Please enjoy this excerpt of Bill Allen and Sefton Boyar’s self-study course on Federal Cost Principles in the Uniform Grant Guidance. The self-study is available for CPE credits here: https://yellowbook.ideamakr.com/
Objectives:
- Determine how to recover building and equipment costs
- Distinguish between idle capacity and idle facilities and related allowable costs
- Identify which costs are allowable as rearrangement and alteration costs
- Assess which rental costs are allowable
Depreciation
Depreciation is a means of allocating the cost of fixed assets to periods benefiting from asset use. The purpose of depreciation is to compensate an organization for the use of its fixed assets.
§200.436 Depreciation.
(a) Depreciation is the method for allocating the cost of fixed assets to periods benefitting from asset use. The non-Federal entity may be compensated for the use of its buildings, capital improvements, equipment, and software projects capitalized in accordance with GAAP, provided that they are used, needed in the non-Federal entity’s activities, and properly allocated to Federal awards. Such compensation must be made by computing depreciation.
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Computation of Depreciation
The computation of depreciation shall be based on the acquisition cost of the assets involved[1]. The value of an asset donated to an entity by an unrelated third party shall be its fair market value at the time of donation.
§200.436 Depreciation.
(b) The allocation for depreciation must be made in accordance with Appendices IV through VIII.
(c) Depreciation is computed applying the following rules. The computation of depreciation must be based on the acquisition cost of the assets involved. For an asset donated to the non‑Federal entity by a third party, its fair market value at the time of the donation must be considered as the acquisition cost. Such assets may be depreciated or claimed as matching but not both. For this purpose, the acquisition cost will exclude:
(1) The cost of land;
(2) Any portion of the cost of buildings and equipment borne by or donated by the Federal government, irrespective of where title was originally vested or where it is presently located;
(3) Any portion of the cost of buildings and equipment contributed by or for the non‑Federal entity, or where law or agreement prohibits recovery; and
(4) Any asset acquired solely for the performance of a non-Federal award.
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Depreciation Methodology
§200.436 Depreciation.
(d) When computing depreciation charges, the following must be observed:
(1) The period of useful service or useful life established in each case for usable capital assets must take into consideration such factors as type of construction, nature of the equipment, technological developments in the particular area, historical data, and the renewal and replacement policies followed for the individual items or classes of assets involved.
(2) The depreciation method used to charge the cost of an asset (or group of assets) to accounting periods must reflect the pattern of consumption of the asset during its useful life. In the absence of clear evidence indicating that the expected consumption of the asset will be significantly greater in the early portions than in the later portions of its useful life, the straight-line method must be presumed to be the appropriate method. Depreciation methods once used may not be changed unless approved in advance by the cognizant agency. The depreciation methods used to calculate the depreciation amounts for indirect (F&A) rate purposes must be the same methods used by the non-Federal entity for its financial statements.
(3) The entire building, including the shell and all components, may be treated as a single asset and depreciated over a single useful life. A building may also be divided into multiple components. Each component item may then be depreciated over its estimated useful life. The building components must be grouped into three general components of a building: building shell (including construction and design costs), building services systems (e.g., elevators, HVAC, plumbing system and heating and air-conditioning system) and fixed equipment (e.g., sterilizers, casework, fume hoods, cold rooms and glassware/washers). In exceptional cases, a cognizant agency may authorize a non-Federal entity to use more than these three groupings. When a non-Federal entity elects to depreciate its buildings by its components, the same depreciation methods must be used for indirect (F&A) purposes and financial statements purposes, as described in paragraphs (d)(1) and (2) of this section.
(4) No depreciation may be allowed on any assets that have outlived their depreciable lives.
When converting from the Use Allowance Method, [2]2 CFR 200 states that the asset being depreciated must be computed as though the asset had been depreciated over its entire life.
§200.436 Depreciation.
(d)(5) Where the depreciation method is introduced to replace the use allowance method, depreciation must be computed as if the asset had been depreciated over its entire life (i.e., from the date the asset was acquired and ready for use to the date of disposal or withdrawal from service). The total amount of use allowance and depreciation for an asset (including imputed depreciation applicable to periods prior to the conversion from the use allowance method as well as depreciation after the conversion) may not exceed the total acquisition cost of the asset.
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Support for Depreciation
The grantee must maintain property records to support depreciation and the value of the asset.
§200.436 Depreciation.
(e) Charges for depreciation must be supported by adequate property records, and physical inventories must be taken at least once every two years to ensure that the assets exist and are usable, used, and needed. Statistical sampling techniques may be used in taking these inventories. In addition, adequate depreciation records showing the amount of depreciation taken each period must also be maintained.
Idle Facilities and Idle Capacity
Definitions
As used in the cost principles, facilities are land, buildings, and equipment.
Capacity relates to the degree to which these facilities are used. Idle capacity is the unused capacity of partially used facilities. Idle facilities, then, are completely unused facilities that are in excess current needs, although they may have been needed at one time.
§200.446 Idle facilities and idle capacity.
(a) As used in this section the following terms have the meanings set forth in this section:
(1) Facilities means land and buildings or any portion thereof, equipment individually or collectively, or any other tangible capital asset, wherever located, and whether owned or leased by the non-Federal entity.
(2) Idle facilities means completely unused facilities that are excess to the non-Federal entity’s current needs.
(3) Idle capacity means the unused capacity of partially used facilities. It is the difference between:
(i) That which a facility could achieve under 100 percent operating time on a one-shift basis less operating interruptions resulting from time lost for repairs, setups, unsatisfactory materials, and other normal delays and;
(ii) The extent to which the facility was actually used to meet demands during the accounting period. A multi-shift basis should be used if it can be shown that this amount of usage would normally be expected for the type of facility involved.
(4) Cost of idle facilities or idle capacity means costs such as maintenance, repair, housing, rent, and other related costs, e.g., insurance, interest, and depreciation. These costs could include the costs of idle public safety emergency facilities, telecommunications, or information technology system capacity that is built to withstand major fluctuations in load, e.g., consolidated data centers.
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Idle Facilities
The costs of idle facilities[3] are unallowable, except to the degree that they:
- Are required to satisfy changes in workload, or
- Were needed at the time of acquisition but, due to adjustments in requirements of the program, are now idle.
The costs of idle facilities, under the exceptions above, are allowable for a reasonable period of time, ordinarily not more than one year.
§200.446 Idle facilities and idle capacity.
(b) The costs of idle facilities are unallowable except to the extent that:
(1) They are necessary to meet workload requirements which may fluctuate and are allocated appropriately to all benefiting programs; or
(2) Although not necessary to meet fluctuations in workload, they were necessary when acquired and are now idle because of changes in program requirements, efforts to achieve more economical operations, reorganization, termination, or other causes which could not have been reasonably foreseen. Under the exception stated in this subsection, costs of idle facilities are allowable for a reasonable period of time, ordinarily not to exceed one year, depending on the initiative taken to use, lease, or dispose of such facilities.
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Idle Capacity
The cost principles recognize that the costs of idle capacity are normal costs of doing business, occurring as a result of normal variations of usage from period to period. Such costs are allowable, provided that the capacity is reasonable.
§200.446 Idle facilities and idle capacity.
(c) The costs of idle capacity are normal costs of doing business and are a factor in the normal fluctuations of usage or indirect cost rates from period to period. Such costs are allowable, provided that the capacity is reasonably anticipated to be necessary to carry out the purpose of the Federal award or was originally reasonable and is not subject to reduction or elimination by use on other Federal awards, subletting, renting, or sale, in accordance with sound business, economic, or security practices. Widespread idle capacity throughout an entire facility or among a group of assets having substantially the same function may be considered idle facilities.
Your organization may have a few unused offices. Under the cost principles, you are not expected to try to rent out those offices, provided that the total space is not unreasonable. Similarly, if an employee leaves and you continue to maintain the space so that it is available for the replacement, such costs are allowable.
Rearrangement and Alteration Costs
When governmental units or nonprofits incur costs to rearrange or alter facilities in the ordinary and normal course of business, such costs are allowable and generally indirect. However, when costs are incurred for special rearrangements or alterations specifically for a federal award, they may be allowable as direct costs, provided that the grantor provides prior approval.
§200.462 Rearrangement and reconversion costs.
(a) Costs incurred for ordinary and normal rearrangement and alteration of facilities are allowable as indirect costs. Special arrangements and alterations costs incurred specifically for a Federal award are allowable as a direct cost with the prior approval of the Federal awarding agency or pass-through entity.
Also allowable is the difference between (a) the costs incurred by the grantee in restoring or rehabilitating facilities to a condition similar to the state of the facilities directly before work began on the grant; and (b) the costs of normal wear and tear.
§200.462 Rearrangement and reconversion costs.
(b) Costs incurred in the restoration or rehabilitation of the non-Federal entity’s facilities to approximately the same condition existing immediately prior to commencement of Federal awards, less costs related to normal wear and tear, are allowable.
For example, in order to appropriately perform services under its grant, an organization needed to erect several temporary walls in its otherwise open space. At the completion of the grant, the walls are no longer necessary or desirable to the organization. In fact, they will hinder its current operational plan. The costs to remove the walls, replace flooring, and rearrange the wiring to these temporary spaces would be an allowable restoration cost provided that the costs meet other applicable cost principles.
Rental Costs
In general, rental costs are permissible, subject to the following general criteria related to the reasonableness of the costs[4]:
- Rental costs of comparable property,
- Market conditions in the area,
- Alternatives available, and
- Leased property’s age, conditions, etc.
§200.465 Rental costs of real property and equipment.
(a) Subject to the limitations described in paragraphs (b) through (d) of this section, rental costs are allowable to the extent that the rates are reasonable in light of such factors as: rental costs of comparable property, if any; market conditions in the area; alternatives available; and the type, life expectancy, condition, and value of the property leased. Rental arrangements should be reviewed periodically to determine if circumstances have changed and other options are available.
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There are a few exceptions to the general rule. If your organization has such a rental relationship, it is essential to read that section of the rules carefully.
Sale and Leaseback Arrangements
Rental costs under ‘‘sale and leaseback’’ arrangements are permissible with limitation. The amounts that are allowable cannot exceed the amount that would be allowed if the property were still owned by the entity. Such costs may include depreciation, maintenance costs, taxes, and insurance.
§200.465 Rental costs of real property and equipment.
(b) Rental costs under “sale and lease back” arrangements are allowable only up to the amount that would be allowed had the non-Federal entity continued to own the property. This amount would include expenses such as depreciation, maintenance, taxes, and insurance.
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Less-than-Arm’s-Length Leases
Like rental costs under sale and leaseback arrangements, such costs under ‘‘less-than-arm’s-length’’ leases are allowable with limitation. The permissible amounts are limited to the costs that would be allowed if the grantee had title to the property.
When we refer to a transaction being “less-than-arm’s-length,” we mean that there is a conflict of interest between the parties. Under the cost principles for both nonprofits and for state and local governments, when one party to a lease agreement has control or considerable influence over the actions of another party of the lease agreement, there is a less-than-arm’s-length lease.
It is not unusual for nonprofit organizations to rent space from one of its board members. The board member in such a transaction would have an inherent conflict of interest. He wishes to increase his income, but he has a fiduciary responsibility to the nonprofit organization.
Less-than-arm’s-length leases can include leases between:
- Divisions of the non-Federal organization;
- Non-Federal organizations under common control through common officers, directors, or members;
- A non-Federal organization and a director, trustee, officer, or key employee of the entity or his immediate family, either directly or through corporations, trusts, or similar arrangements in which they hold a controlling interest; and
- Other similar arrangements.
For instance, a governmental entity may establish a separate corporation for the sole purpose of owning property and leasing it back to the governmental unit.
§200.465 Rental costs of real property and equipment.
(c) Rental costs under “less-than-arm’s-length” leases are allowable only up to the amount (as explained in paragraph (b) of this section). For this purpose, a less-than-arm’s-length lease is one under which one party to the lease agreement is able to control or substantially influence the actions of the other. Such leases include, but are not limited to those between:
(1) Divisions of the non-Federal entity;
(2) The non-Federal entity under common control through common officers, directors, or members; and
(3) The non-Federal entity and a director, trustee, officer, or key employee of the non‑Federal entity or an immediate family member, either directly or through corporations, trusts, or similar arrangements in which they hold a controlling interest. For example, the non-Federal entity may establish a separate corporation for the sole purpose of owning property and leasing it back to the non-Federal entity.
(4) Family members include one party with any of the following relationships to another party:
(i) Spouse, and parents thereof;
(ii) Children, and spouses thereof;
(iii) Parents, and spouses thereof;
(iv) Siblings, and spouses thereof;
(v) Grandparents and grandchildren, and spouses thereof;
(vi) Domestic partner and parents thereof, including domestic partners of any individual in 2 through 5 of this definition; and
(vii) Any individual related by blood or affinity whose close association with the employee is the equivalent of a family relationship.
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During an audit of the subsidiary of a major defense contractor, we discovered that the subsidiary was leasing the space for its headquarters from the defense contractor. When we examined the lease, we found that the contractor was booking a significant profit on the lease. As the lease was not an arm’s-length transaction, the allowable costs were limited to the costs of ownership. All of the booked profit was disallowed.
Capital Leases
When I studied accounting in college, we spent a good two months on capital leases. GAAP is very complicated regarding “renting to own” because organizations can get very creative in financing and depreciating equipment. They may creatively avoid taxes, creatively manipulate earnings, or creatively have another entity foot the bill! Who’d have thought that accountants could be so creative?
When a lease must be treated as a capital lease under GAAP, related rental costs are allowable only up to the cost that would be allowed if the entity had bought the property rather than leased it.
Interest costs related to capital leases are allowable, provided that they meet the applicable criteria regarding interest costs in 2 CFR 200. Interest costs will be discussed in the next chapter.
Costs that would not have been incurred had the grantee bought, rather than leased, the property are unallowable. Such costs might include amounts paid for profit, management fees, and taxes.
§200.465 Rental costs of real property and equipment.
(c)(5) Rental costs under leases which are required to be treated as capital leases under GAAP are allowable only up to the amount (as explained in paragraph (b) of this section) that would be allowed had the non-Federal entity purchased the property on the date the lease agreement was executed. The provisions of GAAP must be used to determine whether a lease is a capital lease. Interest costs related to capital leases are allowable to the extent they meet the criteria in §200.449 Interest. Unallowable costs include amounts paid for profit, management fees, and taxes that would not have been incurred had the non‑Federal entity purchased the property.
(6) The rental of any property owned by any individuals or entities affiliated with the non‑Federal entity, to include commercial or residential real estate, for purposes such as the home office workspace is unallowable.
[1] Where actual cost records have not been maintained, a reasonable estimate of the original acquisition cost may be used.
[2] Use allowances were a technique to reimburse an entity for the usage of its capital assets if the entity did not calculate depreciation costs. “Use allowances” are not permitted under 2 CFR 200, Subpart E. The recovery of the cost of assets over time must be done in accordance with Generally Accepted Accounting Principles. Therefore, entities that have been claiming “use allowances” must convert to claiming depreciation expenses.
[3] Cost of idle facilities or idle capacity means costs such as maintenance, repair, housing, rent, and other related costs, e.g., insurance, interest, property taxes, and depreciation or use allowances.
[4] Rental arrangements should be reviewed periodically to determine whether circumstances have changed and other options are available.
In Chapter 3 we talked about risk very briefly. In this chapter we will start delving deeper into this complex topic.
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