What is cost allocation plan (CAP) and why your organization needs one

What is cost allocation plan (CAP) and why your organization needs one

Recently one of my clients approached me with a question what is a cost allocation plan and how a nonprofit organization can benefit from having one? As a nonprofit accountant (nonprofit CPA), I’d like to dive into what a cost allocation plan is and why it is needed for a nonprofit organization.

Cost allocation plan is a written summary that details out how nonprofit organization allocates their costs among multiple programs.

There several benefit of having a cost allocation plan, but below I identified the main 5:

1. It assists in evaluation of the financial performance of an award or program
2. Helps to plan for future budgets – understanding the true costs
3. Most federal grants require to substantiate the allocated costs
4. It serves as audit evidence during an independent audit and/or single audit
5. It also increases acceptance rate for new grant applications

Cost allocation plan allows organizations to get a true measure of what it takes to run a program. There are a lot of “shared costs” – costs that may not be directly associated with an award but can still be allocated to the award. Some of the examples of the shared costs would be: audit fees, supplies, technology costs, other admin costs.

Cost allocation plan allows to perform a true analysis of each award to see how much it costs to really run an award. Some awards might come out as inefficient and too expensive to run while other might come out as well-run and organized. Using cost allocation plan helps to shed some light on the efficiency as well as helps in making decision when it comes to the next grant application period.

Next, I’d like to dive into the budgeting benefit of having a cost allocation plan. Very often during a budget preparation phase organizations use estimates for coming up with a budget. Those estimates typically end up being way off of the real actual costs. As such, having a cost allocation plan in place provides a history of the financial data that allows to go back and assist with any changes that need to be made throughout the year. In a case when a new contract is added, or a key staff left the organization or premises where the program is ran has suddenly changed: having cost allocation plan in place helps to create a model of how those changes are going to affect the expenses and what the award amount is going to be.

In addition to that, the benefit of having a cost allocation plan allows you to know for sure that all allowable costs are going towards that grant, and nothing is left out.

The next benefit of having a cost allocation plan I’d like to talk about is compliance with federal grants. Most grants require organizations to have a cost allocation plan either within grant budget narrative or within the grant application. In addition to that, federal grants require organizations to be in compliance with CFR 200 Uniform Guidance. There are three main key cost considerations associated with grant costs. Costs must be:

1. Reasonable (2 CFR #200.404)
2. Allowable (2 CFR #200.403)
3. Allocable

Allocable in this case means – benefits both the federal award and other work of the non-federal entity and can be distributed in proportions that may be approximated using reasonable methods. Cost allocation plan is a reasonable method of approximation. If costs are defined and consistent – they can be allocated to a federal grant through cost allocation policy.

Once the cost allocation plan is in place – it serves as a support for going through audit. Either single audit or a desk audit from the funder.

When thinking about the cost allocation plan there are could be two main costs: direct and indirect.

Under 2 CFR #200.413 – direct costs are those cost that can be identified specifically with a particular final cost objective, such as a federal award, or other internally or externally funded activity, or that can be directly assigned to such activities relatively easily with a high degree of accuracy.

Under 2 CFR #200.414 – indirect costs are those (facilities and administrative) costs incurred for a common or joint purpose benefitting more than one cost objective, and not readily assignable to the cost objectives specifically benefitted, without effort disproportionate to the results achieved.

Example of direct costs would be salaries and related fringe benefits for employees who work on multiple projects (timekeeping is crucial in this situation) and operating expenses like rent, supplies, cellphone, travel and other expenses used by the employees who work on the project.

Examples of indirect costs would be costs that are general administrative costs in nature, depreciation on buildings, equipment and capital improvements. An organization may choose to use the de minimis rate of 10% for charging indirect costs or choose to negotiate a different rate. “Any non-Federal entity that has a current federally-negotiated indirect cost rate may apply for a one-time extension of the rates in that agreement for a period of up to four years. This extension will be subject to the review and approval of the cognizant agency for indirect costs. If an extension is granted the non-Federal entity may not request a rate review until the extension period ends. At the end of the 4-year extension, the non-Federal entity must re-apply to negotiate a rate. Subsequent one-time extensions (up to four years) are permitted if a renegotiation is completed between each extension request.”

Steps to prepare a cost allocation plan (CAP plan)

1. Determine method of allocation. The method of allocation can be based on FTE headcount (FTE – full-time equivalent), square footage of space used, timesheets, program outcomes or other reasonable and consistent method (2 CFR #200.416).
2. Gather the required documents (whatever has been selected in step #1 – whether it’s timesheets, measuring your building space, counting computers, running programmatic reports). Nonprofits often use timesheets as their base for cost allocation plans as many nonprofits are driven by people with payroll very often being the highest costs. In this case it is of paramount importance to train employees on accurate timekeeping.
3. Establish a timeline on when the documents will be submitted to the accounting department and how they will be reviewed and approved (who reviews them and makes sure they are accurate). How often is it done by the employee (twice a month) – when is it reviewed and approved by employee’s manager, when is it submitted to the accounting department.

Personnel costs charged to federal awards must be based on records that accurately reflect the work performed:

• Must be supported by a system of internal controls providing reasonable assurance of accuracy
• Must be kept in official records of the organization
• Must encompass total activity (grant related and otherwise)
• Support the distribution of an employee’s salary between cost objectives

4. Determine how often the cost allocation plan (CAP plan) will be updated (monthly, quarterly, annually, or when significant changes arise).
5. Set realistic expectations with vendors, contracts and board presentations. Sometimes vendors are not very timely in sending in their invoices so setting up a cut off period is helpful in that case. For example, if the invoice doesn’t come in within 30 days after month-close – it doesn’t get allocated to the program. Sometimes it is necessary to work with the contracting team to make sure the reporting periods align with the accounting periods. The Board needs to have the most reliable financial information, so communication with the board about the realistic timeline for getting the financial statements is important. For example, if the accounting department needs 30-40 days to do a month close – then a realistic expectation would be to provide accurate financial statements to the board within 30-45 days of the month close.

Once the cost allocation plan is prepared it needs to be very well documented. Critical elements of a good cost allocation plan include:

• It has to be applied consistently
• It can be given to grantors and auditors
• Can be referenced by new employees, management and parties outside of the finance department
• It must conform to limitation and exclusions set by federal award
• It has to be simple enough for staff to understand how to run the calculations
• It has to be easy enough to use to allow for periodic ongoing monitoring for errors

When it comes to the documentation of the cost allocation plan – it needs to include documentation and definition of direct and indirect costs, explanation of methods used for allocation (FTE, square footage etc.), justification for allocations methods (bases selected – must be logical in terms of base used and benefit provided and must be actual, not budget), documentation needs to include any changes throughout the year as well as documentation of personnel costs.

Conclusion

In this article we reviewed some of the key factors related to cost allocation plan establishment. This is a very complex topic and has a lot of nuances to it, navigating the world of grant accounting and federal grant compliance is a quite complex task. If you need additional guidance on this topic – be on the lookout for future articles related to this topic. If you need help with nonprofit accounting from a nonprofit CPA or a specialized nonprofit accountant – do not hesitate to contact us directly. At WCC we specialize in nonprofit accounting, and it is our mission to help mission-based organizations to achieve their mission.