Companion Guide to Video August 2012

www.fhwa.dot.gov/federal-aidessentials

The Federal-aid highway program supports local 

public agencies (LPAs) with funding for highwayrelated construction projects. This funding is in 

the form of reimbursements, or payments, for 

allowable project expenses. In deciding whether 

and how to apply for funding, LPAs need to know 

which project costs are allowable, to qualify for 

reimbursement.

There are three basic conditions an expense must 

meet in order to qualify as allowable. These three 

conditions are that the expense must be 

necessary, reasonable, and allocable. We’ll 

explain more about each of these conditions a bit 

later, but first let’s get an understanding of the two 

types of costs that make up a project’s total direct 

and indirect costs.

A direct cost is an expense for an item or service 

bought specifically and entirely for the project. 

Some good examples of direct costs are project 

travel, rights-of-way, equipment usage, employee 

salaries for time specifically devoted to the project, 

and project building materials, such as concrete 

and asphalt.

An indirect cost is an expense for an item or 

service that benefits more than one project or 

purpose. These may be costs experienced within a 

department of the LPA, for example within the 

accounting or facilities maintenance departments. 

Some good examples of indirect costs include 

those for accounting systems, buildings and 

facilities, general office equipment, and supplies, as 

well as costs for salaries and other compensation 

for employees who carry out these functions.

In order to request and qualify for reimbursement 

on federally funded projects, an LPA will need to 

provide evidence of the costs related to the project 

to its State department of transportation, or State 

DOT. Invoices can serve as an appropriate record 

and evidence of the expenses for the purpose of 

reimbursement of direct costs. However, to include 

indirect costs for reimbursement on federally 

funded projects, you must develop an approved 

Finance

Administrative Requirements

Introduction to Cost Principles

Standards for determining if costs are allowable or not allowable 

for Federal awards
Federal-aid Essentials for Local Public Agencies

Indirect Cost Allocation Plan, or ICAP. Your ICAP 

will need to spell out all of the methods the LPA 

will use to consistently allocate indirect costs to all 

projects.

Now that we have discussed the difference 

between direct and indirect costs, let’s go back to 

the three conditions an expense must meet in 

order to qualify as allowable. As you may 

remember, the expense must be necessary, 

reasonable, and allocable to the project.

First, necessary expenses are those without 

which, the project cannot be completed. Some 

good examples are safety equipment or 

construction materials such as steel and asphalt. 

The second condition an expense must meet to 

qualify as allowable is that it must also be 

reasonable. To determine whether an expense is 

reasonable, you must look at the amount paid and 

the circumstances under which the purchase was 

made. A good rule of thumb is to ask, “Would a 

sensible person pay this expense under the same 

circumstances?” If the answer is “yes,” then the 

cost is reasonable. 

The third and final condition that an expense must 

meet in order to qualify as allowable is that it must 

be allocable. To be allocable, an expense must 

directly benefit the project. Some examples of 

allocable expenses are those for project-related 

salaries, supplies, travel, materials, and services.

In summary, Federal-aid highway project expenses 

must be allowable in order to qualify for Federal 

reimbursement. To be allowable, they must meet 

the three conditions of being necessary, 

reasonable, and allocable.

For additional guidance, contact 

your State DOT.
Federal-aid Essentials for Local Public Agencies

The content of this 

document is not a 

substitute for 

information obtained 

from State departments 

of transportation, 

appropriate FHWA 

Division Offices, and 

applicable laws. 

Scenarios have been 

simplified for emphasis 

and do not necessarily 

reflect the actual range of 

requirements applicable 

to the scenario or this 

topic. This document

was created under 

contract number 

DTFH61-11-D-00023 by 

the Federal Highway 

Administration, U.S. 

Department of 

Transportation, and is 

offered to the public to 

heighten and focus 

awareness of Federal-aid 

requirements within the 

local public agencies 

community and 

reinforces the 

importance of these 

necessary policies, 

procedures, and 

practices.

This Companion Resource 

is the script content for 

the video production of 

the same name. 

Additional Resources

• Link to Title 2 Grants and Agreements covering cost principles for State, 

local, and Indian tribal governments

http://ecfr.gpoaccess.gov/cgi/t/text/textidx?c=ecfr&sid=b1a93d4780a735b935fe0fb65198988e&rgn=div5&view=text

&node=2:1.1.2.10.6&idno=2

• Description of free Web-based course FHWA Planning & Research 

Grants: Cost Principles

http://www.nhi.fhwa.dot.gov/training/course_detail.aspx?num=FHWA-NHI151048&cat=&key=&num=&loc=&sta=%25&typ=3&ava=1&str=&end=&tit=&l

ev=&=drl