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. 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. 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. 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. Inconsistencies in guidance in grant award packages and across federal  programs add to the challenge of administering federal grants. Nonprofits’ Reimbursement for Indirect Costs Largely Depends on Federal, State, and Local Government Practices

For the majority of grants in our review, we found that state and local  government grantees are allowed to decide whether or not and how much  they reimburse nonprofit subgrantees for their administrative or indirect  costs. In all three states we reviewed, we found differences in the rates at  which state and local governments reimburse nonprofits for indirect costs. These differences, including whether nonprofits are reimbursed at all,  largely depend on the policies and practices of the state and local  governments that award federal funds to nonprofits. Although states often enjoy  wide latitude in determining the administrative and indirect  reimbursement rates of their subgrantees, applying a more specific  interpretation of federal statute potentially limits the amount of funds  available to nonprofits. Variations in cost coverage exist not only among different grants across  different states, but also within the same grant across different states. When Nonprofits Report Differences between Indirect Costs Incurred and Reimbursed, They Take a Variety of Steps to Bridge Gaps

		Nonprofits Fund Indirect Costs from a Variety of Sources

To help cover their indirect costs, nonprofits reported using funding from  a variety of sources in addition to federal funds, such as capacity-building  grants, private donations, fundraising, endowment funds, and business  income generated from services provided. Nonprofits Take Steps to Bridge Reported Funding Gaps

Fifteen of the 17 nonprofits in our sample reported that funding received  for indirect costs does not cover their actual indirect costs. Limited Ability to Build a Financial Safety Net

Nonprofits’ strained resources also limit their ability to build financial  reserves for unanticipated expenses. Officials at a Louisiana nonprofit said  that their ability to build a financial safety net is limited because they  struggle to cover their costs and do not have money left over to save. Factors  such as untimely reimbursements and high grant administration costs can  place stress on the nonprofit sector, diminishing its ability to continue to  provide services to vulnerable populations. A 2002 study that reviewed  prior research on this topic noted that when government agencies are  delayed in approving contracts or grant payments, recipient organizations  often experience cash flow problems. Conclusions

Federal, state, and local governments rely on nonprofit organizations as  key partners in implementing programs and providing services to the  public, such as health care, human services, and housing-related services. Recommendation for Executive Action

GAO recommends that the Director of OMB bring together federal, state,  and local governments, and nonprofit representatives to propose ways to  clarify and improve understanding of how indirect costs should be treated,  particularly for grants passed through state and local governments to  nonprofits by    clarifying the definitions of indirect costs and administrative costs and  their relationship to each other and    considering ways to help nonprofits improve their understanding and  ability to better capture, categorize, report, and recover indirect and  administrative costs. Appendix I: Objectives, Scope, and Methodology

Our objectives were to provide information for selected federal grant  programs and nonprofits on (1) how indirect cost terminology and  classification vary, (2) how indirect costs are reimbursed, and (3) if gaps  occur between indirect costs incurred and reimbursed, steps nonprofits  take to bridge the gaps.
Why GAO Did This Study

Nonprofits are key partners in delivering federal services yet reportedly often struggle to cover their indirect costs (costs not readily identifiable with particular programs or projects). This raises concerns about fiscal strain on the sector. To provide information on nonprofits' indirect cost reimbursement, especially when funding flows through entities such as state and local governments, GAO was asked to review, for selected grants and nonprofits, (1) how indirect cost terminology and classification vary, (2) how indirect costs are reimbursed, and (3) if gaps occur between indirect costs incurred and reimbursed, steps taken to bridge gaps. GAO selected six Departments of Health and Human Services and Housing and Urban Development grants and 17 nonprofits in Louisiana, Maryland, and Wisconsin. GAO selected these agencies for their historical relationship with nonprofits. GAO reviewed policies and documents governing indirect costs and interviewed relevant officials. GAO also reviewed research on nonprofits' indirect costs.

What GAO Found

Depending on the grant program, nonprofits may be reimbursed for indirect costs (generally costs such as rent or utilities), administrative costs (generally cost activities such as accounting or personnel), both, or neither. OMB officials said costs can be classified as either indirect or direct, and administrative cost activities are usually, but not always, classified as indirect costs. However, inconsistencies in the use and meaning of the terms indirect and administrative, and their relationship to each other, has made it difficult for state and local governments and nonprofits to classify costs consistently. This has resulted in varying interpretations of what activity costs are indirect versus administrative. As OMB guidance on cost principles for nonprofits recognizes (2 CFR Part 230), because nonprofit organizations have diverse characteristics and accounting practices, it is not possible to specify the types of costs that may be classified as indirect in all situations. This increases the challenges of administering federal grants and, in some cases, makes it difficult for recipients to determine those activities eligible for indirect cost reimbursement under a particular federal grant and those that are not. GAO found differences in the rate in which state and local governments reimburse nonprofits for indirect costs. These differences, including whether nonprofits are reimbursed at all, largely depend on the policies and practices of the state and local governments that award federal funds to nonprofits. Federal grants often provide wide latitude in setting cost reimbursement policies and practices, and some state and local governments do not reimburse these costs at all. Those that do can often choose the reimbursement rate. As a result, GAO found that variations in indirect cost reimbursement exist not only among different grants, but also within the same grant across different states. GAO found that nonprofits fund indirect costs with a variety of federal and nonfederal funding sources, and that when indirect cost reimbursement is less than the amount of indirect costs nonprofits determine they have incurred, most nonprofits GAO interviewed take steps to bridge the gap. They may reduce the population served or the scope of services offered, and may forgo or delay physical infrastructure and technology improvements and staffing needs. Because many nonprofits view cuts in clients served or services offered as unpalatable, they reported that they often compromise vital "back-office" functions, which over time can affect their ability to meet their missions. Further, nonprofits' strained resources limit their ability to build a financial safety net, which can create a precarious financial situation for them. Absent a sufficient safety net, nonprofits that experience delays in receiving their federal funding may be inhibited in their ability to bridge funding gaps. When funding is delayed, some nonprofits said they either borrow funds on a line of credit or use cash reserves to provide services and pay bills until their grant awards are received. Collectively, these issues place stress on the nonprofit sector, diminishing its ability to continue to effectively partner with the federal government to provide services to vulnerable populations.