St. Martin, Iberia, Lafayette Community Action Agency, Inc. (SMILE), DAB No. 633 (1985)

GAB Decision 633

March 29, 1985

St. Martin, Iberia, Lafayette community Action Agency, Inc. (SMILE);
Ballard, Judith A.; Teitz, Alexander G. Settle, Norval D.
Docket No. 84-138


Background. The Office of Human Development Services (OHDS)
disallowed $94,362 in costs under two Head Start grants awarded to
SMILE. There were two groups of allegedly unallowable costs:
undocumented transportation costs, and excess "indirect costs."
Attachment A to Notice of Appeal. After the appellant submitted
documentation during the appeal, the parties resolved the transportation
costs issue, leaving in dispute $61,223 for excess "indirect costs"
claimed for the period June 1, 1982 -- May 31, 1983. As the case
developed, it became clear that this was not a dispute over indirect
costs per se; rather, the case was complicated by a separate but
overlapping limitation on "administrative" costs which turned out to be
the main problem. Once we recognized this, we gave the parties further
opportunities to brief and develop the record, including two telephone
conferences. Based on our review of this enhanced record, we uphold the
disallowance. The limitation on administrative costs. Head Start has a
special limitation on the amount that can be charged for administrative
costs. By statute, no Head Start grant may be awarded to a grantee if
the costs of developing and administering the grantee's program exceed
fifteen percent of total costs (including the non-federal share) of the
program. Pub. L. 97-35, Sec. 644(b) (August 13, 1981). /1/ The
implementing regulation, 45 CFR 1301.32, entitled "Limitation on costs
of development and administration," states:(2)$T( a) The costs of
developing and administering a Head Start program shall not exceed 15
percent of the total costs of such program, unless the responsible HHS
official approves a higher percentage for periods not to exceed 6
months, as necessary to carry out the purpose of the program.

(b) Each Head Start agency shall provide with its application a
statement that the costs of development and administration will not
exceed 15 percent of the total cost.

The regulations define two important terms. "Total costs" are "the sum
of all approved costs incurred in operating a Head Start program during
an approved budget period." 45 CFR 1301.2. "Development and
administrative costs" are defined as:

. . .all costs other than those which are incurred in carrying out
the education, health, social service, and parent involvement functions
prescribed in Part 1304 of this chapter. These costs include, but are
not limited to, the personnel and other costs of overall planning,
coordination, general program direction, accounting, auditing, bonding,
insurance, and the allocated costs of occupying, operating, and
maintaining the space utilized for these purposes. Id. (emphasis added)
Thus, the regulation strictly limits overhead costs, apparently to
assure that most funds go directly to benefit intended recipients.
Indirect costs, and their relationship to administrative costs. Under
Department-wide rules on grants administration, general cost principles
applicable to nonprofit organizations (such as a Head Start agency like
SMILE) are contained in Office of Management and Budget Circular A-122.
See 45 CFR 74.174. Circular A-122, Attachment A, defines "direct" and
"indirect" costs. "Direct costs" are "those that can be identified
specifically with a particular final cost objective . . . ." Para. B.1.
"Indirect costs" are "those that have been incurred for common or joint
objectives and cannot be readily identified with a particular final cost
objective." Para. C.1. Indirect costs are figured "(a)fter direct costs
have been determined and assigned. . . ." Id. Since indirect costs, by
definition, are those which cannot be easily assigned to specific
objectives, HHS and grantees often negotiate an indirect cost "rate,"
which is a ratio of the grantee's indirect costs to some (or all) of the
grantee's direct costs, expressed as a percentage. Id., Para. D, E. The
grantee then may claim funds for indirect costs in an amount
determined(3) by the rate. Para. E. Often a "provisional," or
temporary, rate is set, subject to adjustment when a "final" rate is
later determined. Para. E.l.d., e. During the period involved here
(June 1, 1982 -- May 31, 1983), appellant had a provisional indirect
cost rate of 13.9% of direct costs. /2/

The concepts of "administrative costs" under Head Start and "indirect
costs' are quite separata, and the purposes of the categories are quite
different (as explained above). However, the two concepts coincidently
will cover some of the same type of costs. Head Start administrative
costs, to which the 15% limi applied, can include both direct and
indirect costs. On the other hand, indirect costs, by their nature,
would consist largely of the type of overhead costs included among Head
Start administrative costs. OHDS has described the situation as follows:

The categorization of costs in a Head Start program as development
and administative or program costs is a determination which is deparate
from the decision to charge costs directly or indirectly. Program costs
or development and administrative costs my, in some cases, be directly
charged to the project and, in other cases, may be included as part of
the indirect cost pool . . . organizations may have approved indirect
costs rates which exceed 15 percent as long as their costs of developing
and administering a Head Start program do note exceed 15 percent . . . .

OHDS guidance document ACYF-IM-83-9, 4/11/83, p. 2 (Attachment A to
OHDS Supplemental Brief of February 7, 1985). /3/

The record and its initial development. OHDS based the disallowance on
an audit report prepared for SMILE by a private auditing firm. Notice
of Appeal, Attachment C, Part 2. OHDS's disallowance letter sustained
the auditors' recommended disallowance "for Indirect Costs in Excess of
the Amounts Allowed on Grant Document(s)." Notice of Appeal, Attachment
A.(4)$%The audit report shows the following. For grant H5659, under the
heading "transfers to indirect cost pool," the report showed $53,205
(the amount of the recommended disallowance for this grant). Notice of
Appeal, Attachment C, Part 2, p. 5. For grant 6-C-36, under the same
heading, the report showed $8,018 (the amount of the recommended
disallowance for this grant). Id., p. 7. These amounts total $61,223,
the sum in issue here. On the report's "schedule of recommended costs to
be disallowed" for grant H5659, there is the following explanation:

Grantee transferred funds to the indirect cost pool in excess of
amounts allowed by grant document. However, grantee also has an
indirect cost rate approved by another division of H.H.S. which
authorized 13.9%. Id., p. 9. An identical explanation is offered for
grant 6-C-36. Id., p. 10. SMILE's Executive Director acknowledged
during the second conference that the costs in question were direct
costs (as is implicit in much of the documentation in the file). Tape
of conference of March 11, 1985. Although the record contains some
documents saying the direct costs were transferred to the indirect cost
"pool," we believe this to be merely sloppy terminology; it appears
that what actually happened is that the State simply claimed the amounts
of "transferred" direct costs under the budget category for indirect
costs. Id. /4/ The transfer of these direct costs pushed the indirect
costs over a ceiling limitation which had been set by OHDS -- and
acquiesed to by SMILE -- specifically to avoid the problem of an overrun
of administrative costs.

(5)$%The record shows that OHDS had sent SMILE a letter dated June 25,
1982 indicating that, based on total program costs of $1,945,250, SMILE
had a 15% administrative costs limitation of $291,787 for grant H5659,
which the grantee would exceed by $66,576. OHDS brief of January 7,
1985, Exhibit 4. OHDS had figured this based on total direct
administrative costs of $239,199, plus indirect administrative costs of
$119,164, for an overall administrative cost total of $358,363 (which
exceeds $291,787 by $66,576). Id. To cover the difference, the letter
requested a revised budget limiting indirect costs to $52,588. Id. The
subsequent award document (Id., Exhibit 2) thus restricted the amount of
indirect costs to $52,588 (even though this apparently was otherwise
less than the 13.9 percent indirect cost ceiling). The record contains
no such document for grant 6-C-36, but the parties agreed that the
circumstances were the same for this grant. Tape of conference of March
11, 1985. The description above shows that this case was confusing, and
indeed the record presented by SMILE was not ideally enlightening. To
make sure we fully understood SMILE's case, we went through considerable
extra record development. The Board conducted two recorded telephone
conferences to clarify and supplement the written record. It became
clear during the first conference that OHDS limited indirect costs to
$52,588 solely to offset the excess administrative costs. It also
became clear during the first conference that an underlying issue in the
case was what constituted approvable administrative costs, whether
charged directly or indirectly, for both grants. Tape of conference of
January 14, 1985. The Board therefore asked for further written
development of the record, and thereafter conducted the second
conference. Discussion of expanded record. SMILE submitted what it
described as a "determination provided by OHDS staff of how they arrived
at the excess Administrative Cost." SMILE brief of January 22, 1985, p.
1; attachment C. This document is a letter dated May 20, 1982, with an
attachment detailing OHDS' determination of allowable direct
administrative costs. The letter gave SMILE an opportunity to question
OHDS's categorization of the costs. SMILE responded to the OHDS letter
on May 27, 1982, stating disagreement with the OHDS determinations.
SMILE brief of January 22, 1985, attachment D. OHDS responded to that
letter by letter dated June 11, 1982, which, coincidently, was also a
final decision offering an appeal right to this Board for an(6) earlier
dispute. /5/ The letter stated OHDS's commitment to its earlier
determinations on what constituted direct administrative costs.

By the letter dated June 25, 1982, discussed above on page 5, OHDS
advised SMILE that OHDS had reviewed its request for funds for the year
beginning June 1, 1982, and that the administrative costs appeared to
exceed the 15 percent limitation. OHDS requested that SMILE submit a
revised budget to remove this flaw. SMILE did, in response, submit a
revised budget which met OHDS requirements, reflecting changes in job
duties and assignments to accommodate the OHDS position. There is no
dispute about this, although for some reason the parties have not
submitted the specific documents for the record. Tape of conference of
March 11, 1985. It was on the basis of this revised submission that
OHDS, in September, 1982, awarded funds specifically limited as to the
amount of indirect costs. Id., OHDS Brief of January 7, 1985, Exhibits,
2, 3. /6/

What happened next was reflected in the audit report and acknowledged by
SMILE's Executive Director during the conference of March 11, 1985:
SMILE shifted direct administrative costs to the indirect cost category,
and thereby claimed excess indirect costs, notwithstanding that SMILE
had ealier submitted the revised cost proposal meeting OHDS's
requirements based on which OHDS has awarded SMILE's grants. In fact,
during the conference,(7) the Executive Director acknowledged that SMILE
had charged the costs in violation of its agreements with OHDS, giving
as his reason that SMILE had had "no choice" but to submit the revised
cost proposal, and had continued to disagree with OHDS's categorization.
The foregoing undisputed facts compel us to uphold OHDS's disallowance.
While SMILE would wish us to reach the issue of the validity of OHDS's
definition of administrative costs in the circumstances here, reaching
that issue would require us to overlook SMILE's violation of its grant
agreement, which reflected SMILE's earlier acquiescence in OHDS's
determination. SMILE's belief that it had "no choice" but to acquiesce
(if it wanted OHDS's money) is not sufficient justification for later
ignoring what it had agreed to do. Moreover, there is no authority for
claiming as indirect costs those cost items which can be, and have been,
identified as direct costs. Cf. OMB Circular A-122, Attachment A, Para.
C.1. Based on the foregoing, we uphold the disallowance.n7

/1/ The same provision also provides that even if administrative
costs are under fifteen percent, if the costs are, "in the judgment of
the Secretary, excessive," HHS must require the grantee to "take such
steps . . . as will eliminate such excess administrative cost . . . ."
/2/ According to SMILE's auditors, this provisional rate was set in
August, 1983 for the period June 1, 1982 through May 31, 1984.
Attachment B to Notice of Appeal, p. 1. The final rate apparently was
set in 1984 as 14%. SMILE Brief of November 29, 1984, "Contract Cost
Allocation" exhibit, p. 1. /3/ The guidance document was issued
at the end of the period in question here. We cite it not as
controlling, but as illustrative of what the circumstances would be
whether or not the guidance document existed. /4/ If the direct costs
had been transferred to the indirect cost "pool," this would
have mean that the costs were merely added to the other direct costs to
which the indirect cost rate was applied to produce the indirect cost
amount claimed. The nature of the dispute here, and the amount in
dispute, would have been substantially different. SMILE never claimed
that this was what happened, and the presentations of both parties,
imprecise terminology aside, lead us to find that SMILE merely claimed
the transferred amounts as extra indirect costs under the latter budget
category. /5/ SMILE appealed from this decision in Board Docket
No. 82-113. The issue there was the denial of a retroactive indirect
cost award for the program year prior to the one in question in the
present case. That disallowance was withdrawn by OHDS, and the case was
closed without prejudice to appellant's right to reinstitute the case if
OHDS reissued a disallowance for the earlier period. The Board has
received no further appeal related to the earlier period. While the
record suggests the dispute there concerned some of the same issues
about what was or was not properly an administrative cost, and the June
11, 1982 OHDS letter shows a linkage, the present case is for a
subsequent program year, does not involve the issue of retroactivity of
an indirect cost award, and, as explained in the body, is resolved on a
basis that does not reach the question of what cost items are or are not
administrative costs per se. /6/ The record does not show why
OHDS chose to limit administrative costs by imposing an indirect cost
ceiling, rather than by limiting direct administrative costs (or by
using some mix of the two approaches). We have not explored this, as
SMILE's acquiescence to this approach precludes any need to do so. /7/
Given the communication problems which we found reflected in the
record here, we suggested during the second conference that OHDS might
try to further clarify for SMILE how it arrived at its determenation on
administrative costs here, and counsel for OHDS agreed to explore that
possibility. We note that SMILE apparently has reached some
satisfactory agreement for 1983-1984 and 1984-1985. OHDS Supplemental
Brief of Februar 7, 1985, p. 2.

JUNE 06, 1985