The onset of COVID-19 increased the amount of funding available to life sciences companies, primarily to the Department of Health and Human Services (HHS). This has sparked a lot of interest in the opportunity for life sciences companies to obtain government funding, and as a result has sparked new entry into this market. Federal spending in life sciences was around long before COVID-19 and will be here long after. For those entering this space, navigating the regulatory compliance can often catch companies off guard and cost money.
Indirect rates: Are you maximizing cost recovery on government grants?
For a biotechnology or research and development (R&D) company that has just been awarded their first government grant, the term “indirect rates” may be new, and there may be questions. Depending on the agency or grant, you may see the term “indirect rate,” “overhead rate,” or “facilities & administrative rate (F&A),” but the three are often used interchangeably throughout the industry for one common theme: They are used as the reimbursement method for company costs that are not directly related to a certain project or grant. There are no hard-and-fast rules associated with what is considered an indirect or direct cost. It all depends on the grant and circumstance.
Companies may propose what they consider industry standards as indirect rates to win government grants without taking into consideration their actual indirect rates. For example, National Institutes of Health (NIH) grantees often use a 40% indirect rate because an indirect rate of 40% or less normally is not required to be justified with additional indirect rate supporting documentation. In the case of other agency grantees, companies are often subject to the 10% de minimis indirect rate for those who have never had a negotiated indirect rate. However, during actual performance of the grant work, this often leads to an under-recovery of indirect expenses and ultimately leaving money on the table. Many grantees are surprised when we calculate their actual rates and they realize their indirect rates are actually running significantly higher.
Supporting your indirect rates
In order to recover those additional percentage points in indirect expenses, a company must provide supporting documentation to propose or negotiate the higher rate with the government grant agency. When you are unfamiliar with the government grant world, the thought of supporting indirect rates in order to propose a higher indirect rate can be intimidating. We have identified the following three major areas of concern related to supporting higher indirect rates in government grantees:
- Insufficient and/or unenforced timekeeping policies and procedures
- An accounting system that is not set up to segregate direct and indirect expenses
- Lack of unallowable cost tracking
Using sound financial data and addressing the major areas of concern identified above can help ensure not only the creation of adequate indirect rates but also the maintenance of suitable documentation to support them. This information can be used to develop and review your actual indirect rates and further understand your company’s profitability. Once you identify whether your company is achieving maximum recovery of its indirect costs, you can determine whether you should consider proposing or negotiating a higher indirect rate with your government grant agency.
A grantee must also ensure that the indirect rate structure aligns with the complexity of the company’s organizational structure. There have been instances where the Defense Finance and Accounting Service and the government grant agency have asked the grantee to revise their indirect rate structure or face adverse consequences on current or future awards, because their current structure did not equitably allocate costs to federal grants. Specifically, there have been instances where NIH required a two-tier rate as opposed to the three-tier rate structure that contractors were using on their DOD contracts.
Indirect rates are an important source of cost reimbursement from government grants. Although using an industry standard or de minimis rate can be an easy compromise, it does not maximize cost recovery. Taking the time and effort to develop a supportable indirect rate based on your organizational structure may be worth more in the long run if you can maximize cost recovery and profitability.
For more information, register for our upcoming webinar, “Government funding for life sciences companies: How to obtain awards and master compliance.”
Subject matter expertise
CPA, Partner - Managing Partner, Advisory - Global Consulting Solutions and Government Contracting Industry Leader
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