SUBJECT: Council for Economic Opportunities in
Greater Cleveland

DECISION

The Council for Economic Opportunities in Greater Cleveland (Council) appealed a decision by the HHS Division of Cost Allocation (DCA) to set the indirect cost rate at 18.2 percent for the fiscal year ending on January 31, 2002 (and for future years until amended). In computing the rate, DCA factored in certain "in-kind" expenses. Whether those expenses were properly included in the computation is the primary issue in this appeal.

For the reasons discussed below, we remand this matter to DCA to permit the Council an opportunity to submit additional evidence for DCA review and for a redetermination of the rate.

Case and Legal Background

The Council is a nonprofit corporation that provides social, educational, and other services to low-income children and families in Cuyahoga County, Ohio. The Council's funding comes from various federal, state, and local public assistance programs.

The Council operates or oversees a full-year Head Start program funded by a federal Head Start grant. CEOGC Ex. E at 6, 25, 36. ⁽¹⁾ It also operates one or more state Head Start programs that are funded in whole or part with grants from the Ohio Department of Education. Id. at 24, 25, 36.

An indirect cost rate is used to assign or distribute an organization's indirect costs to a federal grant, contract, or other agreement. ⁽²⁾ See OMB Circular A-122, Att. A, § D. The indirect cost rate for a nonprofit organization must be computed in accordance with OMB Circular A-122, which provides uniform cost principles for determining the "allowability" of a nonprofit organization's costs under a federal award. ⁽³⁾ 45 C.F.R. § 74.27(a). To be allowable under a federal award, a cost must, among things, be "determined in accordance with generally accepted accounting principles (GAAP)." OMB Circular A-122, Att. A, § A, ¶ 2.(e).

In October 2002, the Council submitted to DCA an indirect cost rate proposal for the year ending January 31, 2002. DCA Ex. 3. The proposal was supported by documents reflecting the result of an independent audit of the Council's operations for that year. Id.; CEOGC Ex. E. The audit documents submitted with the proposal included various financial statements, a program-by-program schedule of revenue and expenses (Schedule D), and other material. CEOGC Ex. E.

The financial statement relevant to this case is the "Statement of Revenue, Expenses, and Changes in Net Assets," which we refer to as the consolidated revenue and expense statement. CEOGC Ex. E at 4. It presents revenue and expense totals for all of the Council's operations. These totals are the sum of amounts reported in Schedule D of the audit documents. Id. at 19. Schedule D presents, in numbered columns, a revenue and expense accounting for each of the Council's assistance programs. ⁽⁴⁾ Id. at 19-23.

Under OMB Circular A-122, there are different acceptable methods of calculating an indirect cost rate. OMB Circular A-122, Att. A, § D. The method used by the Council in its proposal was the "simplified allocation method," in which the organization's indirect costs are divided by an "equitable distribution base." Id., Att. A, § D, ¶ 2. The Circular indicates that an organization's "direct salaries and wages" may be used as the distribution base under the simplified method. Id.

In its rate proposal, the Council included in the distribution base the amounts shown on the consolidated revenue and expense statement for "salaries/wages" ($12,054,107) and "fringe benefits" ($4,086,681). CEOGC Ex. E at 4. At issue is whether the distribution base should also have included certain "in-kind expenses." Salaries/wages, fringe benefits, and in-kind expenses appear as separate expense categories, or line items, on the consolidated revenue and expense statement. Id. According to Note A of the financial statements, in-kind expenses include "volunteer services" and "donated space" provided to the Council's Head Start programs. Id. at 7.

For the year ending January 31, 2002, the Council's total in-kind expenses (as shown on the consolidated revenue and expense statement) were $7,460,380. CEOGC Ex. E at 4. At DCA's request, the Council provided an itemization of those expenses. DCA Ex. 5, at 1. According to that itemization, the Council's in-kind expenses included $1,628,430 in "salaries" for the federal full-year Head Start program. Id. at 4. Based on that information, DCA determined that the Council had received $1,628,430 in "donated services," which, according to OMB Circular A-122, must be included in the distribution base under certain conditions. ⁽⁵⁾ DCA Ex. 9, ¶¶ 8-9, 11. The Council disagreed with this position, and subsequent negotiation failed to resolve the disagreement. Id., ¶¶ 11-14; DCA Ex. 8. Accordingly, for the year ending January 31, 2002 (and for future years until amended), DCA unilaterally set the Council's indirect cost rate by including $1,628,430 in the distribution base (along with the totals reported for salaries/wages and fringe benefits). DCA Ex. 9, ¶ 16; CEOGC Ex. A. That determination prompted this appeal.

In its negotiations with DCA, and in the proceedings before us, the Council contended that the disputed expense ($1,628,430) reflected a "direct cash outlay" of state Head Start grant funds, rather than the value of donated services, and as such should not have been included in the distribution base. Reply Brief at 1, 4-5. In support of that assertion, the Council pointed to Note N to the audited financial statements. CEOGC Ex. E at 15. Note N, entitled "Head Start Nonfederal Matching Requirement," indicates that as a condition of receiving a federal Head Start grant, a grantee must provide matching funds, or a "nonfederal share," equal to 25 percent of total federal expenses. ⁽⁶⁾ Id. The Council's nonfederal share for the year ending January 31, 2002 was approximately $7.4 million, and Note N identifies the "nonfederal in kind contributions" received by the Council and its delegate agencies and used to meet the nonfederal share requirement for that year. Of particular relevance here, Note N states that HHS had authorized the Council to use a portion of its "state Head Start expenses" as matching funds for its federal Head Start program. ⁽⁷⁾ In accordance with that authorization, $1,628,430 of "state Head Start Continuation and Expansion funds funded by the Ohio Department of Education" were, according to Note N, "[i]ncluded in the nonfederal in kind expenses" reported in the consolidated revenue and expense statement. ⁽⁸⁾ Id. (All of the expenses designated as "in-kind" are recorded in columns 14 and 16 of Schedule D as revenue and expenses of the Council's federal Head Start and Early Head Start programs. Id. at 21.)

Based on Note N, the Council contended that its federal Head Start program had received no donated services, and that $1,628,430 had been classified as an in-kind expense of the federal Head Start program merely to show that these funds had been used to meet that program's cost-sharing requirement. Reply Brief at 4-5. The Council further asserted that this amount was already included in the distribution base. Id. at 3. To support that contention, the Council pointed to a September 17, 2003 letter written by its accountant. CEOGC Ex. G. Referring to Note N, the accountant's letter states that "$1,628,430 of State Head Start expenditures were included as nonfederal match to the federal Head Start program." Id. The letter further states that these expenditures were recorded as expenses of the Council's state-funded Head Start programs in columns 6 and 17 of Schedule D of the audit documents. ⁽⁹⁾ Id. According to the Council, because $1,628,430 were recorded in these columns as a non-in-kind "salaries/wages," and thus were already included in the totals for salaries/wages on the consolidated revenue and expense statement, DCA's inclusion of that amount in the distribution base resulted in a double-counting of salaries/wages in computing the indirect cost rate. Reply Brief at 1.

DCA responded that because the term "in-kind" refers to donated goods and services (goods and services for which cash would otherwise have been paid), the disputed in-kind expense cannot, by definition, be a state Head Start grant expense. Consequently, said DCA, $1,628,430 must be treated as the value of services donated to the Council and be included in the distribution base in order to comply with OMB Circular A-122. Response Brief at 10-14. DCA further argued that the Council had submitted no evidence that salary expenses had been double-counted in the base, emphasizing that if a particular expense had in fact been reported in two different expense categories on the consolidated revenue and expense statement, then that statement would not comport with GAAP and would misstate the Council's financial condition. Id. at 14.

Following an informal conference conducted by the Board, the parties submitted additional material to elaborate on their positions. Relying on the declaration of its accountant, Michael D. Ryan, the Council asserted that presenting $1,628,430 as both a direct cash expenditure under columns 6 and 17 of Schedule D, and an in-kind expense of the federal Head Start program, was consistent with government auditing standards. Council Post-Conference Brief at 2-3. These standards, the Council argued, permit an auditor to present financial results in conformity with either GAAP or some "other comprehensive basis of accounting" (OCBOA). Id. The Council asserted that the audit results in question were presented on an OCBOA basis, and that the purpose of an OCBOA presentation is to show "results of operations," including the auditee's compliance with grant awards and other regulatory requirements. Id. at 3.

Mr. Ryan stated in his declaration that the Council's nonfederal share for the federal Head Start program consisted of both "in-kind contributions" and "cash assistance" of $1,628,430 in state Head Start grant funds. CEOGC Ex. 1, ¶¶ 6. He explained that the full amount of the Council's nonfederal share was treated as in-kind revenue and expense in order to disclose fully the operational results of the federal Head Start program. Id., ¶ 8. Had this not been done, he said, the audited financial statements "would not reflect CEOGC's complete Head Start revenues and expenditures, and thus would not show the full scope of the activities assisted through CEOGC's federal Head Start award." Id. Mr. Ryan further stated that although presenting $1,628,430 as both a direct cash expenditure and an in-kind expense resulted in a "double-counting" of revenue and expenditures for all of the Council's operations, that presentation was consistent with federal requirements and sound accounting practices and did not misstate the Council's overall financial position because the state grant funds designated as in-kind were recorded with offsetting revenue and expense entries. Id. Notwithstanding Mr. Ryan's assertions, the Council requested an opportunity to reissue its financial statements on a GAAP basis. CEOGC Post-Conference Brief at 8.

In response to the Council's post-conference submission, DCA proffered the declaration of Henry Williams, director of DCA's Central States Field Office and an accountant, who stated in relevant part:

2. OMB Circular A-122 mandates that costs must be determined in accordance with generally accepted accounting principles (GAAP) to be allowable under a Federal award. [A] non-profit organization's indirect cost rate must be reconciled to the entity's audited financial statement. This means that if a non-profit organization grantee uses accounting principles other than GAAP in preparing its financial statement, for purposes of preparing its indirect cost rate proposal[,] the grantee must make whatever adjustments are necessary in the financial statement to comply with the OMB Circular A-122 requirement that indirect costs be determined in accordance with GAAP.

3. Under GAAP, if the same expenditure were recorded more than once on a schedule of total expenditures in an audited financial statement, the financial statement would have to include a note so stating. Unless the financial statement included a note explaining that the same expenditure had been recorded more than once, the assumption would be that each expenditure had been recorded only once on a schedule of total expenditures.

4. Recording expenditures more than once on a schedule of total expenditures in a financial statement, without a note explaining the practice, would not comport with GAAP. Such a practice would result in overstating expenditures, which would not accurately portray the financial condition of an organization.

DCA Ex. 14.

Discussion

DCA's Review Guide For Non-Profit Organization's Indirect Cost Proposals provides that an indirect cost proposal should be reconciled with the nonprofit organization's audited financial statements. DCA Ex. 12, at 10. That is undoubtedly a sound principle, but applying it here is somewhat difficult because the parties disagree about the meaning of the relevant financial statements.

In setting the indirect cost rate, DCA found that the Council's financial statements reflected donated services whose value must be included in the distribution base. DCA Ex. 9, ¶¶ 8-9. Those statements define in-kind expenses to include "volunteer" services. The Council advised DCA that its in-kind expenses for the base year included $1,628,430 for "salaries" benefitting the federal Head Start program operated by the Council. All in-kind expenses were reported in the consolidated revenue and expense statement in their own expense category, separate from "salaries/wages." There is no assertion in the financial statements that $1,628,430 were simultaneously recorded as both an in-kind expense and a direct salaries expense. Based on these circumstances, DCA could reasonably have concluded that $1,628,430 represented the value of services donated to the Council's federal Head Start program.

Note N, however, appears to confirm the Council's assertion that the disputed amount actually reflected an expenditure of state Head Start grant funds, and that this expenditure was deemed to be "in-kind" revenue and expense of the federal Head Start program not for the purpose of recording a contribution of donated services, but to show that state Head Start grant funds had been used to satisfy the federal program's cost-sharing requirement. DCA does not challenge that assertion's plausibility or, for that matter, its truth. As we understand it, DCA's position is that regardless of how the disputed expense is viewed (as an in-kind contribution or a direct cash outlay), it must be included in the distribution base because the Council classified it as a salaries expense, and because nothing in the audited financial statements indicates that $1,628,430 were included in the amount reported for salaries and wages. DCA Post-Conference Brief at 4-5.

That argument has some merit. The Council did in fact tell DCA that $1,628,430 had been expended for "salaries." DCA Ex. 5, at 4. Although Note N indicates that this amount represented state Head Start program funds that were used to meet the cost-sharing requirement of the Council's federal Head Start grant, it does not illustrate or confirm that those funds were included in other revenue and expense categories (such as salaries/wages) on the consolidated revenue and expense statement. We give only minimal weight to the accountant's assertion that the funds were recorded as revenue and expenses of the Council's state Head Start programs in columns 6 and 17 of Schedule D. That assertion was not sworn (or affirmed as true pursuant to 28 U.S.C. § 1746), and the audit documents do not verify it. ⁽¹⁰⁾ Because those documents are silent about whether $1,628,430 in state grant funds were recorded as revenue and expenses of the state Head Start programs, it was incumbent on the Council in this proceeding to demonstrate (not merely assert), with accounting records and backup documentation if necessary, that those funds were recorded in that manner.

We are, in short, confronted with evidence that undermines the factual premise of DCA's rate determination -- namely, that the Council received donated services valued at $1,628,430 -- but that also fails to support adequately the Council's assertion that the disputed expense, identified as being incurred for "salaries," has been counted twice in the distribution base. Although the Council has the ultimate burden of justifying its rate calculations, ⁽¹¹⁾ we note that the rate determination process is set up to produce negotiated results. Through the declaration of Henry Williams, DCA has indicated that the outcome ought to turn on the extent to which the Council's claim of double-counting can be verified in financial statements that accord with GAAP. The Council, for its part, has expressed a willingness to restate its financial statements on a GAAP basis, presumably to explicate, revise, or clarify the reporting or accounting treatment of the state Head Start grant expenditures used to meet its cost-sharing obligation. Given these circumstances, we have determined that a remand is appropriate since there is now a good chance that a rate determination can be made on a mutually acceptable basis.

Accordingly, we grant the Council a limited opportunity to submit additional evidence to DCA in order to establish total direct salaries and wages. That additional evidence may include amended financial statements. The evidence may also include accounting records and other documentary evidence that would permit DCA to verify that the amount of the disputed expense ($1,628,430) was included in the totals reported in the salaries/wages or fringe benefit expense categories on the consolidated revenue and expense statement. ⁽¹²⁾

Conclusion

We hereby remand this case to DCA for the purpose of allowing the Council to submit additional evidence supporting its indirect cost rate proposal. The Council may submit this additional evidence within 60 days from receipt of this decision or such longer period as DCA permits. (We urge the parties to consult during this period about the type or quality of evidence that DCA would find sufficient to approve the Council's proposal.) DCA shall review the Council's additional evidence within a reasonable period of time, then issue a new rate determination based on the entire record. If the Council is dissatisfied with that determination, it may appeal to the Board in accordance with procedures in 45 C.F.R. Part 16. In the event that the Council fails to submit additional evidence within the time allotted, DCA's initial rate determination (CEOGC Ex. A), dated May 18, 2004, shall be treated as having been adopted by the Board as the final decision of the Secretary of Health and Human Services.

Cecilia Sparks Ford

Donald F. Garrett

Judith A. Ballard
Presiding Board Member

1. CEOGC Exhibit E contains the Council's audited financial statements and supplementary information for the year ending January 31, 2002. The Council did not number each page of this exhibit, so our citations reflect the exhibit's internal numbering.

2. "Indirect costs are those expenses that benefit common objectives and therefore cannot be readily assigned to a specific cost objective or project. At nonprofit organizations, such costs normally are classified into one overall pool of costs. This pool is then divided by the allocation base the nonprofit organization has chosen in order to calculate a rate." DCA Ex. 12, at 4 (Division of Cost Allocation, Review Guide for Non- Profit Organization's Indirect Cost Proposals).

3. OMB Circular A-122 was last revised on May 10, 2004. 69 Fed. Reg. 25,970 (May 10, 2004). Before 2004, the most recent substantive revision to the circular became effective on June 1, 1998. Vermont Slauson Economic Development Corp., DAB No. 1955 (2004); 63 Fed. Reg. 29,794 (June 1, 1998). Our citations are to the June 1, 1998 version of the Circular, which was the version in effect when the Council submitted its rate proposal.

4. Revenue and expenses for the federal full-year Head Start program are shown in column 14 of Schedule D. CEOGC Ex. E at 21, 25. Columns 6 and 17 of Schedule D present revenue and expenses of Head Start program activities funded partly or wholly with grants from the Ohio Department of Education. Id. at 19, 21, 24, 25.

5. The relevant Circular provision provides: "The value of donated services utilized in the performance of a direct cost activity shall, when material in amount, be considered in the determination of the non-profit organization's indirect cost rate(s) and, accordingly, shall be allocated a proportionate share of applicable indirect costs when the following circumstances exist: (a) The aggregate value of the services is material; (b) The services are supported by a significant amount of the indirect costs incurred by the non-profit organization; and (c) The direct cost activity is not pursued primarily for the benefit of the Federal Government." OMB Circular A-122, Att. B, § 12, ¶ b.(2) (emphasis added). The Council does not deny the existence of the three threshold conditions for including donated services in the distribution base. Rather, as discussed later, the Council contends that it did not receive any donated services. Reply Brief at 4-5.

6. The correct percentage appears to be 20, not 25 percent. See CEOGC Ex. I, ¶ 4; 45 C.F.R. § 1301.20(a) (providing that "Federal financial assistance granted under the act for a Head Start program shall not exceed 80 percent of the total costs of the program" except in certain circumstances).

7. A November 30, 1995 letter issued by ACF informed Ohio Head Start grantees that they may (to the extent allowed by the state) use state Head Start grant funds to satisfy the cost-sharing requirements of their federal grants. CEOGC Ex. F.

8. In Note N, a table lists, in one column, the amount of "in-kind contributions" to the federal Head Start and Early Head Start programs. CEOGC Ex. E at 15. In a separate column with the heading "State Head Start," the table shows the amount of state Head Start expenses ($1,628,430) used to meet the nonfederal share requirement of the federal Head Start program.

9. As indicated (infra footnote 4), columns 6 and 17 are the revenue and expense schedules for the Head Start programs overseen and financed by the Ohio Department of Education. CEOGC Ex. E at 19, 21.

10. Without evidence showing total state Head Start grant revenue for the base year, where or how that revenue was recorded, and the portion of reported state program revenue derived from federal sources (one of the state Head Start programs was funded with a combination of federal and state dollars), we cannot confirm, simply by looking at the revenue and expense totals in columns 6 and 17 of Schedule D, that $1,628,430 were included in those totals.

11. In general, the burden is on a recipient of federal grant funds to justify both the allowability of its costs, and the methods used to allocate those costs to its federal awards. Vermont Slauson Economic Development Corp.; Vanderbilt University, DAB No. 903 (1987).

12. In providing this opportunity, we make no finding that the submission of amended financial statements prepared in accordance with GAAP will necessarily suffice to support the Council's position. Nor do we find that submission of such statements is a prerequisite for establishing that the disputed amount was already included in the totals reported for salaries and wages on the consolidated revenue and expense statement.