UNDERSTANDING DIRECT AND INDIRECT COSTS

SPONSORED PROGRAMS AS A SOURCE OF INCOME

It's no news to anyone that operating budgets are tight, and will probably continue to be so in the coming years. Sponsored programs represent the university's best alternative source of funding for research activities. Such funds can provide faculty and graduate students the opportunity to work on advanced research with sophisticated equipment that might not otherwise be available. This advanced research also helps increase the prestige and reputation of Virginia Tech as a research institution.

But when the university accepts money from an outside source, whether this be the federal government, a research foundation, or a Fortune 500 corporation, we also accept the responsibility for carefully accounting for those funds to make sure they are properly spent. It is of primary importance that we recover all the costs of that project to the university. These include direct and indirect costs.

The consequences of poor cost accounting are various, but, ultimately, the result is the same: university operating funds will have to be diverted to cover some of the costs of research projects, draining rather than supplementing funds from the university. This kind of drain is especially difficult because it is unplanned, and usually occurs well after the research has been performed.

The Office of Sponsored Programs provides a variety of support services for principal investigators to help in cost accounting on their projects. Our project administrators are experts in the federal, state, and university guidelines that apply. We will help you develop your initial proposal budget so that it accurately reflects the total applicable costs for your project. Once you are on your way, we produce regular budget reports, with possible problem areas flagged for your particular notice. We remind you of any contract terms and conditions that affect the way money can be spent on your project.

But we are not as close to your project as you are. The university depends upon you, as PI, to account for expenditures in a timely fashion, and to examine the reports you receive to make sure that they accurately reflect how costs should be charged. If errors are made and left uncorrected, they are difficult to remedy. In particular, cost transfers from one project to another reflect poorly on our cost accounting ability .

This section can help you understand the key components of any project budget: direct and indirect costs. The next section reviews the forms and reports you need to be familiar with in order to account properly for your costs and to track your budget. If you need more information, contact OSP. We'll be happy to help.
 

DIRECT COSTS: YOU GET WHAT YOU PAY FOR

Any cost charged to a project must be generated by the performance of the project. The actual (not estimated) amount of the expenditure must be auditable. That is, there must be documentation of what the expense was, and clear evidence that the expense was needed for the performance of the project.

The largest portion of direct costs for any sponsored project is for personnel and fringe benefits. The most important document the university has for supporting these costs is certified Personnel Activity Reports (PARs). Through PARs, you will verify that expenditures for direct labor and fringe benefits have been charged properly to the research projects that are your responsibility. You can find more information about PARs on Insert link. For now, suffice it to say that you should carefully review the PARs that are your responsibility, and see they are returned in a timely fashion so that cost accounting for these substantial expenses can be handled correctly.

Other direct costs can include communications, computing, travel, printing, materials

and supplies, equipment, and subcontracting or consulting agreements. See the table on "Defining direct and indirect costs" (Insert link, p15) for more detail on when costs can be charged directly to your project.

Sponsors will often include terms and conditions in an award that stipulate whether direct cost money can be spent in a certain way. Most often, these stipulations require prior consent of the sponsor to:

You will need to work closely with your OSP project administrator to obtain the proper sponsor and university           approval to proceed with such expenditures. Also see (Insert link, p 10-11) for more detail on subcontracts and consulting.

As a general rule of thumb, make sure that the correct project number is noted whenever you are documenting direct costs. This number is required on personnel documents for new hires, PARs, interdepartmental service requests, purchase requisitions, etc. Auditors will be able to track your expenses more easily when your project is complete, and it is likely that the university will be able to collect all the funds that it should for your research efforts.

INDIRECT COSTS: REAL COSTS OF DOING BUSINESS

To understand the importance of indirect costs, we might as well start off by admitting to the obvious — the term "indirect" is a misnomer. It implies that such costs are only vaguely applicable to specific projects. (Dictionary meanings for the word include 'roundabout' and even 'deceitful.') However, such implications could not be further from the truth. Indirect costs represent real dollars being spent by the university in support of all of its programs-including sponsored programs. Without heat, electricity, and telephone service, any research project would be difficult to complete. Without university support for the development of research proposals, sponsored programs would not even exist. And yet, because such expenses cannot be directly attributed to any specific project, they must be recovered in some other fashion.

Thus the concept of indirect costs. Utility costs, general administrative expenses, depreciation of equipment and facilities are common categories of indirect costs. Salaries in support of a secretarial pool may also be considered as indirect costs. These expenses are part of the cost of doing business, although the specific relationship to a given project (in actual dollars) may not be easily defined.

In years past, well-funded universities (including Virginia Tech), were less interested in recovering indirect costs. We can no longer afford this luxury, and are in fact compelled by the state to recover indirect costs whenever possible. Thus, indirect costs need to be considered in the development of every research proposal budget, and fairly charged to each sponsor for the work he or she has asked the university to perform.

Since the early sixties, the federal government has established indirect cost rates for various types of sponsored activities. These rates, negotiated each year by the university with the Office of Naval Research (which does the same task for the federal government with most universities accepting government contracts), are generally accepted by commercial and industrial sponsors, other institutions, and associations.

Indirect costs are applied to direct cost activities on a percentage basis. The formula for developing this percentage is simple. Total costs are examined for a prior fiscal year. The percentage of indirect costs compared to direct costs is determined. With the agreement of the federal government, this percentage becomes the negotiated indirect cost rate for the following fiscal year, and will be applied as a percentage of total costs to all proposal budgets and actual billing.

The PI does not need to be concerned with calculating indirect cost rates. But it is important that indirect costs be included in all proposal budgets. The OSP will help you figure the appropriate amounts, and will negotiate with a prospective sponsor who does not find the federal indirect cost rate acceptable. (We want to reiterate here that you may not negotiate fiscal and administrative terms or conditions on behalf of the university. Please let us handle this.)

You will also come into contact with indirect costs on the Personnel Activity Report.

The percentage of faculty, staff, and graduate student effort spent on direct and indirect activities must be accurately reported and updated on a regular basis through the PAR. Salaries and fringe benefits have the greatest impact of any expenses on both direct and indirect costs. So,again, it is critical that you examine the personnel costs for your projects carefully, and make sure that they are being accurately recorded in the accounting system.

There are a number of reasons why indirect costs are not fully recovered. Not all direct costs generate indirect cost recoveries. Some sponsors decline to pay the full indirect cost rate. Departments, colleges, and the university may elect to cost-share a portion of indirect costs in order to bring a project budget within funding constraints.

It's important to remember, however, that these unrecovered indirect costs are expenses for the university. They are paid for out of the operating budget of the colleges and departments, out of state appropriations for research, and out of central funds managed for the university as a whole. In short, indirect costs are a real cost of doing business (in this case, the business of sponsored research), and we must do all we can to recover those costs if the enterprise is to survive and grow.