Indirect Costs 101

Hi, this is Sally Rockey. I’m Deputy Director for Extramural Research at the National Institutes of Health. And Today I wanted to talk to you about indirect costs or give you a small primer on indirect costs, which I’m calling Indirect Costs 101, and how NIH supports research infrastructure for extramural research. Now you may know of indirect costs as many other things. Some people call them overhead. Some call them F&A costs, which is facilities and administration. But most call them indirect costs, which is a bit of a misnomer because what it means is, while they’re directly important to the conduct of research, generally they’re costs that are incurred that cannot be easily identified with a particular project. So oftentimes they are for facilities and services as a whole, and they might be pooled costs. And therefore while they’re not attributable to any particular project, which gives them their name “indirect,” they are nonetheless very important for the successful conduct of research at funded organizations. So I’m going to talk primarily about indirect costs for colleges and universities and how we calculate them and apply them, the reason being is that NIH primary awardees are colleges and universities. And thus it’s most applicable here to talk about indirect costs as they affect colleges and universities, but we pay indirect costs for all types of organizations that we support. There’s some many unique aspects of institutions of higher education that present very complex costing environments, and again this is why we have indirect cost rates. So for example you might have centralized management of many of the research activities in highly independent departments. You might have mixed and overlapping missions, instruction and research, and clinical care. And these factors have been the base for a number of several unique federal policies in determining indirect higher education cost rates that are not applied to other types of organizations.
So I’ll talk a little bit about those, but again it’s this idea that these are not costs that are directly attributable to any particular project, but again they’re very important to the success of the overall research program that is funded by the federal government. So let me give you a brief… a history of indirect costs. So we’ve been paying indirect costs on federal grants for almost 70 years now. In the 1950s we started paying indirect costs on grants. And the beginning it was only an 8% indirect cost rate, and then it rose to 20% of the total grant could be used for indirect costs. Again in the 50s we saw OMB put out circular A21, which are the federal cost principles, and basically this told you what were allowable costs to use your indirect costs for… so to assure that indirect costs were being used appropriately to support the activities that were being funded by the federal government.And in 1965 we started to negotiate an indirect cost rate, which I’m going to talk about in a few moments, and all that’s established. And then in 1979 we started to talk about modified total direct costs, which are all direct salaries and wages, etc., and that’s very important to the calculation of indirect cost rate. And in 1991, as I told you, there’s two parts to indirect costs—administrative and facilities.
In 1991 there was a cap put on administrative costs at 26% of the modified total direct costs for universities and in institutions of higher education—not for other organizations. And that cap has been in place for 25 years now. When the cap first went into place, most institutions were around the 26% or less for their administrative costs. But as we’ve seen in the last 25 years, when there’s been even more and more complex regulations that federally funded awardees have to comply with, we see that most institutions now are above this 26%, which means that they’re cost sharing the cost of federally funded research. In 1996 we started requiring the use of the negotiated rate for the entire competitive segment, which meant that, if during the course of a grant, the indirect cost rate change… the negotiated rate change, we would still use the rate as we knew it at the beginning of the grant to its completion.
So how do we establish indirect cost rates? For colleges and universities, nonprofit hospitals, and st+ate and local government, the rates are negotiated by cognizant agencies rather than NIH. So this is first and foremost really important to understand. NIH does not negotiate rates with awardee institutions. That is only done by two cognizant agencies. One is at Department of Health and Human Services’ Division of Cost Allocation or at the Department of Defense’s Office of Naval Research. How do we determine which of these organizations will negotiate the rate with a federally supported grantee? It usually depends on which of the organizations provides the most funds to that particular grantee organization. So if you’re doing most of your business with NIH, HHS would likely negotiate your rate. If you’re doing more of your business with the Department of Defense, Office of Naval Research will be the cognizant agency to negotiate your rate. It’s a very complicated process to negotiate a rate. There’s a lot of data and information that goes back and forth between the federal government and the awardee institution. So it does take time to negotiate a rate, and that rate stays in place for up to four years. It also means that, once you’ve established a rate, it applies to all the federal agencies. So if your on-campus rate has been negotiated by HHS, that applies to research done on campus whether or not you’re funded by NIH, by NSF, the Department of Energy, etc. So once your federally funded rate is in place, that applies to all the federal agencies that are going to support the particular grantee institution.There are some places where we establish a rate. It’s not considered a negotiated rate, but establish a rate at NIH. When there is a commercial organization for example like a small business, we will establish the rate at a Division of Financial Advisory Service Office of Acquisition Management and Policy. But again the takeaway message here is that NIH does not establish the indirect cost rate. Oftentimes people are quick to say, “NIH, why don’t you cap the rate? Why don’t you reduce the rates?” We do not establish this rate. This is a good faith effort on the part of the federal government to negotiate a legitimate rate that does cover the cost of the research that the federal government is going to provide to these organizations. And therefore NIH abides by the rates that are negotiated by these two divisions. So how do we establish these rates apply them to a particular project? It’s a very simple calculation. So first of all, you start off with a pool. So the pool is the facility’s administration cost related to the research to be covered by the application of an IDC rate. So in other words, what… that all the program’s going to cost you at the institution. And then the base is… the direct costs to determine the rate… the direct cost is what you would place the IDC rate on top of. So it determines IDC reimbursements to an institution on funded research projects. So it ends up being a very simple equation. The pool divided by the base gives you the rate. So let’s say you had a pool of $200. Your base was $400. Then the rate would be a 50% indirect cost rate. Now you have to understand that it does not mean that 50% indirect cost rate. Now you have to uderstand that this does not mean that
their 50% of the overall grant is going to go for indirect costs. And we’ll get onto that in just a moment. So what are direct costs? Well, direct costs are those that can be identified specifically with a particular research project. So when you have a research project, you know how much you’re going to spend on salaries; you know how much you’re going to spend on personnel, on equipment, on travel, on supplies, on patient care, on consortium costs, and other services. So those are very easily tracked to a particular project. And they’re also the costs that are oftentimes used by peer review to assure that the organization has asked for the appropriate amount of money to conduct the research or whether or not they’ve asked for too much money or not enough money, etc. So peer review can oftentimes consider the costs that you’ve proposed. The indirect costs are twofold. Remember I called them overhead, and I called them F&A, facilities and administrative. Let’s go through what these are. And I’m going to put this up quickly because we’re a little out of sync here. So indirect costs, F&A, are infrastructure costs required to conduct research but cannot specifically be identified or easily allocated to an individual project. Remember that rate is determined and negotiated about every four years. So on the administrative side, the first part of this is general administration. So these are services that are the organizational level, like the university level, for personnel, payroll, purchases, financial management=Remember they’re not going to cover the entire costs of all of these through the indirect costs, but the proportion of those individuals’ time and efforts that go to the research program. Departmental administration, this is at the program and are administrative costs at the college, school, or department level. Then you have your sponsored research office, which is the office that assures that grants are submitted and that there’s compliance with regulations and policy on the part of federally funded research. And so they are very important to the conduct of research at an institution. And there’s student services. So many graduate students are supported by federally funded research grants, and those graduate students require all sorts of services. So again a proportion of your student services costs can be built into the indirect cost rate. And remember one more time that for universities administrative costs are kept at 26% of the modified total direct costs. Facilities and infrastructure costs, first there’s building depreciation. So when you’re negotiating rate, you have a very in-depth space study, which determined what fraction of the building is being used and can be attributable to the research effort. And then you build in the building depreciation as part of your indirect cost rate. There’s interest on debt for certain buildings. So if you’ve gone into debt to pay for a building and/or doing capital improvements on a building that houses federally funded researchers, you can pay for the interest on that debt through your indirect costs. If certain equipment depreciate, you can build in that equipment depreciation, but it has to be equipment that has not been purchased with federal funds. And also operation and maintenance, and this is what we most commonly think about when we think about facility indirect costs. That would be your utilities, your lights, your electricity, etc., the maintenance of the building, the custodial environmental, health, transportation, security—all for the research programs going on in the those buildings. So remember… we support research. That’s what we do at NIH. So we are supporting indirect costs associated with research. Very important to remember that. So institutions are required to separate costs and non-activities from research activities. And this is very important because we are going to negotiate based on what the space and the administrative costs associated with research activities. And that is what we’re going to pay.
So colleges and universities are required to separate instructional and other activities from research, and then your space cost allocated to research is limited to the space utilized by research. So this is very, very important. This separation assures that reimbursements on NIH research grants—both direct and indirect—are solely for the support of the conduct of research. So institutions go to a lot of effort to make sure that they understand in their space allocation what is being used for research. So you will have instruction; you have research and clinical and others. All of them have direct costs, facilities and administrative costs. But remember in this particular example we’re going to play for the indirect costs associated with research. So there’s a lot of talk about how indirect costs, because you can write off building depreciation and how you can write off debt, that leads to perverse incentives to build a lot of buildings on your indirect cost rate. And it may have been at one time an incentive to do that. So for example if you have a building on the left which is old, you’re… first of all it’s not depreciating nearly at the same rate as if it was brand new, and secondly you probably no longer have debt on that. So that can’t go into your research indirect cost facilities base. If you have a brand new building like this on the right, you have a lot of debt you’ve probably gone into pay for that building, and also it’s depreciating at a much rapid pace because it’s new, and therefore you can write off that depreciation. But in reality what has happened now is you have to remember that the federal’s research portfolio has been flat for many years, particularly at NIH. So NIH… those institutions that receive a lot of NIH funding know that there is not as much funds available. So in the past if you were going to build a new building, the thought would be that you could build a new building, fill it entirely with federally funded researchers, and therefore can go into your… (1) you indirect cost base, but secondly be filled with researchers who are bringing in grants and bringing in indirect costs.
But what has happened? We see now that, because of the flattening of the budget, buildings are oftentimes filled with instruction and clinical research and others, and therefore there’s not as much of the building space going into the indirect cost base, and you don’t have as many supported investigators who are bringing in indirect costs. So this idea that indirect costs are leading to overbuilding is really something of the past and probably not to be changed in the foreseeable future. Now I’d like to give you an example of how NIH determines the total award amount for any particular project. First the most important thing is to determine the modified total direct costs. So the modified total direct costs means all direct salaries and wages, applicable fringe benefits, materials and supplies, services, travel, and up to the first 25,000 of each sub-award. There are certain things that are excluded from modified total direct costs, and that includes equipment, capital expenditures, charges for patient care, rental costs, tuition, remissions, scholarships, and fellowships, etc.
So in this particular example, we have a project that has requested $110,000. There are $10,000 worth of equipment. Now remember those equipment are not subject to indirect costs, so they are subtracted from the direct cost amount. So in this case, $10,000 is subtracted from $110,000, leaving us with $100,000 for a modified total direct cost base. Now remember the indirect costs are applied to the MTDC base. So in this case this organization had 50% indirect cost rate. We apply that to the $100,000 MTDC base, and we get indirect costs of $50,000. Now to figure out the total award then that NIH will provide, we take the direct cost, which is $110,000; we add the indirect costs in this case, which is $50,000, leading us to a total aware that we will give this project of $160,000. Now even though this organization has a 50% indirect cost rate, you will note that the indirect costs only comprise about less than a third of the total funds awarded by NIH, which is very typical for NIH. In general, indirect costs are around a third of all the funds that we spend here on research projects. So here’s an example, distribution of costs. And if you look at it at a proportion, here’s the modified direct costs. They represent 63% of the award, the indirect are 31% of the award, and the excluded indirect costs that led to your modified were 6% of the award. So in this particular case, as the entire award, the indirect costs were only 31%. And that’s… basically if we look at the total proportion of NIH funds that go to indirect, it’s around that. And here’s the example. So these are indirect costs as a percentage of our total costs for all institution types for research project grants. And if you look since 1998, our amount that NIH spends on indirect costs as a proportion is about 30% of our total costs. So it is not true that indirect costs and that NIH spends more and more each year on indirect costs as some urban myths have implied. We have been spending… and actually if you look back for the past 25 or 30 years, we spend about 30% of our research funds on indirect cost and 70% on direct cost. Now I’d like to talk to you about how different types of awards can impact the amount of funds available to conduct the research. So this is a case where we have a total cost award instead of award where you have modified direct costs that have indirect costs play top of them. With a total cost award, it provides a designated funding level for award regardless of an indirect cost rate. So for example if you have a program where you have $1 million and you want to give five $200,000 awards, that award amount would be for both the direct and the indirect costs. And so instead of the federal agency asking for direct costs and then applying the IDC rate to them to determine the total amount, the funder provides the total amount available upfront. And the funding organization works backwards to determine what proportion of the award can be spent on direct and indirect costs. Now the reason I’m talking about this is there is sometimes a desire on the part of a funding agency to give out total cost awards because it’s a lot easier to budget. So for example you know exactly how many awards you can give and at what size upfront, and that makes it seem like it’s easier to budget for the future. However these kinds of awards have an impact on what can be the expected outcomes of the research, and I want to explain this to you with an example and why we particularly at NIH have stopped the proliferation of these types of awards. So here’s the example. If you have an award where you’re going to give an institution $110,000 in a total award, we have first Institution A with a 48% IDC rate. Institution A has to subtract out before they make their calculation any costs that are accepted. So in this case just like in the previous examples, we have equipment, which is $10,000, that does not have indirect cost rates applied to them. So now we run an equation, which is the rate times the amount over one plus the rate. So in this example we have 0.48 times 100,000 over one plus 0.48. That’s how we would run to figure out how much is direct and indirect. So in this example for Institution A, Institution A receives $32,000 of indirect costs and receives a $78,000 for direct costs. Let’s say that one of your other recipients is Institution B that has a 60% IDC rate. In this case again we’re going to subtract out $10,000, so now they have $100,000 left to work with to run the equation. So remember our equation R times A over one plus R. So in this case it’s 0.60 times 100,000 over one plus 0.6, and that gives you $36,000 for IDC. So in this case this institution has a higher IDC rate and is indeed getting more indirect costs. That only leaves 74,000 for direct costs. So in this particular case, if the funding agency has an expectation that the same amount of research can be conducted because they’re… both institutions are getting the same size awards, those institutions that have a higher IDC rate and those principal investigators at those institutions are at a disadvantage because they will not have the same amount of project costs or direct costs to run their program. And therefore if we had done this example in the opposite way where we asked for the direct costs and then applied the IDC rates to the direct costs, we would have allowed Institution B to have a larger award so that the project costs or the direct costs were equivalent in both cases. So this is one of the reasons why here particularly at NIH we try to limit these types of awards… total cost awards and instead use our direct costs and indirect costs applied to them—so that we are fully funding both the indirect costs and the direct costs needed to conduct the research. And this happened to be codified in the Uniform Guidance that just came out in 2014. Remember the circular I talked about—the 821 circular, which was our cost principles. A number of these cost principle circulars were combined into one omni-circular, as we called it, in 2014 called the Uniform Guidance. And as a result of this, NIH is required to accept and apply IDC rates to grants and cooperative agreements. In other words, agencies should apply the negotiated rate on federal awards and on the modified direct costs like we talked about earlier. And we only allow any exception to in some way cap the amount of indirect costs when this has been approved by the awarding agency head. In other words, we do not want to have a proliferation by which indirect costs are capped. And this has been codified in the new Uniform Guidance. So there may be some desire on some agencies to programmatically limit indirect costs, but this requires that the head of the agency would approve the allowing of any program to cap the indirect cost rate. And if you do that, you have to require notify OMB, and you must make publicly available the policies, procedures, and criteria to follow when seeking and justifying exemptions from the negotiated rate. So in other words, this OMB’s attempt to make sure the federal agencies pay for the true cost of research. So that’s all I have to say for you. I hope this has helped clarify how NIH applies indirect costs, how indirect costs are negotiated. And if you find this useful, please feel free to share it with others. Thank you very much.

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