,
Respondent made a formal determination that certain space-related indirect
costs should be excluded from the indirect cost pool in computing the indirect
cost rate. (Application for review, Exhibit C) This determination was
subsequently sustained by the Principal Regional Official. (Application for
review, Exhibit E)
The Problem of Distortion
Respondent argued that the application of Appellant' s proposed indirect
cost rate would result in a "distortion" in that it would divide all
of the
space-related indirect costs equally among grants, even though different
numbers of people worked on each grant project occupying different amounts of
space. (Response to appeal, dated August 3, 1981, p. 5; Transcript, pp. 105-
106) Respondent illustrated this alleged problem as follows.
Suppose there are two research projects, A and B. Three people,
including 1 volunteer, work on Project A, with salaries of $10 each. Two
people, neither of them volunteers, work on Project B, with salaries of $10
each. Indirect costs totalling $20 are incurred. A single indirect cost rate,
composed of indirect costs divided by a direct cost base of salaries and
wages, is to be negotiated for both projects.
Under Appellant's proposal, the direct cost base is $40 ($20 for Project
A and $20 for Project B), since no salary is imputed for the volunteer on
Project A. Thus, the indirect cost rate is $20/$40, or 50%. Applying that rate
to the direct costs for each project, the indirect cost recovery is $10 for
Project A (50% of $20) and $10 for Project B (50% of $20).
Respondent contended that this situation was inequitable, in that
Project A, having more persons, should be charged a larger proportion of the
indirect costs than Project B. Respondent argued that the direct cost base
should include an imputed salary for the volunteer, [FN1] for a total of $50
($30 for Project A and $20 for Project B). The indirect cost rate would then
be $20/$50, or 40%. Thus, the indirect cost recovery would be $12 for Project
A (40% of $30) and $8 for Project B (40% of $20). (Transcript, pp. 104-106 and
Respondent's Exhibit 3) Respondent further expressed its belief that the
constituent agency sponsoring Project A would in actuality only pay $8 in
indirect costs, although we do not find any support for that opinion. [FN2]
We agree with Respondent that, in its illustration, there would indeed
be a distortion in the way that the indirect costs are distributed between the
research projects if the volunteer' s salary is not included in the direct
cost base. Such a distortion is impermissible not just as a matter of equity,
but is specifically prohibited by the cost principles applicable to hospitals.
Part 74 of 45 CFR provides, at Appendix E, Part II, D.2., that-- Any costs
allocable to a particular research agreement under the standards provided in
these principles may not be shifted to other research agreements in order to
meet deficiencies caused by overruns or other fund considerations, to avoid
restrictions imposed by law or by terms of the research agreement, or for
other reasons of convenience.
If Project A and Project B are charged the same amount of indirect costs
although Project A is a larger project and actually generates more indirect
costs than Project B, then costs allocable to one research agreement have been
shifted to another research agreement within the meaning of this provision.
Respondent did not allege that the costs were shifted "in order to meet
deficiencies caused by overruns or other fund considerations," and it is
clear
that that could not be the case since the total indirect cost recovery is the
same ($20) under both methods shown in the illustration. However, absent a
showing to the contrary, it can be assumed that the funds were shifted "for
.
. . reasons of convenience."
Although the quoted provision of Appendix E would require that a
volunteer's imputed salary be included in the direct cost base under the
illustration given by Respondent, it does not follow that such an adjustment
must necessarily be applied in the facts of the case before us. This is so
because, while in the illustration only one of the two projects used a
volunteer, there has been no showing that a similar disparity between projects
existed in the case actually before us. It is entirely possible that the
volunteers used by Appellant in fiscal year 1979 were in fact equally
distributed among research projects in proportion to direct costs, in which
event there would be no distortion under Appellant' s proposal since each
project would generate the same amount of indirect costs. The record does not
indicate that Respondent considered the manner in which the volunteers were
distributed among projects before requiring that Appellant adjust its proposed
indirect cost rate. While Respondent itself should not have to establish that
the volunteers were unequally distributed, we believe that it had a duty to
at
least inquire of Appellant whether this was the case. In short, the problem
is
that Respondent, insofar as any showing in the record is concerned, based its
determination on mere speculation; specifically, on an unsubstantiated
assumption that volunteers were unequally distributed. Since there is no
factual basis in the record to substantiate that a distortion existed, we
conclude that no adjustment in Appellant' s proposed indirect cost rate is
justified.
We note here that if the volunteers were equally distributed among
research projects, Appellant could recover the same amount of indirect costs
by including their imputed salaries in the direct cost base, as it would have
under its unadjusted indirect cost proposal, provided that it was able to
include imputed salaries for the volunteers in each grant' s direct costs.
Appellant asserted without contradiction from Respondent, however, that, if
it
adjusted its rate in this manner, it would not be able to recover its full
indirect costs for any grants already awarded because imputed salaries for the
volunteers were not included in each grant's direct costs. (Response to Order
to Show Cause, dated November 24, 1981, pp. 11-13; Transcript, p. 127) Thus,
although an adjustment in future indirect cost rates applicable to grants not
yet awarded might be justified even in the absence of a showing that the
volunteers were unequally distributed, we cannot support Respondent' s
decision to require an adjustment in the rate for fiscal year 1981, since it
might deprive Appellant of the full indirect costs to which it is entitled.
Use of Space by Volunteers
We do not, by our decision that no adjustment in Appellant's proposed
indirect cost rate is justified, imply acceptance of various other arguments
advanced by Appellant in support of its position. One of Appellant' s
principal arguments was that, since space-related costs are distributed based
on square footage, and the square footage used by a project does not increase
significantly with the addition of a few volunteers, there was no distortion
in the distribution of indirect costs by virtue of the presence of volunteers.
It asserted that space was reserved for a project before the grant was
awarded, and did not thereafter change. (Transcript, pp. 19-20, 24, 57, 129;
Appellant's post-conference brief, dated March 29, 1982, p. 7) Appellant
admitted, however, that, when space was assigned, it knew that there would be
some volunteers on the project. (Transcript, pp. 19-20) Obviously, Appellant
was aware of those volunteers named in its grant applications. The fact that
there was some ration of volunteers in determining the amount of space
necessary for a project means that there could have been some distortion
(although perhaps less than posited by Respondent) in the distribution of
space-related indirect costs if volunteers were unequally distributed among
projects.
Consistency with Medicare Principles
Appellant also argued that the adjustment required by Respondent was
inconsistent with the principles for reimbursement under Medicare, in
contravention of 45 CFR Part 74, Appendix E, Part I, B.5. (Transcript, p. 65;
Appellant's post-conference brief, dated March 29, 1982, p. 13) That provision
reads as follows: Hospitals receive reimbursements from the Federal Gov't for
differing types of services under various programs such as . . . Medicare .
.
. It is essential that consistent procedures for determining reimbursable
costs for similar services be employed without regard to program differences.
Therefore, both the direct and indirect costs of research programs must be
identified as a cost center(s) for the cost finding and stem requirements of
the Medicare program . . Appellant pointed out that the procedures in the
Medicare Provider Reimbursement Dual for allocating overhead (indirect) costs
to a hospital's cost centers do not require that overhead costs attributable
to volunteers be excluded from indirect costs in determining patient rates.
(Response to Order to Show Cause, dated November 24, 1981, p. 9; Transcript,
pp. 69; Appellant's post-conference brief, dated March 29, 1982, p. 13) It
further noted that the particular form (Form HCFA-2552) used for determining
costs reimbursable by Medicare was routinely submitted to the Division of Cost
Allocation for its use in determining the indirect cost rate applicable to
research grants. (Transcript, pp. 53, 66, 73) Respondent did not dispute these
assertions, but contended that the Medicare principles had no relevance to how
indirect costs were distributed among research projects. (Transcript, p. 91)
We find that the quoted provision of 45 CFR Part 74 does not support
Appellant' s position. The sentence, "It is essential that consistent
procedures . . . for determining reimbursable costs for similar services be
employed without regard to program differences," is followed by a sentence
which further defines and narrows its meaning: "Therefore, both the direct
and
indirect costs of research programs must be identified as a cost center(s) for
the cost finding and step-down requirements of the Medicare program . . . ."
We read this as requiring that a hospital, in determining the costs of patient
care eligible for reimbursement by Medicare, show all direct and indirect
costs incurred by it, regardless of whether they relate to patient care. Use
of a consistent set of figures for determining amounts due the hospital under
Medicare and other sources of federal funding assures that the institution
will not receive more than the costs actually incurred by it. The fact that
certain costs are shown as indirect or direct costs on Form HCFA-2552 does not
have any bearing on the question whether the indirect costs attributable to
volunteers should be excluded or the direct cost base should be augmented by
volunteers salaries in computing the hospital' s research indirect cost rate.
Distortions Average Out Over Time
Appellant also argued that any distortion in the distribution of
indirect costs as the result of the presence of volunteers was only one among
many distortions or misallocations inherent in the indirect cost allocation
process and would, like the other distortions, "average out" over
time.
(Transcript, pp. 127-128, 130, 132; Appellant's post-conference brief, dated
March 29, 1982, pp. 8-9)
Respondent agreed, and we recognize, that indirect cost allocation is
not a precise art. (Transcript, p. 151) Nevertheless, we cannot accept
Appellant' s argument that any distortion caused by the presence of volunteers
was acceptable based on the likelihood that the awarding agencies which pay
a
disproportionate amount of indirect costs in one year may pay less than their
fair share in another year. In prohibiting the shifting of costs properly
allocable to one research agreement to another research agreement, the cost
principles implicitly require Respondent to prevent, to the extent possible,
any distortion which can be identified. If all apparent distortions can be
excused on the ground that "it will all average out," the cost allocation
process becomes meaningless.
Separate Cost Pools
Appellant also argued that the adjustment required by Respondent would
result in the creation of more than one indirect cost rate, and that the use
of multiple rates was not warranted under the criteria set forth in 45 CFR
Part 74, Appendix E, Part VII, A.l. (Application for review, pp. 10-12;
Appellant' s post-conference brief, dated March 29, 1982, pp. 14-17) Since it
appears that any future adjustment in the indirect cost rate for years after
fiscal 1981 would consist of the addition of imputed salaries for volunteers
to the direct cost base (see footnote I of this decision), and such an
adjustment would clearly yield only a single rate, we need not address this
argument.
Conclusion
We conclude that no adjustment for volunteer services in Appellant's
proposed indirect cost rate for fiscal year 1981 was justified. This
conclusion is based on the lack of evidence that volunteers were unequally
distributed among research projects, which would have caused those projects
with fewer or no volunteers to bear a disproportionate share of indirect
costs. This decision does not preclude Respondent from adding imputed salaries
for volunteers to the direct cost base in computing the indirect cost rate for
future years where Appellant has an opportunity to assure that it will be able
to recover the full amount of indirect costs to which it is entitled.
Alexander G. Teitz
Donald f. Garrett
Norval D. (John) Settle
Presiding Board Member
FN1. Although the adjustment specified in Respondent' s adverse determination
was the exclusion of certain space-related costs used to calculate Appellant'
s indirect cost rate, Appellant took the position that if an adjustment were
found by the Board to be necessary, it would be fairer to add imputed salaries
for the volunteers to the direct cost base (as long as it could also add to
the indirect cost pool indirect costs not previously claimed). (Response to
Order to Show Cause, dated November 24, 1981, pp. 9-11; Transcript, pp. 42-44)
Respondent' s use of the imputation method in this illustration seems to
indicate its willingness to honor Appellant' s preference when an adjustment
is justified.
FN2. Respondent' s opinion was based on its interpretation of Chapter
6-150-30A of the Department's Grants Administration Manual. (Transcript, pp.
99, 106) That provision states that "(i)f the grantee provides a cost-sharing
contribution in a direct cost category used in computing the direct cost base,
the indirect costs applicable to the contributed direct costs may not be
charged to the grant." Appellant asserted without objection by Respondent,
however, that its cost-sharing agreement specifically excluded volunteers from
its cost-sharing contribution. (Transcript, pp. 152-153) Accordingly, under
the illustration given, $12 would in fact be recovered as indirect costs for
Project A.
END OF DOCUMENT