American Rescue Plan Act of 2021: Allowable Costs and Cost Principles (Including Sample Policy and Implementation Tools)

Published for Coates' Canons on December 23, 2021.

Most NC counties and municipalities have received their first of two distributions of Coronavirus State and Local Fiscal Recovery Fund monies, as part of the American Rescue Plan Act of 2021 (ARP/CSLFRF). Understandably, many local officials have been focused on identifying eligible projects. (For more information, on various aspects of the ARP/CSLFRF and eligible projects, see prior posts and other resources.) As of this writing, we are still awaiting US Treasury’s Final Rule implementing the ARP/CSLFRF. We know, however, that expenditure of these funds will be subject to many, if not most, provisions of the Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards, 2 CFR Part 200 (commonly referred to as the Uniform Guidance or UG). The UG is a set of regulations that apply to the management of federal grant awards.

Based on the Assistance Listing: Coronavirus State and Local Fiscal Recovery Funds and Part 2 of the US Treasury State and Local Fiscal Recovery Funds Compliance and Reporting Guidance (Compliance Guide), the following UG provisions apply to the ARP/CSLFRF grant award:

Most of these UG provisions impose process and internal control requirements, but some impose limitations on when, how, and for what purposes federal grant funds may be spent. The UG requirements are in addition to those imposed by the Interim Final Rule/Final Rule related to project eligibility. Many of the UG provisions require that the grant recipient adopt and implement policies and procedures to ensure compliance with its requirements. This is the first in a series of blog posts that will walk through the major UG areas of focus and provide guidance on local government compliance efforts, including, where applicable, sample policies and checklists.

This post focuses on the requirements in Subpart E, related to Cost Principles. Fair warning that this is a long post with a lot of detail. It may take a few reads to put all the pieces together. There is a special section at the end to help small local governments navigate these requirements.

What are Cost Principles?

A local government recipient of ARP/CSLFRF monies is responsible for ensuring that funds are spent for appropriate purposes. There are multiple dimensions to this requirement. First, a local government needs to define a project and determine that project is eligible according to the terms of the grant award. Each project must fit within a single Expenditure Category, as defined in US Treasury’s Interim Final Rule (IFR). A local government must implement a process for making and confirming eligibility determinations and record its findings and justifications, as well as any additional documentation. In our ARP/CSLFRF Course in October 2021, we discussed this process and how it relates to tracking data for the required Project and Expenditure report here. We also introduced a sample project file checklist/eligibility worksheet (credit to the City of Winston-Salem) and project tracking template. Although necessary, these processes are not sufficient for full UG compliance.

Additionally, a local government must ensure that the cost items within a project conform to the UG’s Cost Principles. According to the Compliance Guide,

allowable costs are based on the premise that a recipient is responsible for the effective administration of Federal awards, application of sound management practices, and administration of Federal funds in a manner consistent with the program objectives and terms and conditions of the award. Recipients must implement robust internal controls and effective monitoring to ensure compliance with the Cost Principles, which are important for building trust and accountability.

Cost items are the specific cost objects or functions. Typical cost items include compensation and fringe benefits, materials and supplies, equipment and other capital, consultants/professional services, audits, communications, insurance, maintenance and repair, and rental costs. Read together, the IFR, Compliance Guide, and UG outline the cost items that are allowable, allowable with limitations, and unallowable.

Basic UG Cost Principles Analysis

For all potential cost items within an eligible project, the UG Cost Principles require that a local government perform a basic review to ensure that the cost items are (1) allowable; (2) allocable; (3) reasonable; (4) consistently applied, (5) adequately documented.

Allowable. A cost is allowable when it is compliant with the terms and conditions of the federal award and implementing agency regulations, and the UG. As discussed below, the UG has documented certain specific cost items, some of which are always allowable, some of which are allowable with limitations, some of which are allowable only with permission of the granting agency, and some of which are never allowable. Further, several of the specific cost items require special documentation. A local government must be well-versed in these specified items of costs when performing its cost allowability review.

Allocable. A cost is allocable if either (1) it is incurred solely to benefit an ARP/CSLFRF-eligible project or (2) it benefits both an ARP/CSLFRF-eligible project and another ARP/CSLFRF-eligible project or other work of the local government, in proportions that can be approximated using reasonable methods. A local government must use a consistent method for allocating costs. Some costs will be charged directly to the grant award and other costs will be included in an indirect cost pool.

Reasonable. A cost is reasonable when, in its nature and amount, it does not exceed that which would be incurred by a prudent person under the circumstances prevailing at the time the decision was made to incur the cost. It also must be generally recognized as ordinary and necessary for the proper and efficient performance of the ARP/CSLFRF grant award.

Consistently applied. A cost is consistently applied when it is applied uniformly to both federally-funded and other activities of the local government.

Properly documented. A local government must document its allocation method and its system of internal controls that provide reasonable assurance that amounts charged are accurate, allowable, and properly allocated.

A local government will adopt a UG Cost Principles Policy to guide its implementation of these requirements (see sample below).

Specific Items of Cost

As mentioned above, the UG details several specific items of cost. Not all of these will be relevant to a local government’s expenditure of ARP/CSLFRF monies. In fact, a local government likely will only utilize a handful of cost items for most of its ARP/CSLFRF projects. Local officials, particularly those charged with reviewing projects for conformance with UG Cost Principles, need to understand the specifics of each applicable cost item.

This chart lists the specific cost items, with their UG citations. A local unit may wish to adapt this chart to reflect the cost items it will use in its ARP/CSLFRF projects to streamline its review process. I’ve highlighted several cost items that likely will be of particular importance to local governments. Note that some cost items are allowable only with prior written approval of the federal granting agency. (We are awaiting final guidance from US Treasury on whether some of these pre-approval requirements, including prior written approval for capital expenses over $5,000, will be waived or modified in the Final Rule.)

Example Specific Cost Items – Compensation & Fringe Benefits

To illustrate the required analysis for specific cost items, let’s review Compensation – personal services and Compensation – fringe benefits. These will be common cost items for most ARP/CSLFRF projects. To determine what are allowable compensation and fringe benefit costs, we need to look at the terms of the ARP/CSLFRF grant award, Compliance Guide, US Treasury FAQs, and 2 CFR Sects. 200.430 and .431. (As you’ll quickly see below, there is a lot to factor into this analysis, but most of it will boil down to adopting proper internal control procedures related to documenting eligible compensation and fringe benefit expenses.)

Starting with the Compliance Guide, it states that “[i]n general, certain employees’ wages, salaries, and covered benefits are an eligible use of [ARP/CSLFRF] award funds. Please see Treasury’s Interim Final Rule for details.”

Turning to the IFR, there are a number of different scenarios under which local government employees’ salaries and fringe benefits will be paid by ARP/CSLFRF funds, including:

  • Direct or indirect charges for salaries and fringe benefits of local government employees who carry out ARP/CSLFRF-eligible projects.
  • Salaries and benefits of public health, public safety, and social services employees, to the extent they are dedicated to COVID-19 response.
  • Premium pay for local government employees performing essential work during the pandemic.
  • Self-insured local government expenses for employee COVID-19 treatment, including the long-term symptoms or effects of COVID-19.
  • Salaries and fringe benefits paid to employees to replenish the local government workforce to pre-pandemic levels.
  • Expenses of providing paid sick and paid family and medical leave to local government employees to enable compliance with COVID-19 public health precautions.
  • Direct or indirect charges for salaries and benefits paid by subrecipients to carry out an ARP/CSLFRF-eligible projects.

In terms of what specific benefits are allowable costs, the IFR defines fringe benefits broadly. In footnote 46, it states that

if an employee’s wages and salaries are an eligible use of [ARP/CSLFRF] Funds, recipients may treat the employee’s covered benefits as an eligible use of [ARP/CSLFRF] Funds. For purposes of the [ARP/CSLFRF] Funds, covered benefits include costs of all types of leave (vacation, family-related, sick, military, bereavement, sabbatical, jury duty), employee insurance (health, life, dental, vision), retirement (pensions, 401(k)), unemployment benefit plans (federal and state), workers compensation insurance, and Federal Insurance Contributions Act (FICA) taxes (which includes Social Security and Medicare taxes).

Finally, the applicable UG provisions impose some limitations and documentation requirements. Specifically, 2 CFR 200.430 states, in relevant part:

(a) General. Compensation for personal services includes all remuneration, paid currently or accrued, for services of employees rendered during the period of performance under the Federal award, including but not necessarily limited to wages and salaries. Compensation for personal services may also include fringe benefits which are addressed in § 200.431. Costs of compensation are allowable to the extent that they satisfy the specific requirements of this part, and that the total compensation for individual employees:

(1) Is reasonable for the services rendered and conforms to the established written policy of the non-Federal entity consistently applied to both Federal and non-Federal activities;

(2) Follows an appointment made in accordance with a non-Federal entity’s laws and/or rules or written policies and meets the requirements of Federal statute, where applicable; and

(3) Is determined and supported as provided in paragraph (i) of this section, when applicable.

(b) Reasonableness. Compensation for employees engaged in work on Federal awards will be considered reasonable to the extent that it is consistent with that paid for similar work in other activities of the non-Federal entity. In cases where the kinds of employees required for Federal awards are not found in the other activities of the non-Federal entity, compensation will be considered reasonable to the extent that it is comparable to that paid for similar work in the labor market in which the non-Federal entity competes for the kind of employees involved.

(e) Special considerations. Special considerations in determining allowability of compensation will be given to any change in a non-Federal entity’s compensation policy resulting in a substantial increase in its employees’ level of compensation (particularly when the change was concurrent with an increase in the ratio of Federal awards to other activities) or any change in the treatment of allowability of specific types of compensation due to changes in Federal policy.

(f) Incentive compensation. Incentive compensation to employees based on cost reduction, or efficient performance, suggestion awards, safety awards, etc., is allowable to the extent that the overall compensation is determined to be reasonable and such costs are paid or accrued pursuant to an agreement entered into in good faith between the non-Federal entity and the employees before the services were rendered, or pursuant to an established plan followed by the non-Federal entity so consistently as to imply, in effect, an agreement to make such payment.

(i) Standards for Documentation of Personnel Expenses

(1) Charges to Federal awards for salaries and wages must be based on records that accurately reflect the work performed. These records must:

(i) Be supported by a system of internal control which provides reasonable assurance that the charges are accurate, allowable, and properly allocated;

(ii) Be incorporated into the official records of the non-Federal entity;

(iii) Reasonably reflect the total activity for which the employee is compensated by the non-Federal entity, not exceeding 100% of compensated activities (for IHE, this per the IHE’s definition of IBS);

(iv) Encompass federally-assisted and all other activities compensated by the non-Federal entity on an integrated basis, but may include the use of subsidiary records as defined in the non-Federal entity’s written policy;

(v) Comply with the established accounting policies and practices of the non-Federal entity; and

(vi) [Reserved]

(vii) Support the distribution of the employee’s salary or wages among specific activities or cost objectives if the employee works on more than one Federal award; a Federal award and non-Federal award; an indirect cost activity and a direct cost activity; two or more indirect activities which are allocated using different allocation bases; or an unallowable activity and a direct or indirect cost activity.

(viii) Budget estimates (i.e., estimates determined before the services are performed) alone do not qualify as support for charges to Federal awards, but may be used for interim accounting purposes, provided that:

(A) The system for establishing the estimates produces reasonable approximations of the activity actually performed;

(B) Significant changes in the corresponding work activity (as defined by the non-Federal entity’s written policies) are identified and entered into the records in a timely manner. Short term (such as one or two months) fluctuation between workload categories need not be considered as long as the distribution of salaries and wages is reasonable over the longer term; and

(C) The non-Federal entity’s system of internal controls includes processes to review after-the-fact interim charges made to a Federal award based on budget estimates. All necessary adjustment must be made such that the final amount charged to the Federal award is accurate, allowable, and properly allocated.

(2) For records which meet the standards required in paragraph (i)(1) of this section, the non-Federal entity will not be required to provide additional support or documentation for the work performed, other than that referenced in paragraph (i)(3) of this section.

(3) In accordance with Department of Labor regulations implementing the Fair Labor Standards Act (FLSA) (29 CFR part 516), charges for the salaries and wages of nonexempt employees, in addition to the supporting documentation described in this section, must also be supported by records indicating the total number of hours worked each day.

(4) Salaries and wages of employees used in meeting cost sharing or matching requirements on Federal awards must be supported in the same manner as salaries and wages claimed for reimbursement from Federal awards.

(5) For states, local governments and Indian tribes, substitute processes or systems for allocating salaries and wages to Federal awards may be used in place of or in addition to the records described in paragraph (1) if approved by the cognizant agency for indirect cost. Such systems may include, but are not limited to, random moment sampling, “rolling” time studies, case counts, or other quantifiable measures of work performed.

(i) Substitute systems which use sampling methods (primarily for Temporary Assistance for Needy Families (TANF), the Supplemental Nutrition Assistance Program (SNAP), Medicaid, and other public assistance programs) must meet acceptable statistical sampling standards including:

(A) The sampling universe must include all of the employees whose salaries and wages are to be allocated based on sample results except as provided in paragraph (i)(5)(iii) of this section;

(B) The entire time period involved must be covered by the sample; and

(C) The results must be statistically valid and applied to the period being sampled.

(ii) Allocating charges for the sampled employees’ supervisors, clerical and support staffs, based on the results of the sampled employees, will be acceptable.

(iii) Less than full compliance with the statistical sampling standards noted in subsection (5)(i) may be accepted by the cognizant agency for indirect costs if it concludes that the amounts to be allocated to Federal awards will be minimal, or if it concludes that the system proposed by the non-Federal entity will result in lower costs to Federal awards than a system which complies with the standards.

(6) Cognizant agencies for indirect costs are encouraged to approve alternative proposals based on outcomes and milestones for program performance where these are clearly documented. Where approved by the Federal cognizant agency for indirect costs, these plans are acceptable as an alternative to the requirements of paragraph (i)(1) of this section.

(7) For Federal awards of similar purpose activity or instances of approved blended funding, a non-Federal entity may submit performance plans that incorporate funds from multiple Federal awards and account for their combined use based on performance-oriented metrics, provided that such plans are approved in advance by all involved Federal awarding agencies. In these instances, the non-Federal entity must submit a request for waiver of the requirements based on documentation that describes the method of charging costs, relates the charging of costs to the specific activity that is applicable to all fund sources, and is based on quantifiable measures of the activity in relation to time charged.

(8) For a non-Federal entity where the records do not meet the standards described in this section, the Federal Government may require personnel activity reports, including prescribed certifications, or equivalent documentation that support the records as required in this section.

For fringe benefits, 2 CFR 200.431 generally mandates that eligible benefits be part of existing written benefit policies by the local government.

Putting it all together, compensation and fringe benefits are generally allowable costs if part of an ARP/CSLFRF-eligible project. (As per below, some will be charged directly, others will be included in an indirect cost pool.) A local government, however, must have a clear written policy on effort certification and follow careful processes to document the eligibility of work performed.

Other Cost Items

A local government will repeat this general analysis, consulting all the same sources, for each specific cost item to determine allowable costs (although most of the other cost items will not be as involved as compensation and fringe benefits!)

Direct vs. Indirect Costs

If a cost benefits two or more projects or activities in proportions that can be determine without undue effort or cost, the cost should be allocated to the projects based on the proportional benefit. This is referred to as a direct cost. In other words, a direct cost is an expense that is specifically associated with a particular ARP/CSLFRF-eligible project and that can be directly assigned to such activity relatively easily with a high degree of accuracy. See 2 CFR 200.413. Common examples of direct costs include salary and fringe benefits of personnel directly involved in undertaking an eligible project, equipment and supplies for the project, contracted services for the project, or other materials consumed or expended in the performance of the project.

There are some costs that cannot be proportionally allocated among projects without undue effort. The UG allows a portion of these costs to be charged to the grant award as indirect costs. An indirect cost is (1) incurred for a common or joint purpose benefitting more than one ARP/CSLFRF-eligible project or an ARP/CSLFRF-eligible project and other local government activities, and (2) not readily assignable to the ARP/CSLFRF-eligible project specifically benefited, without effort disproportionate to the results achieved. See 2 CFR 200.414.

What about administrative costs – are they charged as direct or indirect costs? In the Compliance Guide, US Treasury indicates that administrative costs may be treated as either direct or indirect charges, as appropriate.

Administrative costs: Recipients may use funds for administering the [ARP/CSLFRF] program, including costs of consultants to support effective management and oversight, including consultation for ensuring compliance with legal, regulatory, and other requirements. [Recipients also may use ARP/CSLFRF funds directly for administrative costs to improve efficacy of programs that respond to the COVID-19 public health emergency.] Further, costs must be reasonable and allocable as outlined in 2 CFR 200.404 and 2 CFR 200.405. Pursuant to the [ARP/CSLFRF] Award Terms and Conditions, recipients are permitted to charge both direct and indirect costs to their [ARP/CSLFRF] award as administrative costs. Direct costs are those that are identified specifically as costs of implementing the [ARP/CSLFRF] program objectives, such as contract support, materials, and supplies for a project. Indirect costs are general overhead costs of an organization where a portion of such costs are allocable to the [ARP/CSLFRF] award such as the cost of facilities or administrative functions like a director’s office.Each category of cost should be treated consistently in like circumstances as direct or indirect, and recipients may not charge the same administrative costs to both direct and indirect cost categories, or to other programs.

Some local governments have an existing Negotiated Indirect Costs Rate Agreement (NICRA) established with a Federal cognizant agency responsible for reviewing, negotiating, and approving cost allocation plans or indirect cost proposals. If a local government has a NICRA it may, but is not required to, use the NICRA rate to calculate indirect costs for its ARP/CSLFRF award. If a local government does not have a NICRA (or chooses not to use its NICRA), it may elect to use the de minimis rate of 10 percent of the modified total direct costs (MTDC). See 2 CFR 200.414(f). According to 2 CFR 200.68, MTDC means all direct salaries and wages, applicable fringe benefits, materials and supplies, services, travel, and up to the first $25,000 of each subaward (regardless of the period of performance of the subawards under the award). MTDC EXCLUDES equipment, capital expenditures, charges for patient care, rental costs, tuition remission, scholarships and fellowships, participant support costs and the portion of each subaward in excess of $25,000.

A local government must consistently apply its direct versus indirect cost categorization across ARP/CSLFRF projects. A key part of a project’s cost allowability review will be calculating and applying the appropriate indirect cost charge.

Sample UG Cost Principles Policy and Implementation Tools

As stated above, a local government must adopt a UG Cost Principles Policy to implement internal controls ensuring proper cost allowability determinations. The policy should reflect the legal requirements and, importantly, should also detail the cost allowability review processes the local government will follow both as part of a project’s pre-approval process and as part of the unit’s normal disbursement process. (The disbursement process is the state law process for paying invoices or other demands for payment. See G.S. 159-28.) The policy should assign specific roles and responsibilities to individual departments or positions within the local government. And it should incorporate appropriate documentation and oversight measures.

Here is a link to a Sample Cost Principles Policy, with a caveat. A one-size-fits-all policy may work on paper, but it will not work in practice. A local government must adapt the sample policy to fit the realities of its internal controls and review processes. It is essential that a local government carefully follow whatever policy it adopts, so local officials must ensure that they have the capacity to implement the processes dictated by the policy. And I strongly recommend that you have any sample (or example) policy reviewed by your local attorney. He/she must ensure full legal compliance. (I also welcome any suggestions for proposed edits/additions/other modifications to the sample policy as individual units perform your review!)

As part of that policy, a local government must identify how it will document and track cost items. The following are two tools that may help in this effort. The first is a Pre-Project Allowable Cost Review Tool. You may wish to add this as an amendment to your project file checklist/eligibility worksheet that we presented during the ARP/CSLFRF course in October 2021. (See video and slides from that presentation.) The pre-project allowable cost review should be completed as part of the project proposal process, so it will force project planners to identify specific cost items and allow for review by finance on the front end to identify any potential issues.

The second is an Allowable Costs Tracking Spreadsheet. This spreadsheet, or some adapted version of it, could be used to track and document proposed and actual cost items per project. Some local government may want to incorporate this spreadsheet into their existing project and expenditure report tracking spreadsheet. Others may want to track this data separately. (Special thanks to Tiffany Oliva and Abby Gostling, two UNC School of Government MPA students, for all their hard work in crafting these and other implementation tools for local governments!)

It is important to note, though, that these are just tools. If they do not work for your local government, feel free to adopt another approach that does work. The goals are to ensure full compliance with the ARP/CSLFRF award terms and UG provisions and to maintain appropriate documentation and other records in a way that allows for ease of reporting and compliance with audit requirements.

A Note for Small Local Governments

Complying with all the UG compliance requirements, including those related to Cost Principles, may seem daunting, particularly for small units with limited staff and capacity. In the Compliance Guide, US Treasury stresses that local governments must take a reasonable approach to compliance. The following is a checklist to help small units focus on the basics in implementing Cost Principles:

  1. Review the Sample Cost Principles Policy with your attorney and tailor the final section to best reflect the type of internal controls and review process that your unit can reasonably perform.
  2. Adopt the Sample Cost Principles Policy
  3. Whoever is responsible for implementing the Cost Principles Policy (likely your manager/administrator, finance officer, or clerk) should read through the handful of specific items of cost that you are most likely to use (compensation, fringe benefits, materials and supplies, equipment, and other capital, etc.) to identify the limitations and process and documentation requirements. Focus your efforts on personnel costs, procurement contracts and subawards (if any), travel, and capital—knowing these are the most likely areas of focus of federal review.
  4. Create a checklist with common cost items to identify specific cost items for each project and document review for allowability and allocability. (Or use the table provided in the Pre-Project Allowable Cost Review Tool.)
  5. Use the Allowable Costs Tracking Spreadsheet to track actual cost items by project (if your unit’s accounting software does not already track these cost items). You may choose to only use the summary sheet within the spreadsheet document if you do not have the capacity to input the more detailed records.
  6. Require that all invoices or other demands for payment with ARP/CSLFRF funds be broken down by cost item for pre-disbursement compliance review.
  7. Write Everything Down and Keep All Documentation!