1999.02.11 DAB1679 Waccamaw Economic Opportunity Council, Inc. v. Division of Cost Allocation's (DCA)

Department of Health and Human Services
DEPARTMENTAL APPEALS BOARD
Appellate Division

DATE: February 11, 1999

SUBJECT: Waccamaw Economic Opportunity Council, Inc.

Docket No. A-98-88
Decision No. 1679

DECISION

The Waccamaw Economic Opportunity Council, Inc., (Waccamaw) appealed the Division of Cost Allocation's (DCA) determination to disallow $48,155 in federal grant funds that Waccamaw claimed under its Head Start program during 1995. The disallowed funds were used to purchase a pension for Waccamaw's former executive director, covering her employment from July 1967 to June 1992. The payments were required by state law after Waccamaw joined the South Carolina Retirement System (SCRS) and the former executive director elected to purchase pension coverage from SCRS. DCA took the disallowance on the basis that using funds awarded in 1995 to pay for pension costs related to a prior time period violated principles of federal appropriations law and applicable cost principles.

The record consists of the parties' submissions, including DCA's responses to questions posed by the Board. Waccamaw declined to submit a reply brief or to comment on the Board's questions. As explained below, we remand the disallowance to DCA to determine whether any of the disputed payment may be allowable under applicable cost principles which provide specific guidance for determining the amount of pension contributions that may be charged to federal grants, but which were not considered by DCA in presenting its case before the Board.

Applicable law, regulations, and policies

The allowability of charges to federal funds by nonprofit organizations such as Waccamaw is governed by Office of Management and Budget Circular A-122 (OMB A-122), made applicable to HHS grants by federal regulations at 45 C.F.R. . 74.27(a) (1994). See 45 Fed. Reg. 46,022 (1980). OMB A-122 provides a uniform set of cost principles for determining costs of grants, contracts, and other agreements and is designed to promote efficiency and understanding between nonprofit grantees and the federal government. Home Education Livelihood Program, Inc., DAB No. 1598 (1996). It provides general principles on allowable costs, as well as guidance on specific cost items. Id.

OMB A-122 requires that in order to be allowable charges to a grant award, costs must be reasonable for the performance of the grant award and allocable thereto. OMB Circular A-122, Attachment (Att.) A, . A.2.a. A cost is allocable to a particular cost objective, such as a grant, contract, project, service, or other activity, in accordance with the relative benefits received. . A.4.a.

OMB A-122 provides specific guidance on the extent to which the costs of pension plans for a grantee's employees may be allowable charges to federal grants:

(1) Costs of the organization's pension plan which are incurred in accordance with the established policies of the organization are allowable, provided:

(a) Such policies meet the test of reasonableness;
(b) The methods of cost allocation are not discriminatory;
(c) The cost assigned to each fiscal year is determined in accordance with generally accepted accounting principles (GAAP), as prescribed in Accounting Principles Board Opinion No. 8 issued by the American Institute of Certified Public Accountants; and
(d) The costs assigned to a given fiscal year are funded for all plan participants within six months after the end of that year. However, increases to normal and past service pension costs caused by a delay in funding the actuarial liability beyond 30 days after each quarter of the year to which such costs are assignable are unallowable. OMB A-122, Att. B, . 7(h).

Background and arguments

The Head Start program is designed to deliver comprehensive health, educational, nutritional, social and other services to economically disadvantaged children and their families. See 42 U.S.C. . 9831 and 45 C.F.R. . 1304.1-3. The Administration for Children and Families (ACF) provides funds to grantees to serve as Head Start agencies within designated communities and periodically reviews their performance in meeting program and fiscal requirements. See generally 42 U.S.C. . 9836.

Waccamaw's Board of Directors voted to join SCRS in 1993. The following year, Waccamaw's former Executive Director purchased a little more than 24 years worth of retirement service from SCRS, covering the period July 1967 to June 1992. In March 1994, SCRS billed Waccamaw $60,541.19 for the employer's contribution for that period of service. Waccamaw set up a ten-year payment plan with SCRS and made the first two annual payments of $8,225.61 in 1994 and 1995, before making the lump-sum payment at issue here, to save on interest charges associated with the payment plan.

DCA originally disallowed the lump-sum pension payment on the grounds that it was not reasonable and allocable to federal programs as required by OMB A-122. Before the Board, DCA primarily argued that use of federal funds for the pension payment violated the "bona fide needs rule" of appropriations law, which holds that appropriations for a particular year are to be obligated by an agency only to meet legitimate needs arising in the year of appropriation. DCA argued that Waccamaw violated the bona fide needs rule by using funds appropriated and awarded for Head Start expenses arising in 1995 to pay for pension costs related to the years 1967 through 1992.

DCA cited Comptroller General decisions applying the bona fide needs rule to limit a federal agency's expenditures, and argued that the rule applies to grantees because grant funds retain their federal character even after they have been awarded and spent. DCA response to Board questions, citing Neukirchen v. Wood County Head Start, Inc.,53 F.3d 809 (1995) (property purchased with federal funds constitutes federal property). DCA argued that the Board has recognized the principle underlying the bona fide needs rule in decisions holding that funds should be obligated prior to the end of a fiscal year, and holding that program requirements that funds be used for current year purposes were a rational process by which available funds are allocated to priority needs as identified by the grantee agencies.

DCA further argued that the pension payment was not reasonable and necessary and did not benefit federal funding sources because the former executive director had already been fully compensated for her services. DCA argued that by using 1995 funds to pay prior years' expenses, Waccamaw was using funds for purposes other than the purpose for which they were awarded, and risked exceeding its federal award limits for those years. (DCA did not argue that Waccamaw actually exceeded its grant awards for either the prior years or for 1995.)

Waccamaw argued that the disputed pension payment met the standards of allowability for compensation for personal services and pension plan costs found in OMB A-122. Waccamaw argued that it was required by state law to make the pension payment to match the amount that the former executive director paid into the state system towards the purchase of her retirement benefits. Waccamaw noted that its contribution, broken down by year, amounted to $2,522.55 for each of the former Executive Director's 24 years of service. Waccamaw argued that these annual amounts were allowable under OMB A-122 as reasonable compensation for the services she performed.

Analysis

We find that DCA has failed to show that the bona fide needs rule applies to how grantees may spend their awards, as opposed to how federal agencies obligate their appropriations. We further find that specific provisions of OMB A-122 governing the allowability of pension payments may allow the use of current year funds to pay for pension costs relating to periods of service prior to the adoption of a pension plan. Because the applicability of these provisions of OMB A-122 has not been specifically addressed by either party, we remand the disallowance to DCA to determine whether any of the disputed payment may be allowable thereunder.

1. The bona fide needs rule does not apply here.

The bona fide needs rule provides that federal agencies may obligate fiscal year appropriations only to meet legitimate, or bona fide, needs arising in (or in some cases prior to but continuing to exist in) the fiscal year for which the appropriation was made. See Principles of Federal Appropriations Law, 2d ed., U.S. General Accounting Office, Office of the General Counsel, July 1991, OGC-91-5, at 4-2, 5-9 to 5-42. The rule has been applied to prevent agencies from using unspent appropriations at year's end for supplies and other expenses that will not be needed until subsequent years; rather, the expenditures must be for bona fide needs of the year of the appropriation. Id.

While the bona fide needs rule governs how federal agencies may expend their appropriations, DCA has not shown that it also applies to determine the allowability of a grantee's expenditures of the funds it receives under a federal award. The Comptroller General cases cited by DCA as applying the bona fide needs rule (71 Comp. Gen. 502; Comp. Gen. Opinion No. B-257977) simply do not address whether a federal grantee's expenditures are allowable charges to federal funds. Rather, they address the timing and manner in which a federal agency obligates its fiscal year appropriations. Those decisions provide no guidance for applying the bona fide needs rule to this disallowance.

That the bona fide needs rule offers little guidance on how grantees may spend their awards is evident from the only specific reference to the bona fide needs rule in materials that agencies use in administering grants expenditures of which the Board is aware. The ACF Grants Administration Manual (GAM) provides that:

A fundamental principle of appropriations law is the "bona fide need" rule which states that a fiscal year appropriation may be obligated only to meet a legitimate or "bona fide need" arising in (or in some cases arising prior to but continuing to exist in) the fiscal year for which the appropriation was made. An appropriation for a given fiscal year is not available for the needs of a future fiscal year. Determination of what constitutes a "bona fide need" of a given fiscal year depends largely on the facts and circumstances of the specific case.

All ACF financial assistance awards subject to this section must include some performance by the grantee in the fiscal year from which funding of the award is taken. That is, no ACF financial assistance award may be funded from a given fiscal year appropriation if there is no grantee performance during that same fiscal year. ACF GAM . 3.04.403.G. (emphasis added)

This language addresses whether ACF may fund an award from a fiscal year's appropriation and provides no guidance on whether a grantee's expenditures under an award are allowable. By the terms of the GAM, ACF complies with the bona fide needs rule by awarding a grant prior to the end of a fiscal year, so long as there is some performance of the award by the grantee during that fiscal year. That Waccamaw fulfilled this requirement was not disputed here.

The bona fide needs rule and its originating statute apply by their terms to government agencies and the manner in which they obligate their appropriations. Grantee recipients of awards under those appropriations are governed by the terms of the award documents and the applicable laws, regulations, and cost principles. DCA has not shown that these materials incorporate the bona fide needs rule. Moreover, some of these cost principles permit grantees to obligate their awards in ways that would be inconsistent with the way that DCA argued that the bona fide needs rule applies here.

For example, federal regulations provide that HHS funding agencies may permit grant recipients to carry forward unobligated balances from one funding period to subsequent funding periods. 45 C.F.R. . 74.25(d)(3). The federal regulations and the various GAMs also permit grantees to recover pre-award costs under appropriate circumstances. 45 C.F.R. . 74.25(d)(1).

If the bona fide needs rule applied directly to grantees in the manner that DCA asserted, then funding agencies would not have this discretion to permit grantees to receive preaward costs or to carry over unobligated funds to subsequent budget periods and thus fiscal years. The fact that agencies such as ACF are empowered to permit grantees to carry over surplus grant funds from year to year and receive preaward costs strongly suggests that the bona fide needs rule does not apply in the way that DCA argued.

Despite DCA's claim that the bona fide needs rule is a basic principle of appropriations law underlying other disallowances upheld by the Board, the rule has never been cited by the Board as the basis of a disallowance, and DCA has not shown that it has ever presented an argument in support of a disallowance based on the bona fide needs rule. Further, no Board cases have cited 31 U.S.C. . 1502(a), the statutory basis of the bona fide needs rule, as the basis for upholding a disallowance. We note that the two Board decisions DCA cited as holding that funds be used during the year of the award did not cite the bona fide needs rule and are not controlling in any event because they were based on specific program provisions not applicable here.

While it is a longstanding rule that a grantee must use funds awarded for a particular budget period for obligations made during that budget period or any extension thereof or for approved pre-award costs, the bona fide needs rule is not directly the source of this requirement. Moreover, to the extent that the cost principles specifically permit allocation of part or all of a lump sum pension payment to the year of payment the amount allocated may reasonably be considered a legitimate need of that year and thus comply with DCA's interpretation of the bona fide needs rule.

2. Payment of past pension costs may be allowable under OMB A-122.

In addition to arguing that the pension payment violated the bona fide needs rule, DCA also argued that the payment was not allocable to nor reasonably necessary for the performance of Waccamaw's Head Start grant. These requirements for allowable costs are contained in the cost principles applicable to grantees. However, DCA did not address provisions in those cost principles governing payment of pension costs and raising the possibility that payment of pension costs relating to employee services in prior periods may be allowable charges to current grant funds.

The allowability of pension contributions by non-profit organizations such as Head Start grantees is governed by subparagraph 7(h) of OMB A-122. Among other tests of allowability, subparagraph 7(h) requires that the costs of pension plans assigned to each fiscal year be determined "in accordance with generally accepted accounting principles (GAAP), as prescribed in Accounting Principles Board Opinion No. 8 issued by the American Institute of Certified Public Accountants," and that the costs assigned to a given fiscal year be funded for all plan participants within six months after the end of that year. OMB A-122, Att. A, . 7.h.1.c,d.

DCA argued that OMB A-122 does not provide for retroactive payments for a former employee's pension when there was no established policy of providing pensions in existence during the period of employment. DCA did not address OMB A-122's reference to Accounting Principles Board Opinion No. 8, which clearly contemplates that when an organization adopts a pension plan, it may pay pension costs attributable to employee services rendered during the years prior to the plan's inception. The opinion provides for an acceptable range of annual provisions for pension funding between stated minimums and maximums. The minimum annual provision includes "an amount equivalent to interest on any unfunded prior service cost" (with possibly more if a provision is made for vested benefits, in the event that they exceed the pension fund balance, including anticipated accruals). The maximum annual provision for pension funding includes 10 percent of the prior service cost until fully amortized; the 10 percent limitation is considered necessary to prevent unreasonably large charges against income during a short period of years.

Thus, the Accounting Board Opinion clearly permits using current year funds to pay pension costs associated with years of service prior to the adoption of the pension plan. OMB A-122's adoption of the opinion is qualified, however, by the further requirement that costs assigned to a given fiscal year be funded for all plan participants within six months after the end of that year. OMB A-122, Att. A, . 7.h.1.d. DCA did not address the applicability of these provisions in taking the disallowance or in presenting its case before the Board. Accordingly, a remand is appropriate to permit DCA to determine how these provisions of OMB A-122 apply for the purpose of determining whether any of the pension payment may have been an allowable charge to 1995 Head Start grant funds.

DCA also cited OMB A-122's definition of compensation for personal services (which includes pension costs) as all compensation paid or accrued for employee services rendered "during the period of the award." Presumably, DCA meant that this language would bar payment of the pension costs, since the services of the former executive director were rendered well before the period of the 1995 federal award to which the pension costs were charged. DCA failed to cite the entire sentence, which goes on to state "except as otherwise provided in subparagraph h," the subparagraph governing the allowability of pension costs. As noted above, subparagraph h, through its reference to Accounting Principles Board Opinion No. 8, may permit the payment of pension costs associated with prior years' service.

Finally, DCA argued that the pension payment was not a necessary charge to the grant and thus not allowable because Waccamaw's decision to join SCRS was optional. However, any employer's decision to establish a pension plan may be characterized as "optional," yet the pension payments that the employer incurs therefrom are recognized by the cost principles as allowable charges to federal funds under appropriate circumstances. DCA failed to show that a reasonably prudent person in Waccamaw's circumstances would not have elected to join SCRS, or why the resulting costs associated with prior years' service were not reasonable charges under cost principles specifically governing the allowability of pension payments. See OMB A-122, Att. A, . A.3.

Conclusion

For the reasons stated above, we remand the disallowance to DCA to apply these provisions of OMB A-122 for the purpose of determining whether any of the pension payment may have been an allowable charge to 1995 Head Start grant funds. In making this determination, DCA should seek the assistance of staff such as accountants or actuaries able to interpret and apply the provisions of "Accounting Principles Board Opinion No. 8." DCA on remand should also determine whether the disputed payment was charged directly or indirectly and, if charged as an indirect cost, determine whether any indirect cost rate adjustment is required. Within 30 days after receipt, Waccamaw may appeal DCA's determination to the Board pursuant to 45 C.F.R. Part 16.

Donald F. Garrett

Judith A. Ballard

Cecilia Sparks Ford
Presiding Board Member