Federal grants are forms of financial assistance from the government to a recipient for a particular public purpose that is authorized by law. Federal grant funds flow to the nonprofit sector in various ways, as shown in figure 1. Some grant funds are awarded directly to nonprofits, while others are first awarded to states, local governments, or other entities and then awarded to nonprofit service providers. Federal laws, policies, regulations, and guidance associated with federal grants apply regardless of how federal grant funding reaches the final recipients. Some federal grant programs contain statutory limits on administrative cost reimbursement for state and local government grantees. Additionally, some federal grant programs predetermine a limit for subgrantees (see table 1 for the statutory limits on the six grants we reviewed). OMB circulars A-87 and A-122 provide guidance to state and local governments and nonprofits on classifying costs as direct or indirect and direct state and local governments to employ the necessary management techniques in order to efficiently and effectively administer federal awards. OMB circulars A-87 and A-122 generally define direct and indirect costs as follows: Direct costs are those that can be identified specifically with a particular final cost objective, that is, a particular award, project, service, or other direct activity of an organization. Indirect costs are those that have been incurred for common or joint objectives and are not readily assignable to the cost objectives specifically benefited, without effort disproportionate to the results received. A cost may not be allocated to an award as an indirect cost if any other cost incurred for the same purpose, in like circumstances, has been assigned to an award as a direct cost. Direct costs of minor amounts may be treated as indirect costs under certain conditions. Recognizing that nonprofit organizations have diverse characteristics and accounting practices, the guidance states that it is not possible to specify the types of cost that may be classified as indirect costs in all situations. Whether a nonprofit classifies costs as direct or indirect is often a result of the organization’s ability to link costs to a particular program. OMB Circular A-122 guidance to nonprofits further divides indirect costs into two broad categories: facilities and administration. Facilities costs generally include costs related to the “depreciation and use allowances on buildings and equipment, as well as operations and maintenance expenses.” Administration costs generally include “general administration and expenses such as the director’s office, accounting, personnel, library services and all other expenses not listed under facilities.” OMB Circular A-133 provides general guidance on the roles and responsibilities of the federal awarding agencies and primary recipients of government funds regarding audit requirements of grantees. It sets forth standards for obtaining consistency and uniformity among federal agencies for the audit of states, local governments, and nonprofit organizations expending federal awards totaling $500,000 or more annually. Among other responsibilities, it gives federal awarding agencies the responsibility to advise recipients of requirements imposed on them by federal laws, regulations, and the provisions of contracts or grants and primary recipients the responsibility to identify grant awards; advise subrecipients of requirements imposed on them by federal laws, regulations, and the provisions of contracts or grant agreements as well as any supplemental requirements; and monitor the implementation of the grants. Awarding agencies and all recipients and subrecipients of federal grant funds must comply with certain data collection, record-keeping, and reporting requirements to help monitor grant implementation. These requirements differ across grants and are determined by the federal awarding agency, federal law, or both. State and local governments sometimes impose additional requirements on their subgrantees. Understanding OMB guidance regarding the relationship between indirect and administrative costs is particularly challenging for state and local governments and nonprofits. According to OMB officials, the terms “direct” and “indirect” can be thought of as ways to classify costs; that is, they are “cost buckets.” In contrast, the term “administrative” refers to a cost function or activity—such as accounting, procurement, personnel, or budgeting. On the one hand, OMB Circular A-122 cost guidance to nonprofits indicates that administrative costs are usually but not always indirect costs; on the other hand, that same guidance lists “administration” costs as one of two categories of indirect costs. Further, OMB Circular A- 87 cost guidance to state and local governments uses the terms indirect and administrative interchangeably in certain places. Taken together, the OMB guidance can be viewed as ambiguous. Guidance is most useful when it is clear and well understood. OMB officials told us that given the uncertainty and confusion with respect to these definitions and their application, it may be helpful to bring federal, state, and local officials together with representatives from nonprofit organizations to discuss these issues. Doing so, they acknowledge, could help clarify and improve understanding of how indirect costs should be treated. Classifying similar costs differently can make it difficult to determine how much money grantees receive for cost activities typically thought of as indirect, and at what rate. For example, the ESG program provides states or local government grantees up to 5 percent for administrative costs. As the primary recipients of ESG funds, states are required to share at least a portion of this funding with local government subgrantees; however, there is no such requirement for cost sharing with nonprofits. Thus, on its face it may appear as if ESG provides no administrative cost reimbursement for nonprofits. However, the ESG statute allows some emergency shelter costs, such as rent and utilities, which are typically thought of as indirect costs, to be claimed as a direct cost under ESG’s “operating costs” activity—one of five direct program activities for which subgrantees may be reimbursed. In another example, the statute for the HOPWA grant program limits administrative cost reimbursement for project sponsors to 7 percent. Because administrative costs can either be charged as direct or indirect costs depending on the circumstance, and because HOPWA has no explicit limit on indirect costs, it is difficult to accurately characterize cost reimbursement for activities commonly thought of as indirect. When grants and grantees classify similar costs differently it can also result in the same cost activity being covered for some nonprofits but not others, and can increase the complexity of administering the grants. Nonprofit association officials told us that because grant award packages and federal guidance contain unclear or conflicting information on how to allocate costs, nonprofits sometimes unknowingly exclude eligible expenses in their calculation of administrative costs and, as a result, limit their own reimbursement potential. Further, some of the nonprofit and association officials we spoke with said that because grant programs have different definitions of indirect costs, they must take care to reconcile their own accounting systems with the requirements of each grant they receive to ensure that they properly account for the funds. They also said that this is time consuming and resource intensive, and that more consistent classifications and treatment across federal grants would simplify grant administration and may reduce costs. We and others have previously reported that federal grant programs sometimes classify similar or identical costs differently. In 2006, we reviewed seven programs from HHS, and the Departments of Agriculture and Labor, and found that the legal definitions of and the federal funding rules for administrative costs varied even though many of the same activities were performed to administer the programs. The report noted that the statutes and regulations that define administrative costs for these programs differ in part because the programs evolved separately over time and have different missions, priorities, services, and clients. Further, the report noted that a number of state budget officials said that varying definitions of administrative costs create challenges for them. For example, one said that it can be difficult to develop coding for accounting and budgeting that can be used across programs and, as a result, it can be difficult to monitor costs accurately; another shared this concern and said that consistent definitions of and caps for administrative costs would make it easier to allocate costs across programs and, therefore, might reduce costs. This concern is not new; in a 2002 report on tax-exempt organizations, we reported that different approaches for charging expenses, as well as different allocation methods, can result in charities with similar types of expenses allocating them differently. Even though the terms indirect costs and administrative costs are not synonymous, we found that some nonprofit, state, and local government officials we spoke with use them interchangeably. A national nonprofit association official made a similar observation, noting that terminology varies throughout the nonprofit sector. State and local government and nonprofit officials we spoke with also reported using other terms, such as overhead, general operating expenses, or management and general expenses, synonymously with indirect and administrative costs. A 2007 report on nonprofits’ overhead costs also discussed widespread confusion about indirect costs throughout the sector, and identified “variations in definitions of overhead and the overhead cost rate” as areas of concern among nonprofit researchers and practitioners. The report also concluded that there is a substantial difference between indirect costs and administrative costs, noting that not all indirect costs are administrative, such as the costs of a telemarketing campaign, which is a programmatic or fundraising function. The report also said that there are administrative costs that are direct costs, such as those for the computers and office supplies used by the finance department. Inconsistencies in guidance in grant award packages and across federal programs add to the challenge of administering federal grants. For example, officials from a Louisiana nonprofit said that one federal contract may allow them to charge rent as a direct cost, while another federal contract states that it is to be charged as an indirect cost. These officials told us that they should be able to “call an apple, an apple….every time.” In another example, HUD’s supplemental guidance for HOPWA recipients advises that in reviewing administrative and indirect costs, recipients should keep in mind that “all administrative costs are indirect costs, but not all indirect costs are administrative costs.” Conversely, in describing HHS’s PSSF grant and the Family Violence Prevention Services/Battered Women’s Shelter grant, ACF officials explained that administrative costs can be either direct or indirect costs.