By Rick Shields, CPA, Principal at Blue & Co.

When not-for-profits receive grants from governments and foundations, the application process often includes an estimate for indirect costs which is then factored into the overall award. Those who may be less familiar with grants sometimes think the indirect rate on a grant award is the final rate.

This can lead to the perception that a higher indirect cost rate is useful. Management may assume the organization’s administrative costs will easily exceed the amount reimbursed from grants and there is no exposure for the organization.

While it is true that a higher indirect cost rate will generate larger individual grant draws, and can increase the overall award, it is still only a reimbursement. The portion of grant draws attributable to indirect costs is not simply an assignment of the rate from the grant award. Grantors can require true-ups and ultimately a “clawback” if it is determined that the amount of indirect costs reimbursed exceeded actual. Below is an example.

The above table demonstrates the effect that occurs when the organization’s program costs shift away from the grant program. This can happen when the organization receives additional grants or other funding that it then spends on other programs. Even though total indirect costs were greater than estimated, the portion attributable to the grant is less than estimated.

There are numerous calculation options and specifics for indirect cost rate proposals, but the basic principle is the same – it is a reimbursement based on a formula. Applying a higher rate than actual can place the organization at risk. If the actual costs to administer the grant are less than estimated, the organization can be required to refund a portion of its previous draws. This outcome can be particularly painful because it often occurs after the grant has concluded and the organization has not budgeted for the expense.

Below is a second example which reflects a scenario where direct costs shift away from the grant program, but a refund isn’t required because total indirect costs increased in a manner that correlated with total direct costs.

The above notwithstanding – there is an argument for a higher indirect cost rate on a grant application. If the actual direct costs for other programs is less than estimated, and actual direct costs for the grant program as well as administrative costs are in line with estimates, then the amount of actual indirect costs associated with the grant program are greater than estimated.

In the above scenario, the $36,904 cannot be recovered. Therefore, it is important to estimate costs using the best possible information and not underestimate the percentage of grant program costs to total program costs.

Some grantors will have a set indirect cost rate that can be applied without any support, but in those cases the rate is typically 10% or lower and only partially funds the actual indirect costs incurred by the organization to service the grant. Thus, while the amount is not subject to refund and isn’t impacted by changes in circumstances it still requires the organization to subsidize part of the indirect costs from other sources.

If you have any questions about indirect cost rates, please contact your local Blue & Co. advisor.