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Give That Gift Horse Another Look

Stimulus funds for university research can be a mixed blessing, causing an institution’s facilities and administration rate to shrink. A case study presents strategies to keep rates in check.

By Paul Harris, Dan W. Hamlin, and Louis Guin

*The American Reinvestment and Recovery Act (ARRA) presented higher education institutions with an unprecedented level of funding to expand and improve their research opportunities. Since ARRA's creation in February 2009, however, the government and academic community have debated the best approach to accounting for the additional funding and capturing its effect on facilities and administration (F&A) rates—the amount of overhead, or indirect costs, associated with federally funded research that universities can recoup.

The government, understandably, wants justification of every ARRA dollar awarded; ARRA grants come with a host of documentation and reporting requirements. Equally understandably, universities with increasingly tight budgets seek to recover from the government a significant percentage of their overhead costs. These costs have escalated with ARRA's administrative requirements, as universities must devote more staff time to gathering and submitting the required data. Given the government's regulations and stance in F&A rate negotiations, university leaders now question whether they'll be picking up more of the research tab—and, if so, just how much it could cost them.

Unanticipated Consequence 

How ARRA Funding Can Affect F&A Rates

The following model captures various effects on F&A cost recovery and individual components of F&A rates when ARRA funding is included in prospective, predetermined rates.

An F&A rate (R) is simply a ratio of facilities and administrative costs, or overhead (O), divided by the Modified Direct Total Cost (MTDC) research base, or (M), defined as total direct costs minus equipment and subcontracts. Simply stated, the formula is: R = O/M.

Including ARRA funding in the MTDC research base, or M, may decrease the base-year negotiated rate, which serves as the basis for determining rates in future years, provided overhead costs do not increase proportionally. If, however, the institution increases its overhead costs—by adding new research facilities, for example—the change in overhead, or ∆O, would likely be significantly higher than the ∆M, and the institution could expect an F&A rate increase.

The expression O = R * M + M * R + M * R can be derived from the basic formula to measure the effect of ARRA funding on prospective years' rates:

R = Old year's F&A rate.

M = Old year's MTDC base.

O = Increase (decrease) in the amount of F&A support cost from old year to new year.

M = Increase (decrease) in MTDC from old year to current year.

R = Increase (decrease) in the F&A rate from old year to new year.

A Sample Scenario

Using this expression, the following table displays the results of a 10 percent increase in the MTDC research base from 2010 to 2011. This example uses 2010 as the base year, an MTDC research base of $50 million, and ARRA funding of $5 million in 2011. (Note: The $5 million—or 10 percent increase in MTDC, from $50 million to $55 million—was used to highlight the full impact of new ARRA funding on the rate and the institution's recovery of F&A costs. Additionally, to show a sudden surge of ARRA-funded research, we assumed the institution did not significantly alter its facilities costs.)

In this scenario, a 10 percent increase in the MTDC research base results in a 1.9 percent decrease in the institution's proposed F&A rate (from 57 percent to 55.1 percent). The institution's proposed overhead recovery increases by 6.3 percent because the proposed F&A rate is applied to the larger research base. Unrecoverable administrative costs increase from $5 million to $5.2 million, reflecting a $200,000 unrecoverable increase in administrative costs related to the support required to process ARRA funding. Such increases may be much larger at some universities and bump up against the administrative cost cap, thus significantly decreasing the amount of overhead that can be recovered.

As unrecoverable administrative costs increase, the positive effects of a higher MTDC research base diminish. Moreover, if an institution's negotiated rate is less than its proposed rate, the amount of unrecoverable overhead has an even greater negative impact on the total dollars ultimately recouped by an institution. (The scenario above assumes that the institution receives its proposed F&A rate.)

You can use this model to determine relationships between actual, proposed, negotiated, and effective recovery costs and rates. In practice, the actual rate (the total F&A costs that should be recovered) typically exceeds the proposed rate; the proposed rate exceeds the negotiated rate; and the negotiated rate exceeds the effective rate. Many institutions' effective rates—representing the dollars they ultimately recover—are just a fraction of their negotiated rates. As a best practice, however, universities should aim to capture 75 percent to 85 percent of their negotiated rates.

For example, management of the San Jose State University (SJSU) Research Foundation recently learned that ARRA funding could come with a price greater than just the time and expenses associated with increased reporting requirements.

The foundation submitted $65 million in ARRA proposals and was awarded $2 million. When calculating its F&A rates for this year, the foundation considered whether and how to incorporate these ARRA dollars. These considerations included:

  • The dollar amount that would apply to on-campus research (only on-campus grants are relevant when calculating the F&A rate).
  • The dollar amount that would fund equipment (universities cannot recover any expenditures associated with equipment expenses).
  • The dollar amount expected annually for multiple-year grants (these grants should be evaluated each year for the life of the grant). 

Concluding that the ARRA dollars awarded to the foundation would not significantly affect its research base, the university calculated an F&A rate of 57.6 percent—31.6 percent recovery of facilities costs and 26 percent recovery of administrative costs—for research conducted at its Moss Landing Marine Laboratory, located on a satellite campus. The Department of Health and Human Services (DHHS), however, rejected that F&A rate for Moss Landing. DHHS required SJSU to include the $2 million already granted to the foundation—and an estimate of future ARRA funding—in its research base.

In other words, the award of ARRA dollars resulted in a reduction of the university's F&A rates. (The hypothetical rate calculations, shown in the sidebar, demonstrate how ARRA funding can cause that rate to shrink.) After negotiations, DHHS approved an F&A rate of 51.5 percent for the Moss Landing Marine Laboratory. Of the negotiated reduction from the proposed rate, 2 percent was attributed to the ARRA funding.

Tallying the Costs

The inclusion of ARRA funding isn't the only component that can affect F&A rates and cost recovery. An institution should also note the magnitude of change in its overhead costs. ARRA requirements, for example, involve a new reporting structure that existing systems and data collection processes at universities may not currently support, resulting in another expense: training.

For instance, in addition to preparing training materials for all personnel who would be involved with the university's ARRA funding, SJSU's Research Foundation posted ARRA guidelines on its Web site and developed new accounting reports to satisfy ARRA reporting requirements. To fulfill government requirements, SJSU personnel also participated in multiple webinars sponsored by the Office of Management and Budget (OMB) that offered training on the various aspects of ARRA reporting, including how to collect and report job creation, job retention, and the “Buy American” purchasing statistics from recipients' vendors. In practice, reporting these numbers meant long hours of research, plus many e-mails and phone calls, because government agencies did not have uniform standards. OMB set tight deadlines for quarterly reporting that required mastery of OMB's reporting templates as well as differing templates from individual agencies.

When assessing changes in overhead costs, the amount recoverable is affected by two major factors: administrative cost caps and the probability of capturing the change in facilities costs. OMB Circular A-21 limits the percentage of administrative costs that a university can recoup. Many institutions already recover the maximum administrative costs associated with their research programs; they could not, therefore, recover any additional administrative costs related to new ARRA-funded research. Moreover, estimates indicate that only about 50 percent of ARRA research funding has been awarded. This means that, as the volume of grants awarded increases, the administrative cost bubble will continue to expand.

The recovery of facilities costs to offset the effects of ARRA funding on F&A rates shows more mathematical promise. Universities, however, face the challenge of updating the space-utilization data needed to capture changes in these costs, thus justifying an increase in F&A rates. While higher facilities costs can contribute to higher rates of F&A cost recovery, universities must demonstrate those costs through space-utilization studies of the base and future years.

Updating space inventories in accordance with federal guidelines and approved processes can help maximize universities' ability to recoup recoverable research costs. Universities can also mitigate the potential for reduced F&A recovery rates by:

  • Strengthening their proposals.
  • Informing political and institutional leaders of the impact that ARRA funding has on the institution.
  • Preparing for ARRA-compliant data collection and reporting.
  • Examining and reducing the risk of reporting errors.
  • Taking measures to identify, report, and capture all overhead costs in F&A rate calculations.

In a tight budget environment, every dollar counts. Yet universities must seek a balance between enough funding to effectively stimulate more research and a flood of funding that could potentially reduce their recovery of research-related overhead costs. With the right preparation, thorough documentation, and compelling F&A proposals, a university can tap ARRA funding to successfully support its research goals and strengthen America's competitive edge.

PAUL HARRIS is director, finance and accounting, San Jose State University Research Foundation, California; DAN W. HAMLIN is vice president, higher education and nonprofits practice, Attain LLC; and LOUIS GUIN is a consulting associate, Attain LLC.