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Introduction The concept of indirect costs is the most misunderstood element of sponsored projects. It's not hard to see why -- it's complicated! Yet, indirect cost recovery provides more than $65 million to the University (approximately $31 million to University Park campus, $23 million to the Applied Research Laboratory, and $11 million to the Medical School) to support programs and projects. So, it's important that faculty and administrators know what they are, how they are calculated, and how they are used. President Spanier has set a goal for Penn State to be the best university in the country at the integration of teaching, research, and service. In order to accomplish this goal, the University relies heavily on external funds. In fiscal year 2000, for instance, the University was awarded $390 million in sponsored projects from the sources outlined in Chart I to support its efforts in teaching, research, and service. This amount represents approximately 20% of the total University budget. Our successful competition for funds to support our sponsored projects reflects the high quality of our faculty, staff, students, and facilities.
Costs involved in conducting projects can be categorized in two ways: as direct costs or as indirect costs. Indirect costs are referred to officially by the federal government as facilities and administrative (F&A) costs. They are also sometimes simply called overhead. Direct costs are defined as "those costs that can be identified specifically with a particular sponsored project relatively easily with a high degree of accuracy." For example, the salary of a principal investigator (PI) or the purchase of a chemical reagent for a specific experiment is a direct cost to the project. Direct costs must be:
Indirect costs are defined as "those that are incurred for common or joint objectives." In other words, indirect costs are costs that cannot be specifically attributed to an individual project.
Examples of indirect costs (we'll call them "F&A costs" hereinafter to be consistent with the new federal terminology) include the services of the accounting staff and research administrators, the cost of utilities for a building housing several research projects, office supplies, postage, local telephone service and communications infrastructure, or salaries of personnel engaged in providing a broad range of departmental support activities. In unusual circumstances costs ordinarily claimed as F&A might be considered direct. The mitigating circumstances relate to the size, nature, or complexity of the project. For example, although administrative and clerical staff salaries are ordinarily defined as F&A costs, if the duties required for a project are of a highly technical nature, then those salaries might be considered direct costs to the project. Typical F&A costs, like postage, photocopying, office supplies, and local telephone service, might be considered a direct cost if justified by the nature of the project, e.g., mail or telephone surveys or supplies for participants. Within University guidelines, PI's must be able to justify a cost as direct or F&A on a case-by-case basis, and those justifications are reviewed by their college financial officer or research administrator. (See Research Administration Guideline RAG-01.)
How is the F&A Rate Calculated? The F&A rates that can be charged to federally sponsored projects are compiled and presented to the U.S. Office of Naval Research (ONR) in a proposal submitted by the University and audited by the Defense Contractor Audit Agency (DCAA). For these negotiations, the University categorizes all F&A costs as facilities or administrative based on the nature of the cost. Costs for building depreciation, equipment depreciation, libraries, and operations and maintenance are categorized as facilities, while costs for general, departmental, and sponsored project administrations are categorized as administrative. The following represents some of the many institutional resources that are included in the F&A rate:
Once the portion of these costs attributable to the research enterprise is calculated, it is converted to an F&A rate by dividing it by the modified total direct costs attributable to research, that is [salaries and wages, fringe benefits, materials and supplies, services, travel, etc.] minus [graduate assistant tuition remission, equipment, plant construction, the portion of each subcontract in excess of $25,000, and patient care costs]. The F&A rate is usually reviewed and updated annually by the Office of Naval Research.
The F&A cost component of a sponsored project is intended to reimburse the University for the costs it incurs to support research. Unfortunately even when the current (FY 2001) 41.4% rate is applied, a portion of the actual costs are not recovered because of limitations placed on us by the federal cost principles. The University further subsidizes the actual costs of research when non-standard F&A rates are applied. Normally no F&A costs are collected from the Commonwealth and some awarding agencies (such as the U.S. Department of Agriculture and many foundations) often limit the allowable F&A costs. The result is that the University collects a little less than 50 cents on every indirect cost dollar spent for sponsored projects. When the standard F&A rate is applied, the costs of graduate student tuition remission, a portion of subcontract amounts, and equipment are subtracted from the total direct costs to establish the MTDC base for the project. The F&A rate is then multiplied by the MTDC base for the project and the resulting F&A costs are added to the direct costs to obtain the total cost for the project. When a non-standard F&A rate is allowed there are usually no deductions from the base; the percent is applied to all direct costs. This is known as the Total Direct Cost (TDC) base. The University's policy covering the recovery of indirect costs is contained in RA06 (http://guru.psu.edu/policies/RA06.html) . Requests for F&A cost modifications should be submitted in accordance with RA06 to the Assistant Vice President for Research or the University Controller through the Office of Sponsored Programs. The request must include letters of support from the unit head(s) and dean(s), written statements from the funders, a brief description of the project, a budget, and a rationale for the request.
What costs are reimbursed by F&A funds? F&A costs represent a reimbursement for expenses already incurred. Therefore, all F&A costs recovered are deposited as general income. They become part of the pool from which the general funds budget is developed for the entire University. To understand how F&A is used, we need to examine what costs are being reimbursed. We will follow administrative costs down three levels in the following illustrations. Level One
Level Two
Level Three
Research Incentive Fund Each year, colleges and IRP* units receive an allocation of special funds to encourage development of faculty research initiatives and new sponsored programs. The size of the allocation provided to each College or Unit is in proportion to their recovered F&A costs.
* Intercollege Research Program (IRP)
F&A - The National View In 1998, Congress directed the White House Office of Science and Technology Policy (OSTP) to conduct a study of university F&A costs. Two reports emerged from this request. The studies covered:
The two studies are:
Concluding Remarks Whether we call them indirect costs or F&A or overhead -- these costs are REAL COSTS. The University is absolutely dependent upon the recovery of our F&A costs in order to maintain the infrastructure necessary to support our sponsored projects. Whether they recognize it or not, faculty experience the benefits of the F&A cost recovery every day -- when they turn on the lights, when their graduate student gets paid, when they order a piece of equipment, when they ask for a time extension on their project, when they file an invention disclosure, when they pick up the telephone, when they use the library, when they ask a staff assistant to type up a report, when they get on the Internet . . .
Penn State Research Administration Tool Box (http://www.rtto.psu.edu/toolbox/index.htm) Penn State Indirect Cost Rates (http://www.rtto.psu.edu/toolbox/rates99-00.htm) University's Policy on Charging of Direct and Indirect Costs (http://guru.psu.edu/policies/RA06.html) Implementing Revised OMB Circular A-21 (http://guru.psu.edu/policies/RAG01.html) U.S. Office of Management and Budget (OMB) Circular A-21: Principles for Determining Costs Applicable to Grants, Contracts and Other Agreements with Educational Institutions (http://www.whitehouse.gov/OMB/circulars/a021/a021.html) Cost Accounting Standards (http://www.rtto.psu.edu/toolbox/cas.pdf) Office of the Vice President for Research (http://www.research.psu.edu/) Office of Sponsored Programs (http://infoserv.rttonet.psu.edu/osp.htm) Penn State University gratefully acknowledges the assistance of the University of Minnesota in the development of this information. Parts of this primer were orginally developed and copyrighted by the University of Minnesota. Their copyrighted material is used with permission.
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Since about two-thirds of the
funds the University receives for sponsored projects come
from the federal government, we must comply with federal 
As an illustration, it is
difficult to say how much of a PI's lab space is used for
a specific research project when multiple research
projects are being conducted there simultaneously. We know the project is
benefiting from the lab
space, but how do we calculate the cost associated with that benefit?
The answer is by using formulae that spread the costs of
the whole lab across all the projects conducted there.
The same basic process is used to do this with all
indirect costs across all projects. 
When conducting sponsored
projects, the University strives to be reimbursed for its
full costs. The components of the total costs of a
research project are shown in Chart II. 
