University Research: Policies for the Reimbursement of Indirect Costs Need to Be Updated
Published: 2010-09-08T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In fiscal year 2007, the majority of the Department of Defense's (DOD) basic research obligations were provided to higher education institutions. DOD reimburses these institutions for both direct and indirect costs for research. Two federal agencies, DOD and the Department of Health and Human Services (HHS), negotiate indirect cost rates used to reimburse higher education institutions for indirect costs on federally funded research awards, including DOD awards. GAO was asked to examine the following issues related to higher education institutions performing basic research for DOD: (1) the variation in proposed and negotiated indirect cost rates and factors that may contribute to variations; (2) how and to what extent the administrative cap and the DOD basic research cap limit reimbursement of indirect costs; and (3) the methods DOD uses for overseeing compliance with indirect cost reimbursement for grants. GAO surveyed a generalizable sample of higher education institutions performing basic research for DOD; reviewed agency guidance and policies; and interviewed officials from federal agencies, independent public accounting firms, and higher education institutions.
section_title: What GAO Found
paragraphs: GAO identified wide variation in indirect cost rates at schools receiving DOD funding in fiscal year 2007, which may be related to a number of factors. For example, the average difference between a school's proposed and its negotiated rate was much larger for schools with HHS as the cognizant rate-setting agency than for those with DOD, in part due to the agencies' differing approaches to negotiation. GAO also found that schools receiving a 1.3 percent add-on to their rate to assist with the cost of utilities both proposed and negotiated higher rates than those without the adjustment. Contrary to guidance to periodically review school eligibility, the fixed list of schools eligible to receive this add-on has not been revisited since established in 1998. The cap on the administrative portion of the indirect cost rate limited fiscal year 2007 reimbursement for about 83 percent of schools. The cap was established nearly 20 years ago with the intent of limiting federal reimbursement for schools' administrative costs, and OMB has not reexamined this cap since its implementation. We estimate the DOD basic research cap might have limited fiscal year 2008 reimbursement for some awards at about 22 percent of schools, but the limitation depends on the types of costs included in each individual award and is difficult to determine up front on a schoolwide basis until total costs for each award are tallied. GAO identified weaknesses in the three methods DOD says it uses to oversee that indirect costs for research grants are reimbursed appropriately: the single audit, the closeout process, and audits by DOD's Defense Contract Audit Agency or by cognizant agencies for audit. At least one of the three methods was used at most of the schools we reviewed, but four schools were not covered by any of the methods, indicating a gap in coverage. In our discussions with cognizant agencies for audit, we learned that recent audits of research awards to schools at HHS have led to some significant findings of improper billings of indirect costs. Inconsistencies in rate-setting and reimbursement processes lead to perceived and actual differences in the treatment of schools. Moreover, because of the weaknesses in its oversight methods, DOD lacks assurance that it is reimbursing indirect costs appropriately.
section_title: What GAO Recommends
paragraphs: GAO is making recommendations to address consistency in rate-setting and to improve oversight of indirect cost reimbursement. The agencies generally agreed with these recommendations.

section_title: Letter
paragraphs: In fiscal year 2007, the federal government obligated nearly $27 billion for  basic research, the majority of which went to higher education institutions  in the form of research grants and contracts. The federal government has  recognized that university research contributes to American  competitiveness and leadership in science, in effect creating shared goals  between the federal government and universities, and has committed to  sponsoring a share of the research costs. The government’s contribution  can be broken down into direct costs (those costs specifically identified  with individual research projects) and indirect costs (those that are not  directly attributable to a specific project or function, such as the costs for  administrative staff), also referred to as facilities and administrative costs  when dealing with higher education institutions. While direct costs are  relatively easy to define and measure, indirect costs can be more difficult  to allocate to individual projects. Further, there has been debate over what  portion of indirect costs is the responsibility of the government and what  portion is the responsibility of the research institution.
Over the years, Congress has enacted legislation and agencies have issued  guidance to clarify what indirect costs the government will reimburse. For  example, in the early 1990s, revisions to the Cost Principles for  Educational Institutions limited reimbursement of the administrative  portion of indirect costs for higher education institutions to 26 percent of  the modified total direct cost base. More recently, Congress enacted  legislation which capped the reimbursement of indirect costs on  Department of Defense (DOD) basic research grants, contracts, and  cooperative agreements to 35 percent of the total cost of the award. The  House Committee on Armed Services Report for the Duncan Hunter  National Defense Authorization Act for Fiscal Year 2009 (H.R. 110-652)  directed that we review the DOD processes and procedures related to  indirect costs for research. In response, we examined the following issues  related to higher education institutions performing basic research for  DOD: (1) the variation in proposed and negotiated indirect cost rates and  factors that may contribute to variations; (2) how and to what extent the  administrative cap and the DOD basic research cap limit the government’s  reimbursement of indirect costs; and (3) the methods DOD uses for  overseeing compliance with indirect cost reimbursement for grants and  the extent to which each method was used.
To determine the proposed and negotiated indirect cost rates at higher  education institutions performing DOD basic research, we surveyed  university administration officials at schools that DOD reported had active  grants, contracts, or cooperative agreements in fiscal year 2007 that were  coded as basic research. The survey sample was comprised of (1) the 32  higher education institutions that received more than half of the funding  DOD obligated for basic research, and (2) a random selection of 146 higher  education institutions with obligations of more than $100,000 in fiscal year  2007. Of the 178 sampled higher education institutions to whom we sent  the surveys, 144 responded for an 87 percent response rate. Of the 144  respondents, 114 used a standard format proposal for negotiating an  indirect cost rate, and 29 used a simplified format proposal, which can be  used by higher education institutions that received $10 million or less in  total direct costs for federally sponsored grants, contracts, and  cooperative agreements annually. For the purposes of this report, we  produce population estimates for the higher education institutions within  the United States that use the standard format for proposal submission  and that DOD identified as performing more than $100,000 of basic  research in fiscal year 2007. Based on our survey, we estimate that this  would correspond to about 263 schools. Characteristics and demographic  information for the higher education institutions that used a simplified  form of submitting indirect cost rate proposals can be found in appendix  V. To determine what factors may contribute to rate variations, we  surveyed university administration officials concerning various factors,  such as the school’s cognizant rate-setting agency (which can be either the  Department of Health and Human Services (HHS) or DOD), whether an  institution received an adjustment for the cost of utilities, and whether an  institution is public or private (see appendix III for a list of factors),  interviewed DOD and HHS officials, and interviewed representatives from  higher education associations. Detailed analysis of the factors that  contribute to variations in research rates can be found in appendix III,  with the analysis of key factors included in the objective 1 findings. To  determine how and to what extent the administrative and DOD basic  research caps limit reimbursement of indirect costs, we collected  information through our survey of university administration officials at  higher education institutions and reviewed the intent and legislative  history of the administrative and DOD basic research caps. To identify and  understand the methods DOD uses for overseeing compliance with  reimbursement of indirect costs, we interviewed DOD officials. To  determine the extent to which each of the methods identified by DOD was  used, we focused on the 32 higher education institutions that received  more than half of DOD’s fiscal year 2007 basic research obligations. For  these institutions, we reviewed documentation such as DOD guidance on  grant administration, financial reporting forms for grants, data from  independent public accounting firms on the research and development  awards sampled for the single audit, and previous reports by GAO and  others. We also interviewed officials at DOD, the Office of Management  and Budget (OMB), cognizant agencies for audit such as HHS, the National  Science Foundation (NSF), and the Department of Education, as well as  officials of independent public accounting firms and higher education  institutions to understand their role in reviewing indirect cost  reimbursement on DOD basic research awards. See appendix I for  additional details on our objectives, scope, and methodology.
We conducted this performance audit from October 2009 to September  2010 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: In fiscal year 2007, the federal government obligated nearly $27 billion for  basic research, with DOD obligations accounting for $1.5 billion of that  total. As shown in figure 1, more than half of DOD basic research funding  was provided to schools in the form of research grants and contracts. “Other” includes Federally Funded Research and Development Centers and foreign performers.
OMB Circular A-21, Cost Principles for Educational Institutions,  establishes principles on how schools charge costs to federally funded  research. Circular A-21 requires all costs for reimbursement to be  allowable, allocable, and reasonable, and provides that the federal  government bear its fair share of total costs, determined in accordance  with generally accepted accounting principles, except where restricted or  prohibited by law. While the federal government and schools share  certain research goals, there is debate on what constitutes the federal  government’s fair share of research costs.
The federal government reimburses both direct and indirect costs  associated with federally funded research. Direct costs can be specifically  identified with individual research projects and are relatively easy to  define and measure. They include, for example, the researcher’s salary,  subawards, equipment, and travel. Indirect costs represent a school’s  general support expenses and cannot be specifically identified with  individual research projects or institutional activities. They include, for  example, building utilities, administrative staff salaries, and library  operations (see fig. 2).
As shown in figure 2, indirect costs are divided into two main components,  facilities costs and administrative costs. Facilities costs include  operations and maintenance expenses, building use or depreciation costs,  equipment use or depreciation costs, and library expenses. Administrative  costs include general administration expenses, such as the costs  associated with executive functions like financial management;  departmental administration expenses, including clerical staff and  supplies for academic departments; sponsored projects administration  expenses, that is the costs associated with the office responsible for  administering projects and awards funded by external sources; and  student administration and services expenses, such as the administration  of the student health clinic.
subsections: section_title: Indirect Cost Rate
paragraphs: Circular A-21 outlines the process for establishing an indirect cost rate for  schools performing federally funded research. The indirect cost rate is the  mechanism for determining the proportion of indirect costs that may be  charged to federally funded research awards. The rate is established based  on a historical fiscal year of cost data from a school, and is applied to  individual research awards. The indirect cost rate is applied to a modified  set of direct costs referred to as “modified total direct costs” (MTDC) (see  figs. 3 and 4). MTDC includes the salaries and wages of those conducting  the research, fringe benefits (e.g., pensions), materials and supplies, travel,  and the first $25,000 of each subaward. MTDC excludes costs such as  equipment costs, capital expenditures, tuition remission, equipment or  space rental costs, and the portion of each subaward in excess of $25,000  (see fig. 4).
The indirect cost rate is developed as follows:    Each subcomponent of the facilities component of the indirect cost rate  (e.g., building use, depreciation, operations and maintenance) is divided  by MTDC and added together to derive the facilities component of the  rate.
Similarly, each subcomponent of the administrative component of the  indirect cost rate (e.g., general administration, sponsored administration)  is divided by MTDC and then added together to derive the administrative  component of the rate.
Then, the facilities component and the administrative component are  added together to equal the indirect cost rate.
section_title: Indirect Cost Rate-Setting Process
paragraphs: A school’s indirect cost rate is negotiated between the school and the  federal government. A school can establish three types of indirect cost  rates (see table 1).
Circular A-21 assigns rate-setting responsibility to either HHS or DOD, as  the cognizant rate-setting agency. The Division of Cost Allocation (DCA)  handles this responsibility within HHS and the Indirect Cost Branch within  the Office of Naval Research (ONR) does so for DOD. Currently, HHS,  with 50 rate negotiators in four field offices and headquarters, is the  cognizant rate-setting agency for more than 1,000 schools, while DOD,  with four negotiators and a director in one location, is responsible for 44  schools.
As shown in figure 5, a school establishes its indirect cost rate by  submitting a proposal to its cognizant rate-setting agency using a base year  that represents a historical fiscal year of costs. HHS reviews the proposal  while DOD generally sends the proposal to the Defense Contract Audit  Agency (DCAA) to be audited. After the proposal has been reviewed or  audited, the cognizant rate-setting agency and the school negotiate, and  come to agreement on the rate. The rate is then documented in a formal  indirect cost rate agreement.
section_title: Indirect Cost Reimbursement Limitations
paragraphs: Across the federal government, there are limitations, or caps, placed on  the reimbursement of indirect costs. Two related to DOD-funded research  at schools are known as the administrative cap and the DOD basic  research cap.
subsections: section_title: Administrative Cap
paragraphs: In 1991, Circular A-21 incorporated an administrative cap limiting the  administrative costs for which a school may be reimbursed to 26 percent  of the MTDC for research awards. This cap is applied during the rate- setting process. This limitation only applies to higher education  institutions, as stated in OMB Circular No. A-21. Despite the circular’s  administrative cap, DOD regulations, which implement a statutory  mandate, provide that for DOD contracts, versus grants or cooperative  agreements, schools have the option to negotiate a separate rate that is not  subject to the administrative cap.
section_title: DOD Basic Research Cap
paragraphs: The Department of Defense Appropriations Act, 2008 incorporated a cap  limiting the indirect costs for which a research performer (including a  school) may be reimbursed to 35 percent of a DOD basic research award’s  total costs. This cap, which applies to all nonfederal research performers,  that is, schools, nonprofits, and private sector companies performing on  contracts, grants, and cooperative agreements, was also included in the  fiscal year 2009 and fiscal year 2010 defense appropriations acts. In  contrast to the administrative cap, which is applied to the negotiated rate  applicable to all of a school’s federal research awards, the DOD basic  research cap is applied to individual DOD basic research awards, and  while the school can monitor whether the charges have exceeded the   35 percent limitation as it performs the research, the school (or other  performer) ultimately ensures government reimbursement does not  exceed the cap once all costs are known.
The DOD basic research cap is calculated with different cost bases than  either the school’s indirect cost rate or the administrative cap. As  previously discussed, a school’s indirect cost rate is applied to a modified  set of total direct costs to arrive at the dollar amount of indirect costs  applicable to a specific research award. In contrast, the 35 percent cap on  DOD basic research awards limits indirect costs as a proportion of total  costs. Total costs include all allowable direct and indirect costs on an  individual award.
Because of the different cost basis, the 35 percent DOD basic research cap  does not mean that an institution with an indirect cost rate higher than   35 percent will be limited by the cap. The threshold for a school to be  limited by the 35 percent DOD basic research cap is a negotiated indirect  cost rate of 53.8 percent. This is demonstrated through the following  example: if a school receives a DOD basic research award for $100,000, the  maximum amount of the award that may be reimbursed as indirect costs is  $35,000.
This threshold holds true in situations where no direct costs are excluded  from total direct costs. In this circumstance, total direct costs are  equivalent to modified total direct costs. This allows us to use the formula  for an indirect cost rate to calculate the threshold (see fig. 7 below).
If a school has an indirect cost rate below this 53.8 percent threshold, it  will not be affected by the DOD basic research cap on indirect costs at   35 percent of total award costs. If a school has an indirect cost rate above  this threshold, it may not be reimbursed for all its indirect costs,  depending on each award’s costs.
section_title: Variations in Indirect Cost Rates Are Driven by Multiple Factors
paragraphs: We identified multiple types of variation in indirect cost rates for schools  performing DOD basic research, driven by several different factors (see  appendix III for detailed information on the factors and variations we  identified). Across all schools, wide variation was identified in proposed  rates, negotiated rates, and in the difference between the proposed and  negotiated rates at schools receiving DOD research funding in fiscal year  2007. The difference between the proposed and negotiated rates was  significantly larger for schools that negotiate with HHS than for those that  negotiate with DOD. Differing policies and procedures employed by the  two cognizant rate-setting agencies, including, for example, different  approaches and differing use of rate types, may explain some of this  variation. Another source of variation was that schools eligible for a rate  increase of 1.3 percent to account for the cost of utilities, known as the  utility cost adjustment, both proposed and negotiated higher rates than  those not receiving the adjustment. The increase for the costs of utilities is  received by a fixed list of schools that are listed in OMB Circular A-21.  OMB has not reexamined the list of those receiving the adjustment since  1998 and DOD and HHS officials responsible for rate-setting were unclear  on what the process should be for receiving and approving applications for  use of the utility cost adjustment.
subsections: section_title: Proposed and Negotiated Indirect Cost Rates Varied Widely among Schools Performing DOD Research
paragraphs: The proposed and negotiated indirect cost rates at schools performing  DOD research varied widely from one school to another. Figure 8  summarizes the distribution of schools with various levels of proposed  and negotiated rates. For example, whereas about 14 percent of schools  proposed a rate of less than 45 percent, about 17 percent of schools  proposed a rate of 60 percent or higher. Similarly, while about 24 percent  of schools negotiated rates that were less than 45 percent, about 7 percent  of schools negotiated a rate of 60 percent or higher. Variation between  what was proposed and what was negotiated can also be seen in this  figure. For instance, while about 17 percent of schools proposed a rate of  60 percent or higher, only about 7 percent of schools negotiated a rate that  high.
section_title: The Difference between Proposed and Negotiated Rates was Larger for Schools Negotiating with HHS Than Schools Negotiating with DOD
paragraphs: The difference between a school’s proposed and negotiated rates varied  significantly based on the cognizant rate-setting agency with which a  school negotiated. Specifically, the average difference between proposed  and negotiated fiscal year 2007 rates for schools with HHS’s Division of  Cost Allocation as their cognizant rate-setting agency was about   4.5 percentage points. In contrast, the average difference between  proposed and negotiated rates for schools with DOD’s Office of Naval  Research as their cognizant rate-setting agency was less than 1 percentage  point (see fig. 9 below).
Schools’ explanations for the difference between their proposed and  negotiated rates varied based on the schools’ cognizant rate-setting  agencies. For example, we estimate that about 60 percent of schools with  HHS as their cognizant rate-setting agency identified negotiation that was  not clearly tied to specific aspects of their rate proposal as a part of the  explanation for the negotiated rate reduction. For example, one school we  surveyed stated that HHS officials told them that 2 percentage points  would be the most that their rate could increase over the previous  negotiated rate. The National Director of HHS’s Division of Cost Allocation  confirmed that a limitation on the increase in negotiated rates of   2 percentage points had been the practice in one of the DCA field offices.  Once this matter was brought to the attention of the National Director of  HHS’s Division of Cost Allocation, he ordered that the practice be  discontinued both to ensure consistent treatment across field offices and  because it was not a practice supported by policy or regulation. For  schools with DOD as their cognizant rate-setting agency, none of the 15  sampled schools identified negotiation that was not clearly tied to specific  aspects of their rate proposal as a part of their explanation of the  difference between their proposed and negotiated rates. When DOD was  the cognizant rate-setting agency, school officials generally indicated the  difference between the rate proposed and negotiated resulted from  disagreements with DOD over specific costs or methodologies used in  their rate proposal. For example, some schools said that DOD officials  made changes to the school’s proposed classification and allocation of  space to research. In addition to the findings from the survey, interviews  with school officials revealed that schools perceived that the reasons for  rate reductions varied depending on which agency the school negotiated  with. For example, in discussions with a group of senior-level university  research administrators, HHS negotiations were described as arbitrary,  whereas administrators negotiating with DOD stated that they clearly  understood why reductions were being negotiated. However, HHS officials  stated that their negotiations are not arbitrary. Prior to the negotiation,  HHS provides schools written documentation of its position that was  developed based on its review of facts included in the school’s indirect  cost rate proposal.
section_title: Differing Policies and Procedures Employed by the Cognizant Rate-Setting Agencies Are Factors That Contribute to Differing Rate Reductions for Each Agency
paragraphs: The differences between the proposed and negotiated rates based on  cognizant rate-setting agencies and schools’ perceptions of the reasons for  the rate reductions may be related to differences between the processes  employed by the two rate-setting agencies. For example, the two cognizant  rate-setting agencies express differing approaches to executing  responsibilities under Circular A-21 in terms of rate-setting goals. OMB  Circular A-21 states that the cognizant rate-setting agencies are  responsible for negotiating and approving indirect cost rates for schools  on behalf of all federal agencies. DOD policy on rate-setting for indirect  costs states that DOD is to implement relevant regulations (including OMB  Circular A-21) in a manner that “ensure uniform and consistent  treatment of indirect cost issues at all DOD cognizant institutions” and  DOD officials have stated that a broader goal is to ensure that DOD is able  to obtain high-quality research by reimbursing all allowable, allocable, and  reasonable costs. In contrast, HHS’s approach, as identified in its rate- setting mission, includes two components – being “fair, reasonable and  equitable when communicating and negotiating with the grantee  community” and having “a fiduciary responsibility to protect the public  funds.”
HHS and DOD use different processes for evaluating a school’s rate  proposal. DOD officials told us it generally performs audits of its indirect  cost proposals to validate costs enumerated in the proposal. HHS does not  generally perform an audit of indirect cost proposals, but they review the  cost proposal data. HHS officials stated that the findings from the review  are used as the basis for their negotiation with a school.
The frequency with which the two cognizant rate-setting agencies approve  predetermined and fixed with carry-forward rate types also varies.  Although both cognizant agencies expressed a preference for negotiating  predetermined rates, in part due to the burden associated with carry- forward adjustments, in our survey 5 out of the 15 DOD schools negotiated  fixed with carry-forward rates, while no more than 1 percent of schools  with HHS as their rate-setting agency did.
The year on which a school based its proposal for 2007 rates also varied by  the cognizant rate-setting agency, with schools negotiating with HHS  using, on average, earlier base years than those negotiating with DOD. In  addition, while none of the 15 DOD schools we surveyed used a base year  prior to 2002 to negotiate 2007 rates, about 17 percent of HHS schools did.  Further, schools that reported an early base year (2001 or earlier)  negotiated an average rate of 6.5 percentage points below their proposed  rate, compared to a 3.6 percentage point rate reduction for schools with  more recent base years. The interaction between cognizant rate-setting  agency, base year, and the degree of rate reduction may relate to the  different policies the two agencies have related to extending rates. DOD  officials stated that DOD does not allow extensions, whereas HHS policy  allows for an extension of an existing rate agreement in some  circumstances. HHS granted extensions to some of the schools included in  our survey and, according to HHS officials, many of the extensions were  granted with associated reductions in the rate, ranging from half a  percentage point to 2.5 percentage points. This may account for some of  the rate reduction observed at these schools.
Our findings on different approaches used by the cognizant rate-setting  agencies are similar to our findings of nearly 20 years ago. Specifically, in  1992, we reported that different approaches used by the two cognizant  rate-setting agencies resulted in variation in negotiated rates. We found  that DOD’s approach generally provided for full recovery of claimed  allowed indirect costs, whereas HHS’s approach generally resulted in  limiting the federal reimbursement of indirect costs. At the time, we  reported that the average rate negotiated by DOD was about 59 percent,  whereas the average rate negotiated by HHS was about 50 percent. For our  fiscal year 2007 survey data, proposed rates averaged 53.4 percent for  schools assigned to HHS and 51.7 percent for schools assigned to DOD.  Negotiated rates averaged 49.1 percent for HHS schools and 51.6 percent  for DOD schools. In both cases, the averages did not vary between the two  cognizant rate-setting agencies by a statistically significant amount.  However, the different approaches identified in the 1992 report are  consistent with the different processes we found today.
section_title: The Utility Cost Adjustment Is Linked to Schools That Propose and Receive Higher Rates, but Is Not Clearly Associated with Current Utility Costs
paragraphs: The utility cost adjustment—a 1.3 percentage point increase in the  negotiated indirect cost rate—is linked to institutions with higher  proposed and negotiated indirect cost rates. The utility cost adjustment  was implemented in 1998 to replace a system of special utility cost studies.  It was made available to 65 institutions identified in Exhibit B of OMB  Circular A-21, based on whether they had submitted a special study in  their most recent indirect cost rate proposal. Schools on the list receive  this adjustment in addition to the utilities portion of indirect costs that a  school negotiates based on its proposal. In fiscal year 2007, the average  negotiated rate for schools that reported receiving the utility cost  adjustment was 54.7 percent and the average for those reporting not  receiving the utility cost adjustment was 47.6 percent.
Although OMB Circular A-21 states that, beginning in July 2002, federal  agencies must reevaluate periodically the eligibility of institutions to  receive the utility cost adjustment, no changes have been made to the list  since the utility cost adjustment was implemented in 1998. Also, OMB  Circular A-21 states that federal agencies may receive applications for use  of the utility cost adjustment from schools not on the list. An OMB official  stated that OMB considers the list of utility cost adjustment recipients to  be final for the time being, and the eligibility list has remained unchanged  since 1998. The official also told us that OMB has not been asked to  reassess the utility cost adjustment by federal agencies. DOD and HHS  officials responsible for rate-setting reported that schools have requested  to be added to the eligibility list; however, these officials also stated they  were unclear on what the process should be for receiving and approving  applications for use of the utility cost adjustment.
section_title: Administrative Cap Generally Limits Reimbursement, but the Effects of DOD Basic Research Cap Are Unclear
paragraphs: The limitation on government reimbursement of administrative costs  affects most schools. Based on our survey results, about 83 percent of  schools had fiscal year 2007 administrative costs above the administrative  cap, with a reported average administrative rate component of 31 percent.  The cap was established in 1991 with the intent of limiting federal  reimbursement for schools’ indirect costs. When the cap was originally  proposed in 1986, it was established at 26 percent for that year for the  administrative portion of indirect costs because it was the 5-year average  administrative cost reimbursement rate for all major universities. OMB has  not formally reexamined this cap since its implementation in 1991. In  survey responses and interviews, school and association officials reported  that growing administrative costs were associated with modern research  and complying with federal regulations. Some government officials also  attributed the potential increase to federal regulations, particularly those  enacted since September 11, 2001.
The administrative cap limits reimbursement of indirect costs in different  ways than the DOD basic research cap. For example, whereas the  administrative cap is applied to a school’s negotiated indirect cost rate and  limits reimbursement of administrative costs on all federal awards to the  school, the DOD basic research cap is applied at the close of an award and  limits reimbursement only on DOD-funded basic research awards. We  estimate the DOD basic research cap may affect some awards at about 22  percent of schools, based on schools’ negotiated indirect cost rates for  fiscal year 2008. It is difficult to pinpoint the extent to which the DOD  basic research cap limits indirect cost reimbursement at a school in part  because it operates differently than the guidance for rate-setting and  reimbursement familiar to schools, as outlined in OMB Circular A-21. For  example, unlike for the administrative cap, the DOD basic research cap’s  impact cannot be determined up front on an institution-wide basis because  its limitation on indirect costs depends on the types of costs included in  each individual award. In addition, the cap’s impact cannot be fully  determined until total costs for an award are known, making it difficult for  schools to know up front whether their reimbursement will be limited for  a given award. These differences between the DOD basic research cap and  the rate-setting and reimbursement structure familiar to schools under  Circular A-21 may contribute to confusion reported by schools about how  the cap is applied to awards.
subsections: section_title: The Cap on Administrative Costs for Research Limits Reimbursement at Most Schools
paragraphs: The administrative cap limits reimbursement at most schools. An  estimated 83 percent of schools reported administrative costs that were  higher than the 26 percent administrative cap. During the rate-setting  process, schools generally provide cost information in their proposal that  identifies the administrative component of their indirect cost rate based on  their total administrative costs, regardless of the 26 percent cap. These  rate components averaged 31 percent in fiscal year 2007, which represents  an average 5 percentage point difference between these proposed  administrative rate components and the cap at 26 percent.
The fact that about 83 percent of schools had administrative costs in fiscal  year 2007 higher than the administrative cap indicates that the cap  controls government costs through limiting reimbursement. The cap was  enacted in 1991 to stop abuses related to indirect cost reimbursement at  schools. In addition, the federal government acknowledged that indirect  costs were rising rapidly, and characterized the situation as problematic  and therefore in 1986 proposed what it considered to be a reasonable  ceiling on all administrative costs for that year. To determine the ceiling,  OMB used the 5-year average administrative rate component for all major  universities. OMB first proposed establishing the cap at 26 percent and  subsequently reducing the reimbursement rate to 20 percent after a year.  This further reduction was not included in the final revision of the circular,  but reflects the initial goal of controlling government costs even below the  average reimbursement rate for administrative costs. An OMB official  stated the agency believes that over time the administrative cap has forced  the schools to be more efficient with their administrative effort and to be  more disciplined in spending. OMB has not reopened the administrative  cap issue since its implementation because they have not seen evidence  that this is a priority issue.
According to school and association officials we spoke with,  administrative costs have been rising over time. They attribute these  changes, in part, to increased federal regulations, such as regulations  related to national security standards, human subjects and animal care, as  well as reporting and audit requirements, having large impacts on their  indirect costs. However, school and association officials were unable to  provide an estimate of the increased costs associated with federal  regulations. In response to these regulations, schools we surveyed report  taking a number of actions that have raised administrative costs. These  include the following:    hiring new staff to, for instance, report data on grants and subrecipient    opening new offices to monitor compliance with federal regulations,  implementing new information technology systems,    developing processes for improving security and safety, and  training staff on new systems and compliance efforts.
In order to respond to the government’s research needs with respect to  complex research topics, such as nanotechnology, some schools we  surveyed report making investments in research capabilities which could  require hiring personnel to manage programs in new or upgraded facilities.  Schools claim these indirect costs may not be fully reimbursed because of  the administrative cap. Since the implementation of the administrative  cap, some schools tell us they have had to identify additional sources of  funding to conduct the research. When asked how they bridge the gap  between actual administrative costs and the reimbursement from the  federal government for administrative costs, school officials offered  examples including the use of funds from university endowment and  investments, and student tuition.
Some government officials have also observed increasing administrative  costs over time. For example, HHS officials who review indirect cost rate  proposals told us they have seen a trend of increasing administrative costs  reflected in schools’ rate proposals. These officials attributed the  increased administrative costs to federal regulations such as post-9/11  regulations related to security standards and foreign students that have led  schools to spend resources on security clearances, student visas, and  other screening efforts. Despite reported increasing administrative costs  and related under-reimbursement, some DOD officials who are  responsible for awarding basic research told us that schools continue to  compete for federal research awards and produce the research that meets  the government’s needs.
section_title: The Administrative Cap and the DOD Basic Research Cap Limit Reimbursement for Schools in Different Ways
paragraphs: The administrative cap and the DOD basic research cap limit government  reimbursement of indirect costs in distinct ways, as shown in table 2  below. Whereas the administrative cap limits reimbursement of  administrative costs specifically, the DOD basic research cap limits  reimbursement of all indirect costs for an applicable award. Additionally,  the design of each cap differs in terms of when the cap is calculated, what  entities and awards the cap applies to, and what cost base is used to  calculate the cap’s impact.
The differences in the way the caps limit reimbursement also means each  cap’s impact may differ and cannot be compared to the other.
section_title: The Cap on Indirect Costs for DOD Basic Research May Limit Reimbursement for Some Schools, but the Extent That Reimbursement Is Limited Is Difficult to Determine
paragraphs: Approximately 22 percent of schools had a fiscal year 2008 indirect cost  rate high enough for awards to be potentially limited by the 35 percent cap  on indirect costs of DOD basic research awards. While the legislative  intent for including this cap in certain defense appropriations acts is  sparse, House Report 110-279 for the Department of Defense  Appropriations Bill, 2008 indicated that overhead costs had grown to  unwarranted levels, and the House Committee on Appropriations  recommended that DOD limit the percentage of overhead costs that would  be reimbursed for basic research awards. Because the cap could have  affected only some of the fiscal year 2008 awards at about 22 percent of  schools, the scope of its effect might have been limited.
It is difficult to determine the extent to which the DOD basic research cap  will affect schools in part because its key features differentiate it from the  rate-setting and reimbursement structure outlined in OMB Circular A-21,  the guidance familiar to schools. The DOD basic research cap limits  reimbursement of indirect costs as a proportion of total award costs,  instead of MTDC, which has two important outcomes on the way its  impact is determined. First, the final impact on reimbursement cannot be  determined until total costs are tallied. Second, the cap’s limitation  depends on the types of costs included in each individual award, and  therefore its impact cannot be determined up front on a schoolwide basis.  Moreover, because the cap uses a base of total costs instead of MTDC, the  cap is not structured in the same way as an indirect cost rate.  Consequently, the cap at 35 percent of total award costs does not require  schools to negotiate an indirect cost rate below 35 percent. However, in  our survey we found that some schools mistakenly perceived they would  be affected by the cap if their negotiated indirect cost rate was above   35 percent. For example, two schools stated that the 35 percent rate cap  was lower than their indirect cost rates of approximately 50 percent, and  therefore they believed the cap would decrease their reimbursement. In  another example, a school with a 45 percent indirect cost rate stated the  cap at 35 percent of indirect costs would result in a 10 percent reduction  in recovery of indirect costs on each of their awards. These schools  misunderstood how using a base of total costs instead of MTDC makes the  cap different than their indirect cost rates. In fact, none of the schools in  the examples stated above would be affected by the cap, because their  negotiated indirect cost rates were below 53.8 percent, a mathematically  determined threshold below which no school is affected by the cap.
The 53.8 percent indirect cost rate at which awards may begin to be  affected by the DOD basic research cap is a minimum and does not mean  that all awards above this rate will be affected by the cap. Multiple schools  may have the same indirect cost rate above this threshold, but each school  may experience different effects from the cap, depending on the  proportion of direct costs that are excluded from the MTDC base for each  individual award. For example, we looked at a DOD award for each of two  schools in our survey that had indirect cost rates of 57 percent in fiscal  year 2007. One of the awards was for research on laser technology at a  large private school. The other award was for research on prostate cancer  at a smaller private school. With an indirect cost rate of 57 percent, if more  than about 6 percent of the total direct costs are excluded from MTDC,  reimbursement on an award is not limited by the DOD basic research cap.  Only one of the two sample awards would have been limited by the DOD  basic research cap because of the level of exclusions for the award. The  affected award—research on prostate cancer at the smaller school—had  no total direct costs excluded from its MTDC, making the proportion of  indirect costs to total costs above 35 percent. The award for laser  technology research at the larger school had more costs (9 percent)  excluded from its MTDC, and therefore the proportion of indirect costs to  total costs was below 35 percent. The higher the percentage of costs  excluded from an award’s MTDC, the less likely the award would be  affected by the DOD basic research cap. Whether the DOD basic research  cap limits reimbursement depends on the level of an award’s exclusions;  therefore, it is difficult for a school to pinpoint and predict the effects of  this cap on a schoolwide basis.
section_title: The Three Methods DOD Uses to Oversee Reimbursement of Indirect Costs to Schools Have Weaknesses
paragraphs: DOD identified three methods it uses to oversee indirect cost  reimbursement for research grants awarded to schools: the annual single  audit, the award closeout process, and agency audits, performed by DCAA  or by cognizant agencies for audit. However, we identified weaknesses in  DOD’s use of each of these methods. DOD relies primarily on the single  audit, but some schools we reviewed were not individually audited as a  part of the single audit. The second method identified by DOD, the  closeout process, is conducted by DOD administrative grants or  contracting officers using various processes. However, DOD officials told  us they do not verify mathematically if the correct indirect cost rate and  dollar amount was charged at grant closeouts. The third method, audits by  DCAA or by cognizant agencies for audit, covered only a limited number of  the schools in fiscal year 2008, and cognizant agencies for audit had  inconsistent approaches to auditing the awards of other agencies, with  only HHS conducting a limited number of audits on DOD awards. At least  one of the three methods was used in fiscal year 2008 at 25 of the 32  schools we reviewed. However, 4 schools were not covered by any of the  three methods, indicating a gap in coverage (see table 3).
In our discussions with cognizant agencies for audit, we learned that HHS  has increased the audits of research awards to schools in recent years,  which have led to some significant findings of improper billings of indirect  costs.
subsections: section_title: Some Schools Are Not Individually Audited under the Single Audit, DOD’s Primary Method for Overseeing Reimbursement of Indirect Costs
paragraphs: DOD reports that its primary method for overseeing compliance with  indirect cost reimbursement on research grants is the annual single audit  under the Single Audit Act, as amended. The Single Audit Act adopted a  single audit concept to help meet the needs of federal agencies for grantee  oversight and accountability as well as grantees’ needs for single,  uniformly structured audits. The act was intended to promote sound  financial management with respect to federal awards administered by  nonfederal entities. An audit performed in accordance with the Single  Audit Act is directed at operations of an entire entity. While the auditors  must conduct audit procedures that address particular compliance  requirements as they apply to specific federal programs identified by the  auditors as high risk, the Single Audit Act does not require that auditors  test all federal programs administered by an entity for compliance with all  related requirements. For a large and complex organization such as a  state government or a university system, the auditors examine selected  federal programs administered by the entity based on guidance in OMB’s  Circular No. A-133 Compliance Supplement.
OMB’s Compliance Supplement identifies the compliance requirements  relevant to audits that are applicable to the major programs, including  research and development, and provides suggested audit procedures for  testing compliance with those requirements, including sampling. The  Compliance Supplement includes a section on testing for allowable costs,  including allowable indirect costs, and the auditor may sample a certain  number of transactions (claims for reimbursement) from federal awards.  Table 4 below shows the indirect cost audit objectives provided by the  Compliance Supplement for use by auditors for federal awards selected  for audit.
For single audit reporting purposes, the parameters of the reporting can  differ from one school or school system to another. As a result, in some  cases individual educational institutions are considered separate entities  and audited separately, while in other cases they may be audited as a part  of a university system, or even as a part of an entire state government,  which includes numerous institutions or agencies within the reporting  entity.
The fact that the single audit may not be sufficient to provide assurance  that an entity is in compliance with requirements for indirect costs  charged to research and development grants was reflected in our findings.  In 2008, no research and development awards or transactions were  selected for review at 7 of the 32 schools we reviewed. For 6 of these  schools no research and development awards or transactions were  selected because the schools were a part of larger reporting entities and  the auditors told us that the research and development program from  other schools within the larger reporting entity were selected for audit in  2008. Each of the 6 schools was either a campus at a major public  university and the entity was defined at the university-wide level, or the  entity was defined at the statewide level and the school was included  under the umbrella of the state. However, in terms of receiving federal  awards, each school functioned independently by, for example,  negotiating an indirect cost rate agreement with the federal government  that was only applicable to that school. Further, based on data from the  National Science Foundation, each of these schools received more than  $97 million in federal research and development funding in 2007, an  amount much greater than the $500,000 threshold over which an entity is  required to receive a single audit. For example, the University of California  (UC) was defined as one entity subject to the single audit, although each  of its 10 campuses and the Office of the President separately negotiate an  indirect cost rate agreement. In 2008, no research and development  awards or transactions were sampled for any of the 4 UC campuses  included in our 32 schools, including UC campuses at Berkeley, Los  Angeles, Santa Barbara, and San Diego, because the University of  California is defined as one entity. Similarly, in 2008 the University of  Virginia was defined as a part of the Commonwealth of Virginia for the  purposes of the single audit, although the university negotiates its own  indirect cost rate agreement with the federal government. Because the  university falls under the umbrella of the state as an entity, in 2008 no  research and development awards or transactions were selected from the  university for the single audit. Table 5 breaks down how many of the 32  schools that we reviewed had awards or transactions selected as a part of  the single audit in 2008, and how many did not.
Furthermore, as shown in figure 10, based on data provided by  independent public accounting firms, few awards were sampled as a part  of the annual single audit in 2008, and even fewer DOD awards were  included in the sample. Specifically, for the 22 of the 32 schools where  research and development awards were sampled as a part of the 2008  single audit, the average number of total awards sampled was 21 awards,  and the average number of DOD awards sampled was 5. Also, the  percentage of total federal award dollars sampled for the annual single  audit ranged from 0.5 to 36 percent, and the DOD award dollars sampled  represented between 0.1 and 65 percent of all federal award dollars.
section_title: DOD Does Not Use the Grant Closeout Procedure to Determine Whether Indirect Cost Charges Were Correct
paragraphs: DOD also reported that it uses the award closeout procedure—part of the  postaward administration process conducted on an award after its period  of performance has ended—for overseeing indirect cost reimbursement to  schools. According to DOD, for grants to schools, postaward  administration responsibilities are generally delegated to administrative  grants or contracting officers at DOD’s ONR. As a part of award closeout,  an ONR administrative grants or contracting officer reviews the costs  incurred under a given award to determine whether all costs are  allowable, allocable, and reasonable. According to DOD officials, an  administrative grants or contracting officer may also request an evaluation  of a final voucher be conducted. To facilitate a financial review, schools  fill out a final financial status report within 90 days of the end of the period  of performance, which is to be reviewed and approved by the  administrative grants or contracting officer. The Standard Form 425, or the  “Federal Financial Report”, is used for the final financial status report and  includes a section for recording indirect costs charged by the school on  the award.
DOD officials at ONR asserted that they use the award closeout procedure  as a method for overseeing indirect cost reimbursements. However, DOD  administrative grants and contracting officers told us that they do not  regularly use the closeout procedure to determine whether or not the  dollar amounts of the indirect costs charged were correct. For example,  DOD administrative grants and contracting officers at two ONR regional  locations and two other DOD service locations that provide contract  administration services for school awards informed us they did not  regularly check indirect costs to determine if they were accurately  charged, even though we found that they can use information related to  indirect costs provided by awardees in the indirect expense section of the  Federal Financial Report to do so. OMB officials told us that, at a  minimum, awards officers are to use information in the Federal Financial  Report at award closeout to determine whether or not the correct indirect  costs were charged to the government. However, the Federal Financial  Report Instructions by OMB on completing the Indirect Expense section  of the form says to complete this section only if required by the awarding  agency and in accordance with agency instruction. According to DOD  officials, this section may or may not be required by DOD awarding  agencies and it is not the current practice of DOD administrative grants or  contracting officers that we spoke with to use information in the Indirect  Expense section to mathematically calculate if indirect costs were  accurately charged.
While ONR administrative grants and contracting officers stated they do  not use information entered in the Federal Financial Report to verify that  indirect costs were charged accurately on a particular award, ONR does  use information in the form’s Indirect Expense section, and other  information in the form, to determine whether or not a school charged  indirect costs at or below the DOD basic research cap of 35 percent of  total costs. For example, at the two regional ONR offices we visited, the  administrative grants and contracting officers informed us that ONR  developed a form that incorporates data from the Federal Financial Report  for use in determining whether or not an awardee receiving DOD basic  research funds was below the cap of 35 percent of total costs. If the  percentage is over the 35 percent cap, then the awardee is responsible for  paying back to the awarding DOD agency the amount of the  reimbursement over the limit.
section_title: DCAA Audited a Limited Number of Schools We Reviewed and Cognizant Agencies for Audit Have Differing Practices for Overseeing Indirect Cost Reimbursement of Other Agencies’ Awards
paragraphs: The third method DOD identified to oversee reimbursement of indirect  costs on its research grants was audits conducted by DCAA or by  cognizant agencies for audit. DCAA and HHS in its role as a cognizant  agency for audit conducted audits of DOD awards at some of the 32  schools in fiscal year 2008, but DCAA’s coverage of the schools was  limited and the practices of the various cognizant agencies for audit  differed.
DCAA performs audits of DOD awards, generally on contracts but also  grants. DCAA’s audit types include pre-award audits (such as an audit of a  proposal), postaward evaluations or audits (such as an evaluation of a  final voucher, or an incurred cost audit of an institution), and system  audits (e.g., an audit of an institution’s billing system or accounting  system). For audits related to reimbursement of indirect costs, for  example, a DOD administrative grants or contracting officer may request  that DCAA conduct an audit of a school’s final incurred cost submission or  an evaluation of a final voucher on an individual award.
In fiscal year 2008, DCAA performed a total of 88 audits or evaluations at  10 of the 32 schools that accounted for more than half of fiscal year 2007  DOD basic research funding. Approximately one-third of the audits and  evaluations performed were conducted at 1 of the 10 schools (see table 6  below). We asked the DCAA Chief in the Policy Programs Division whose  areas of responsibility include audits of schools to identify which types of  audit services would include a check on indirect costs. Based on the  official’s descriptions of the audit services, about two-thirds of the audits  were of the type where indirect costs were a main purpose, about a third  of the audits were audit types where indirect costs were not the subject of  the audit but were tested as a part of the basis of the audit opinion, and 3  of the 88 audits were types of audits that typically do not test indirect  costs. Of note, 38 of the 88 audits were of the type conducted prior to an  award, for example, an audit of a proposal. In some cases, an audit that  takes place prior to an award may not oversee compliance with  reimbursement of indirect costs since the costs have not yet been  incurred.
In addition to performing DCAA audits, DOD officials noted that DOD  awards to schools may be audited by other agencies, in particular when  another agency is designated the role of cognizant agency for audit for that  school. Award recipients expending more than $50 million in federal  funding are assigned a cognizant agency for audit in accordance with OMB  Circular No. A-133. Generally, the cognizant agency for audit is the federal  agency that provides the predominant amount of direct funding to a  recipient. Some of the responsibilities of the cognizant agency for audit  include coordinating audits by federal agencies of the school, performing  quality control reviews of audits by nonfederal auditors, and coordinating  a management decision for audit findings that affect federal programs of  more than one agency.
We determined that there were four cognizant agencies for audit  (including DOD) for the top 32 schools we reviewed, and these agencies  differ in their practices for addressing other agencies’ awards. Of the four  cognizant agencies for audit, Education and NSF told us they have not  audited the awards of other agencies. HHS has a reimbursable audit  program administered out of its Office of Audit Services. The Office of  Audit Services establishes memorandums of understanding with other  agencies, including DOD, stating they will perform audits on a  reimbursement basis. Through the program, HHS retains its right, as the  cognizant agency for audit, to perform audits of DOD awards at DOD’s  request. In addition to conducting audits for the three schools in our  review for which it is cognizant, DOD reported that it, like HHS,  establishes memorandums of understanding with other agencies to  conduct audits of their awards. Circular A-133 requires, to the extent  practical, cognizant agencies for audit to coordinate audits or reviews  made by or for federal agencies in addition to the single audit.
Consistent with their stated practices, for the three cognizant agencies for  audit besides DOD included in our review, only HHS conducted audits of  DOD awards in fiscal year 2008. Specifically, HHS performed 12 audits of  DOD awards at 6 of the 32 schools we reviewed. These audits were  generally closeout or incurred cost audits on individual awards. Table 7  identifies the breakdown of cognizant agencies for audit for the 32 schools  and the audits conducted by each of these cognizant agencies for audit.
section_title: One Agency Reported Increasing Its Audit Activity in Recent Years to Oversee Compliance with Reimbursement on Individual Awards
paragraphs: HHS officials told us that in 2003, a lack of confidence in the single audit  and a significant increase in the amount of money awarded to schools led  the agency to seek other ways to oversee the reimbursement of research  costs. As a result they identified five areas where additional audits were  necessary including audits of administrative and clerical salaries, an area  that is associated with indirect costs.
HHS officials also told us that there have been significant findings in the  area of administrative and clerical salaries. For example, the HHS Office of  the Inspector General (OIG) conducted a review of administrative and  clerical costs at Duke University and found the school claimed an  estimated $1.7 million in unallowable charges by improperly billing  indirect costs as direct costs. The HHS OIG found that these unallowable  claims occurred because the school had not established adequate controls  to ensure consistent compliance with the federal requirements applicable  to charges for administrative and clerical costs. HHS officials also told us  they are currently undertaking a review of administrative and clerical  costs at another school as a follow-on to significant problems found during  a closeout audit of one of the school’s awards.
section_title: Conclusions
paragraphs: Inconsistencies in the rate-setting and reimbursement processes lead to  perceived and actual differences in the treatment of schools performing  DOD basic research. The difference between the proposed and negotiated  indirect cost rate varied based on whether a school negotiated with DOD  or HHS and leads schools to perceive unequal treatment, though  negotiated indirect cost rates were not different. Even though this is only a  perceived difference there are actual differences in how schools may be  defined for rate-setting purposes versus the oversight of cost  reimbursement purposes. Schools are treated differently in terms of the  oversight on their reimbursement of indirect costs because of the  flexibility in how the definition of a nonfederal entity is applied, in some  cases, creating a situation where a school that expends $500,000 or more  in federal funds may not be audited as a separate entity, but is included as  part of a larger entity. DOD does not effectively use the other methods to  oversee indirect costs when a school is not separately audited. As a result,  DOD lacks assurance that it is reimbursing indirect costs appropriately. In  addition, guidance for the indirect cost rate-setting and reimbursement  processes contains provisions that have been in place for a long time, but  are overdue to be reviewed and updated. Because the utility cost  adjustment eligibility is based on information that is 12 years old and  therefore does not necessarily reflect schools’ current costs, the OMB  guidance runs the risk of inadvertently providing benefits to some schools  and not others. Similarly, because the rate at which administrative cost  reimbursement is limited has not been reviewed since it was implemented  approximately 20 years ago, and administrative costs may have changed  over time, it is unclear whether the current limitation achieves the desired  balance between controlling government costs and sponsoring  government’s fair share of research costs.
section_title: Recommendations for Executive Action
paragraphs: To address different processes for negotiating rates by the two cognizant  rate-setting agencies for higher education institutions, we recommend that  the Director of OMB:  Identify methods to ensure that the rate-setting process is applied  consistently at all schools, regardless of which agency has rate cognizance.  This would include identifying ways to ensure that differences in  cognizant rate-setting agencies’ approaches, goals, policies, and practices  do not lead to unintended differences in schools’ rate reductions for  indirect costs.
To ensure that indirect cost reimbursement practices are consistent with  the current state of indirect research costs at schools providing federal  basic research, we recommend that the Director of OMB:    Clarify the roles and responsibilities of federal agencies (including DOD,  HHS, and OMB) in accepting applications and reevaluating the eligibility of  schools to receive the utility cost adjustment.
Reexamine and determine whether reimbursing administrative costs at a  maximum rate of 26 percent achieves the appropriate level of cost control  and achieves the government’s objective that the federal government bears  its fair share of total costs.
To improve DOD’s ability to oversee reimbursement of allowable indirect  costs to schools, we recommend that the Secretary of Defense direct that  the Under Secretary of Defense for Acquisition, Technology and Logistics:    Establish a process for administrative grants/contracting officers to verify  at grant closeout whether a school has requested reimbursement at the  accurate indirect cost rate and dollar amount, which includes calculating  whether the dollar amount reflects the appropriate application of rates for  that award.
Assess the current level of audit coverage for monitoring DOD indirect  cost reimbursement for schools and determine what level is sufficient and  whether to expand use of closeout audits and other audits to oversee  compliance.
Develop a policy for oversight of indirect costs that includes the use of  alternative oversight information (1) for those schools not individually  audited under the single audit, and (2) for those schools where the audit  coverage of research and development awards is not sufficient for  oversight of indirect costs.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to DOD, HHS, OMB, Education, and NSF  for review and comment.  In written comments, DOD generally agreed  with all three recommendations.  Specifically, DOD concurred with two of  the recommendations and partially concurred with the third.  DOD cited  short-term actions it planned to take to address some of the  recommendations.  For example, to address our recommendation that  DOD establish a process for verifying whether a school has requested  reimbursement at the accurate indirect cost rate and amount, DOD stated  it would require university recipients of research grants to complete the  field for indirect expenses on the final submission of the Federal Financial  Report and have postaward administrators conduct the recommended  verification on a sample of awards each year, using a risk-based  assessment.  While DOD concurred with our recommendation that DOD  assess the current level of audit coverage and determine what level is  sufficient, DOD did not identify any new actions it would take to do so,  relying instead on continued efforts.  Given our findings that there was  limited audit coverage by DCAA and cognizant audit agencies of DOD  grants, the intent of our recommendation was for DOD to identify  additional actions.  In response to our recommendation that DOD develop  a policy for oversight of indirect costs that includes the use of alternative  oversight information in certain circumstances, DOD partially concurred,  indicating it would look to identify alternative approaches, to the extent  DOD identifies insufficiencies in its oversight.  In this recommendation  and the others, DOD emphasized that seeking improvements so DOD can  continue to rely on the single audit to oversee compliance with  reimbursement of indirect cost reimbursement for grants is its preferred  approach.  However, while the single audit is a valuable tool, it may not  always be the right tool for DOD to ensure compliance with indirect cost  reimbursement for research grants.  In addition to written comments, DOD  provided technical comments, which we incorporated as appropriate.  The  department’s written comments are included in their entirety in appendix  II.
OMB provided oral comments, indicating they generally agreed with the  recommendations, and technical comments, which we incorporated into  the report as appropriate.  Education also provided technical comments,  which were incorporated into the report as appropriate.  HHS and NSF  had no comment.
We are sending copies of this report to the Secretary of Defense, the  Secretary of Health and Human Services, the Director of the Office of  Management and Budget, the Secretary of Education, the Director of the  National Science Foundation, and other interested parties. This report will  also be available at no charge on GAO’s Web site at http://www.gao.gov.
If you have any questions concerning this report, please contact me at  (202) 512-4841 or by e-mail at needhamJK1@gao.gov. Contact points for  our Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. Other staff making key contributions to this  report were Penny Berrier Augustine, Sharron Candon, Pamela Davidson,  Morgan Delaney Ramaker, Anne-Marie Fennell, Art James, Janet  McKelvey, Ruben Montes de Oca, Amy Moran Lowe, Susan Neill, Kenneth  Patton, Angela Pleasants, Scott Purdy, Mark Ramage, Sylvia Schatz, and  Suzanne Sterling.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: The objectives of this study were to examine the following issues related  to higher education institutions performing basic research for the  Department of Defense (DOD): (1) the variation in proposed and  negotiated indirect cost rates and factors that may contribute to  variations; (2) how and to what extent the administrative cap and the DOD  basic research cap limit reimbursement of indirect costs; and (3) the  methods DOD uses for overseeing compliance with indirect cost  reimbursement for grants and the extent to which each method was used.
To identify the proposed and negotiated indirect cost rates of schools  performing basic research for DOD and factors that may contribute to  variation in the rates, we collected and analyzed information from a  probability sample of schools that performed basic research for DOD in  fiscal year 2007, according to DOD-provided data. Detailed information on  the survey is available below. We also interviewed government officials at  DOD and other government agencies on regulations and policies relating  to the reimbursement of indirect costs for research. This included  cognizant rate-setting officials in DOD’s Office of Naval Research and the  Department of Health and Human Services’ (HHS) Division of Cost  Allocation; DOD officials in offices awarding and overseeing basic  research, such as the Air Force Office of Scientific Research; the Army  Research Office; the Office of the Director, Defense Research and  Engineering; the Defense Threat Reduction Agency; and the Defense  Advanced Research Projects Agency; and regulatory officials overseeing  indirect cost policy in the Office of Management and Budget (OMB).  Through interviews with these officials, we obtained views and  documentation on the indirect cost process and on factors that they  believed might contribute to variation in rates. In addition, we spoke with  representatives of the academic community to obtain information on their  perspectives on the indirect cost rate-setting process and to better  understand the information that would be available through our survey.  These representatives included university faculty and research  administrators, as well as associations representing the research  community, including the Association of American Universities (AAU), the  Council on Government Relations (COGR), the Association of Public and  Land-grant Universities, and the Federal Demonstration Partnership.  Through these interviews, we obtained perspectives on factors that they  believed might contribute to variation in rates and information on the  impacts of federal regulation on the research community. Finally, we  reviewed reports and documentation pertaining to indirect cost regulation,  policies, and processes, most notably OMB Circular A-21, governing  school indirect cost reimbursement, but also including cognizant rate- setting agency process documentation, past GAO reports, and reports on  indirect costs by other organizations, such as the RAND Corporation and  Arthur Andersen.
To determine how and to what extent the administrative cap and the DOD  basic research cap limit reimbursement of indirect costs at higher  education institutions performing DOD research, we collected and  analyzed information from a probability sample of schools that performed  DOD basic research in fiscal year 2007, according to DOD-provided data  (see detailed survey information below). We also interviewed government  officials at OMB and at the cognizant rate-setting agencies on regulations  and policies relating to the application of caps to indirect cost rates.  Through interviews with these officials, we obtained views on how the  caps were developed and their perspectives on how the selected caps may  affect research institutions. In addition, we spoke with representatives of  the academic community to obtain information on their perspectives on  the selected caps and to better understand the information that would be  available through our survey. These representatives included university  faculty and research administrators, as well as associations representing  the research community. Through these interviews, we obtained  information on the impacts of selected caps on the research community,  as well as information about what information would be available to  evaluate these impacts. Finally, we reviewed documentation pertaining to  selected indirect cost caps, including OMB Circular A-21, the Department  of Defense Appropriations Act, 2008, and legislative and regulatory  histories related to the caps.
To determine the methods DOD uses to oversee indirect cost  reimbursement on grants, we interviewed DOD officials at the office of the  Director, Defense Research and Engineering and the Office of Naval  Research (ONR). To identify the extent to which each of the three  methods identified by DOD was used, we focused on the 32 schools  representing more than half of DOD’s fiscal year 2007 basic research  obligations, based on DOD data. We obtained information about the extent  to which these methods are used from DOD, independent public  accounting firms conducting the annual single audit, higher education  institutions, cognizant agencies for audit, and previous reports by GAO  and others. We also interviewed officials at DOD, OMB, HHS, the National  Science Foundation and the Department of Education, as well as  independent public accounting firm representatives and higher education  representatives. To determine the extent to which the first method, the  single audit, was used, we collected and analyzed data provided by  independent public accounting firms, state auditors, and DCAA on their  sampling of research and development awards for the fiscal year 2008  single audit. To determine the extent to which the second method, the  grant closeout process, was used by DOD, we reviewed DOD  documentation and examples related to the various processes to closeout  a DOD basic research grant. For example, we reviewed examples of  financial information on a standard form that tracks the status of the  grant, including direct and indirect costs. We discussed with the DOD  award officers what and how the process and procedures and forms for  grant closeout check indirect costs to determine if these costs were  accurately charged during the award. In addition, we interviewed OMB  officials to determine the purpose of the Indirect Expense section of the  form developed by OMB, the Federal Financial Report (SF-425). To  determine the extent to which the third method, audits by DCAA and  cognizant agencies for audit, was used, we identified the agencies with  audit cognizance for the 32 schools we examined. We requested and  obtained information from the four agencies with cognizance for the 32  schools—NSF, Education, HHS, and DOD. In addition, we collected  information on the number and type of audits of DOD awards conducted  by DCAA and by HHS at schools in fiscal year 2008 related to indirect  costs. Through interviews with officials from the four agencies, we  obtained information and documentation related to their audit cognizance  programs. We also learned about school audit programs at one of the  cognizant agencies for audit and heard their views on why they no longer  rely on the single audit to oversee the reimbursement of indirect costs.
subsections: section_title: Survey Details
paragraphs: To address our first and second objectives, we designed and conducted a  mail-based survey of a sample of schools in the U.S. that received basic  research awards from DOD that were active in fiscal year 2007. The study  population consisted of all U.S.-based schools receiving more than  $100,000 in DOD funds to do basic research in fiscal year 2007. We  developed our sample frame from DOD-provided award-level data. After  excluding schools with $100,000 or less in DOD basic research dollars in  fiscal year 2007, there were a total of 343 schools in our population.
From this population, we selected a random sample of 178 schools,  stratified by total award dollars. The first stratum was comprised of the 32  institutions with the highest amount of DOD basic research award dollars  in fiscal year 2007, accounting for over 50 percent of the DOD basic  research dollars for that year. All of these 32 schools were selected in our  sample. From the remaining 311 schools in the second stratum, we  selected a random sample of 146 for our study. The population, sample,  and survey disposition by stratum is displayed in the following table.
Several of the sample schools were determined to be “out-of-scope” for the  purposes of this study. In particular, we determined that 13 of the  institutions selected in stratum 2 either did not receive basic research  awards in fiscal year 2007 (e.g. the award really was to a different  institution) or the research institution was not a university (e.g. the award  was to a university-affiliated nonprofit not subject to higher education  indirect cost rules). These schools were dropped from the analysis. Of the  178 selected institutions, we obtained useable responses from 144 for an  overall response rate of about 87 percent. The survey data were collected  from July 2009 to October 2009.
The survey was designed to collect information about a school’s indirect  cost rates and demographic information, as well as the university  administrator’s opinions on factors influencing the rates. Because we  followed a probability procedure based on random selections, our sample  is only one of a large number of samples that we might have drawn. We  express our confidence in the precision of our particular sample’s results  as a 95 percent confidence interval. This is the interval that would contain  the actual population value for 95 percent of the samples we could have  drawn. Unless otherwise noted, in this report estimates of indirect cost  rates based on our survey have 95 percent confidence intervals within   +/- 2 percentage points of the estimate itself. Estimates of the percentage  of schools with particular characteristics have 95 percent confidence  intervals within +/- 7 percentage points of the estimate itself. Estimates of  totals based on this sample are presented along with their corresponding  95 percent confidence interval in the report.
At each school, we also selected a nongeneralizable sample of one DOD  research award with over $10,000 of activity in fiscal year 2007 and  requested award and reimbursement data pertaining to that year of the  award.
Where appropriate, we followed up on unclear answers by calling the  school-identified key contact at the sampled institutions for clarification.
Each school in our sample can have multiple proposed and negotiated  indirect cost rates, for a number of categories of rate agreements (e.g., on- campus organized research, off-campus organized research, instruction, or  other sponsored activities). Unless otherwise specified in this report,  estimates relating to proposed or negotiated rates are limited to the rate  that is associated with on-campus organized research. We focused on this  rate because it represents a comprehensive measure of indirect costs for  research to be reimbursed by the federal government, including both  facilities and administrative costs.
In our questionnaire, we asked the university administrator to provide the  proposed indirect cost rate applicable to fiscal year 2007, along with the  elements of that proposed rate (the portions for facilities, administration,  and carry-forward). Throughout our report estimates related to the  proposed fiscal year 2007 indirect cost rates are not based on the  proposed rate provided by the school. Instead we calculated each school’s  proposed rate based on the information in the survey responses.  Specifically, the GAO version of the proposed rate is the sum of the fiscal  year 2007 proposed facilities component of indirect cost rate, the carry- forward, and the lesser of the proposed administrative component or 26  percent. We used this as the proposed rate for our analysis to ensure  proposed rates were comparable across schools.
In addition to sampling error, the practical difficulties of conducting any  survey may introduce nonsampling errors, such as nonresponse bias or  measurement errors. We took steps in developing the questionnaire,  collecting the data, and analyzing the data to minimize such errors.
To gain an initial understanding of the information reasonably available  from schools about their research costs, as well as their thoughts on  factors that may influence a school’s indirect cost rate, we reviewed  regulatory documents pertaining to indirect cost rates, particularly OMB  Circular A-21, and interviewed officials from government agencies,  including rate-setting officials from HHS’s Division of Cost Allocation and  DOD’s Office of Naval Research. We also spoke with university research  administrators and representatives of associations representing the  interests of research institutions and reviewed past GAO reports and  analysis by other organizations to identify possible influencing factors.
We pretested our survey instrument with six schools to determine if the  questions were clear, if the survey questionnaire placed an undue burden  on schools, and to determine the sources of information schools would  use to answer the questions. The information learned through the pretests  was used to refine the survey.
To ensure the best possible response rate, we contacted individuals from  each sampled school via telephone to identify the person most qualified to  answer our survey questions and to confirm the mail, phone, and e-mail  information for that individual.
After revising the survey to incorporate pretest comments and identifying  the best survey contact, we mailed the survey to sampled schools and  followed up with nonrespondents by e-mail and telephone to encourage  their responses, and we followed up with survey respondents to clarify  unclear or unlikely responses.
We conducted this performance audit from October 2009 to September  2010 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
section_title: Appendix II: Comments from the Department of Defense
section_title: Appendix III: Detailed Analysis of Factors
subsections: section_title: 10-Year Trend in Negotiated Rates
paragraphs: Analysis of average negotiated rates across a 10-year period indicates that  these rates have remained generally stable over time. The average  negotiated rate across schools increased by less than a percentage point in  total over the 10-year period, from 48.4 percent in 1999 to 49.3 percent in  2008.
section_title: Variations in HHS Cognizant Rate-Setting Agency Field Offices
paragraphs: Schools perceive different HHS Division of Cost Allocation (DCA) field  offices as using differing and inconsistent practices for negotiating rates.  For example, university officials GAO interviewed described negotiations  with the New York office as less arbitrary, whereas they described  “unwritten rules” to limit reimbursement at the Dallas office. While we did  not examine the particular practices at DCA field offices, our survey  results indicate there was not a significant difference in negotiated rate  reductions across these offices. Specifically, average rate reductions  negotiated by each of DCA’s four field offices are all relatively close to one  another, and HHS described processes that it uses to ensure consistency  across the field offices.
Variation in schools’ proposed and negotiated rates based on the DCA field  office with which a school negotiates may be driven more by geographic  factors than by the specific actions of the offices. Schools proposed and  negotiated significantly higher rates to the New York field office (with an  average proposed rate of 60.6 percent and an average negotiated rate of  55.9 percent) than those rates proposed to and negotiated by the other  DCA field offices (average proposed rates in the other three regions all fall  between 51 and 52 percent and average negotiated rates in the other three  regions all fall between 46 and 48 percent). This result is consistent with  similar findings for average rates based on the school’s geographic region,  regardless of the cognizant rate-setting agency. Specifically, schools in the  Northeastern region negotiated an average rate of 56.4 percent, with all  other regions falling near 48 percent. According to the Bureau of Labor  Statistics the cost of goods and services, measured by things such as  housing, health care, fuel, and utilities, varies by region, and the Northeast  region is generally higher than other regions.
section_title: Variation between Schools Receiving Different Amounts of DOD Funding
paragraphs: On average, schools receiving the largest proportion of DOD basic  research money proposed and negotiated higher rates than those schools  with a smaller DOD basic research volume. For fiscal year 2007, more than  half of DOD’s basic research funding was obligated to just 32 schools, all  of which were included in GAO’s survey sample. These schools proposed  an average rate of 57.3 percent and negotiated an average rate of 53.0  percent. For the remaining schools in the population, the average  proposed rate was 52.5 percent and the average negotiated rate was 48.8  percent. These differences may be related more generally to the size or  research-intensive nature of the schools.
section_title: Variation between Schools Receiving or Not Receiving a Separate DOD Contract Rate
paragraphs: Another factor that may be related to the amount of funding received is  whether a school negotiated a separate rate for DOD contracts that allows  for reimbursement of an administrative component without the standard  26 percent cap. Schools negotiating such a rate, on average, proposed  higher indirect cost rates (i.e. for awards other than DOD contracts) than  those schools that did not—57.5 percent versus 52.6 percent. A similar  relationship held true for negotiated rates, with schools negotiating a  separate DOD contract rate receiving an indirect cost rate of 53.0 percent,  compared to 48.9 percent for schools not negotiating a separate rate. One  of the main reasons schools provided for not negotiating a separate DOD  contract rate was that they did not have enough research volume in DOD  contracts to make it worthwhile. Consequently, this difference in  estimated rates may be driven by higher overall rates at schools doing  more research for DOD that are more likely to find value in a separate  DOD contract rate.
section_title: Variations between the Negotiated Rate and the Rate Applied to an Individual Award
paragraphs: Based on survey responses, there was generally not much variation  between the negotiated rate and the rate applied to a specific DOD basic  research award. As part of GAO’s survey, data were collected on a  nongeneralizable selection of one DOD award from each of the schools  surveyed. Most schools reported that the rate applied to the selected  award was their negotiated fiscal year 2007 rate. However, about one-third  of schools reported that in 2007 a reimbursement rate other than their  negotiated fiscal year 2007 rate was applied to the award on which GAO  requested information. When there was a variation the primary reason  schools identified for the difference was the OMB guidance that requires a  school to use the rates negotiated at the time of an award throughout the  life of that award, known as the “fixed for the life of the award provision.”  For example, one such school reported a fiscal year 2007 negotiated rate  of 55.5 percent, but indicated that the selected award was reimbursed at a  rate of 54.0 percent, representing the school’s negotiated rate in fiscal year  2003 when the award was initiated.
section_title: Factors
paragraphs: Tables 9 and 10 contain a list of the factors GAO analyzed to identify  which ones may contribute to variations in proposed indirect cost rates,  negotiated indirect cost rates, and the difference between proposed and  negotiated indirect cost rates. In addition to those discussed in the body of  the report, we found statistically significant differences in relation to the  following factors:    Geographic region: Northeast region schools both proposed and  negotiated higher rates than other regions.
HHS DCA field office: Schools negotiating with the DCA Northeastern field  office both proposed and negotiated higher rates than other DCA regions.
Stratum: The 32 schools with the largest DOD research volume both  proposed and negotiated higher rates than the schools with smaller  research volume.
Type of institution: Private schools both proposed and negotiated higher  rates than public schools.
Negotiation of separate indirect cost rate for DOD contracts: Schools  negotiating a separate rate for DOD contracts both proposed and  negotiated higher rates for non-DOD-contract awards than schools that did  not negotiate such a rate.
Proposal cost type: The difference between the proposed and negotiated  rate was higher at schools using actual base year costs in their proposal  than at schools using projected costs.
section_title: Appendix IV: Survey Data for Standard Form Schools
paragraphs: The following data represent the responses of schools that reported using  the standard form for their indirect cost rate proposal in fiscal year 2007.  These schools receive more than $10 million in annual federal grants. In  this report we produce population estimates for the schools within the  United States that use the standard format, which we estimate would  correspond to about 263 schools.  All estimates based on this survey are  subject to sampling error. The 95 percent confidence interval for this  estimate is from 244 to 283 schools. Percentage estimates presented in this  appendix have 95 percent confidence intervals within +/- 7 percentage  points of the estimate itself, unless otherwise noted.
Dallas (Central)
New York (Northeastern)
San Francisco (Western)
Washington, DC (Mid-Atlantic)   percentage points of the  estimate itself.
Cost not allocable or allowable  Cost associated with cost sharing  Fixed for the life of the award provision   percentage points of the  estimate itself.
What F&A cost rates for organized research did your institution have for  FY1999 to FY2008 for federal grants and contracts?
section_title: Appendix V: Survey Data for Simplified Method Schools
paragraphs: Some schools submit their indirect cost rate proposals to the federal  government using a simplified method instead of the standard form. Each  of these schools’ total direct cost of work is no more than $10 million and  they are therefore considered small enough to use a simplified method of  proposing a rate. Our survey sample included schools that may have used  either the standard form or the simplified method for their rate proposal  for fiscal year 2007. The following data represent the responses of schools  that reported using the simplified method in fiscal year 2007. Because this  survey was not designed to produce reliable estimates for simplified  method schools, the 95 percent confidence intervals are wider than for  other survey estimates and are noted along with each table.
Dallas (Central)
New York (Northeastern)
San Francisco (Western)
Washington, DC (Mid-Atlantic)