Quick – what’s the one audit finding that plagues most nonprofit organizations year after year? If you guessed allocation, you’re correct! What you don’t know can and will hurt you – a bit trite and cliché, but nevertheless, in this case very true. And possibly to your organization’s own detriment, if not heeded.
Take for instance, one particular consortium center that contracted with the Department of Community and Senior Services (CSS) to serve participants residing in Los Angeles County. The Consortium’s main funding consisted of Workforce Investment Act grants from CSS, grants which were designed to assist individuals (adults, dislocated workers and youths) in obtaining employment, retaining their jobs and increasing their earnings. The Consortium’s monitoring reports prior to Fiscal Year (FY) 2010-2011 came out fairly clean. However, the two monitoring reports post FY 2010-2011 weren’t as favorable. Specifically, they identified approximately $135,000 in questioned costs, many of which were mainly attributable to – you guessed it – allocation issues.
Where is the consortium now? Their Board of Directors has been dissolved, the consortium is longer in operations and it has been placed in the LA County Contractor Alert Reporting Database (CARD). CARD is a county database that tracks and alerts departments of poorly performing contractors. CARD may also adversely affect contractors during the request for proposal (RFP) bidding process for any future grants/contracts. Needless to say, CSS did not extend the consortium’s contract, and in doing so, wiped out approximately 90 percent of the Consortium’s main funding stream in one fell swoop. Out of business they went. As I was saying – to the consortium’s own detriment, indeed.
Did that grab your attention? Great – now that I have your full attention, let’s tackle this head on. Don’t let this happen to your organization. The only way to prevent or solve any issue is to bring it to the surface and shed some light on it.
Unsupported and Unallowable
Generally speaking, allocation issues fall into two main categories: unsupported and unallowable allocation rates/methodologies.
Let’s first take a look at unsupported allocation rates. This means that in relation to the type of shared cost, you’re utilizing an appropriate allocation methodology, but failed to maintain adequate documentation to support the allocation base. For instance, if you’re using square footage to allocate rent expense among three different programs, you must maintain a floor plan identifying the number of square footage each program is occupying. That floor plan must be updated and valid during the time period in which it is being tested because, rest assured, the auditors at a minimum will perform a facility walk through and conduct interviews to verify that the numbers are accurately reflected. Factors such as time frame, valid lease agreements, number of programs occupying space in the facility, rent invoice and cancelled checks will be taken into account.
Now, let’s discuss unallowable allocation rates/methodologies. Putting a twist on the earlier example, assume that an inappropriate methodology was used instead. Suppose rent expense was allocated among three different programs based on the number of new clients per program. Why is this inappropriate? According to the OMB Circular A-122 (Cost Principles for Non-Profit Organizations), “a cost is allocable to a particular cost objective, such as a grant, contract, project, service or other activity, in accordance with the relative benefits received. A cost is allocable to a federal award if it is treated consistently with other costs incurred for the same purpose in like circumstance and if it can be distributed in reasonable proportion to the benefits received.”
Let’s illustrate what this means by expanding on the example above. We know that the nonprofit organization has three different programs occupying space in one facility. Percentage of new clients per program is used to allocate rent expense between the three programs. For one month, program one has no new clients, program two has 15 new clients and program three has 20 new clients. Under their chosen allocation methodology, Program one (not having any new clients) would not bear any cost; even though they directly benefit by physically have staff in the facility working with existing clients. This methodology would result in a disproportionate distribution of costs, resulting in over-billing Programs two and three, while under-billing Program one. Faster than you can blink an eye, in violation of OMB A-122, this would result in two audit findings: inappropriate allocation methodology and unsupported rent expense, where it’ll be more likely than not, that the organization will be asked to repay the amounts in question. Not only for the specific month that was tested, but expanded to capture the total amount that has been charged for the entire fiscal year. Ouch!
Easy Fixes for Compliance
Below are some effective, but often overlooked, measures that can easily be put into place to avoid the common traps that’ll get you into hot water.
- Check your contract terms and conditions to identify the number of years you are required to maintain program-related records. Pay special attention to when the clock starts ticking. Does the clock start ticking at the end or start of the first fiscal year in which the contract was acquired? Most contracts require that documentation be preserved for five years. Keep current and prior fiscal year records within reach. Monitoring reviews normally evaluate activities relating to the current fiscal year and the last quarter of the prior fiscal year.
- Most agencies are required to maintain a cost allocation plan (CAP), and if not, one should immediately be put into place. At a minimum, the CAP should be evaluated and updated every fiscal year. A CAP is advantageous in that it provides a written guide for how to accurately treat costs (direct, shared and indirect).
- If ever in doubt, ask. Ask the funding department’s representative (usually the individual who signed the contract) for clarification and for documentation purposes, get it in writing. To protect yourself from any possible future conflicts, ensure the person you’re connecting with has proper authority to assist you with your questions.
- Staff your organization with employees or consultants who possess a wide range of experience, background and knowledge of grants. For example, a CPA may appear to be the most likely candidate for managing your nonprofit’s finances. However, keep in mind that although a CPA may be well versed in accounting and GAAP, they may be in the dark about the cost principles or allowability of expenditures governing federal grants. This discrepancy is often highlighted in situations where the single audit report comes back clean, whereas the audit reports from your grant’s funding department identifies numerous issues of noncompliance.
- Ongoing training and in-service of staff. Staff turnover may leave your organization in a vulnerable position. Your cost allocation plan may be all well and good; however, if it’s not correctly applied, it’s just as good as not having one. Continuing education and training will at worst serve as refresher course for existing staff and at best ensure that new hires are adequately equipped with the sharpest tools to get the job done correctly from the start. Furthermore, cross-training employees will serve as a check and balance tool in the sense that it will give assurance that nothing falls through the cracks. See it as an added layer of self monitoring: what one employee may fail to see another employee will notice and timely corrections can be made, if warranted.
- Do not assume that if it was not a finding in the prior year’s monitoring report that it will not surface as an issue in the current year’s review. It is likely that a different auditor from the prior year will be conducting the current monitoring review. This means a fresh pair of eyes and, depending on his/her level of experience, it may or may not be in your favor.
Final Thoughts
Shift from a mentality of complacency to one of active contemplation. This places you in the powerful position of being proactive rather than reactive. Subtle difference, but one that you can feel. One comes from a place of weakness while the other comes from a place of strength.
