Published by the MIT News Office at the Massachusetts Institute of Technology, Cambridge, Mass.
Published by the MIT News Office at the Massachusetts Institute of
Technology, Cambridge, Mass.
5/8/91 2:58 PM 1 FACILITIES ARE 3/5 OF INDIRECT COSTS Overhead at MIT--What's It All About? (This is the third article in an occasional series on overhead or indirect costs. It is presented in the format of a question-and-answer interview conducted by MIT Tech Talk with James J. Culliton, Vice President for Financial Operations. Italics have been used to highlight key sentences from the Federal laws or regulations. Bold-face type is used to highlight information for the reader.) TT: Let's start with a bit of history about MIT's involvement in research for the government. Culliton: MIT has been a major contributor to federally-funded research since before World War ll, when President Franklin D. Roosevelt appointed Vannevar Bush of MIT to head a new agency called the National Defense Research Committee. The committee evolved into the Office of Scientific Research and Development (OSRD) employing over 30,000 scientists concentrating on scientific research for all aspects of the war. At MIT, these efforts resulted most notably with the development of microwave radar at the MIT Radiation Laboratory. TT: How was this followed up after the war? Culliton: The Navy, recognizing the benefits to the nation of university-based scientific research, established the Office of Navy Research (ONR) in 1946 to "plan, foster, and encourage scientific research". In 1947, MIT negotiated the first formal principles for determining and reimbursing applicable research costs based on MIT's accounting system. This very productive research relationship between MIT and ONR has continued to the present day. TT: How have these early principles of cost-sharing between the government and university evolved and developed? Culliton: The Executive Office of Management and Budget (OMB) first issued "Circular A-21" in 1958 and has modified it over the years. TT: What is Circular A-21? Culliton: It establishes the cost principles for educational institutions to assure "that the Federal Government bears its fair share of total costs, determined in accordance with generally accepted accounting principles." PRINCIPLES OF OMB CIRCULAR A-21 TT: What about the practices of cost-recovery used at MIT? Culliton: Most of these have been in effect for a number of years and have evolved from extensive consultation, discussion, and documentation between government agencies and MIT. They have been developed primarily in recognition of two basic principles established in Circular A-21: TT: And these are? Culliton: First, "Each institution, possessing its own unique combination of staff, facilities, and experience, should be encouraged to conduct research and educational activities in a manner consonant with its own academic philosophies and institutional objectives...." Second, "The dual role of students engaged in research and the resulting benefits to sponsored agreements are fundamental to the research effort and shall be recognized in the application of these principles". TT: Has this had a salutary effect on university-based research? Culliton: In my opinion , these two principles of research policy have created a cost accounting structure that has helped to make the United States the unquestioned leader of the world in scientific and technological research and development. TT: To get to specifics, how are these principles applied in the case of MIT? Culliton: There are four tests of allowability of costs that have developed in A-21 as the result of extensive consultation between university and government officials. Rather than explicit definition, these tests rely heavily on judgment and historical precedent. TT: What are the four tests, in general terms? Culliton: One. They must be reasonable Two.They must be allocable to sponsored agreements under A-21 principles and methods. Three they must be given consistent treatment through application of those generally accepted accounting principles appropriate to the circumstances Four They must conform to any limitation or exclusions set forth in A-21 or in the sponsored agreement as to type or amount of cost items." HOW IT WORKED IN FY90 TT: How does MIT fit into all of this? What are the numbers? Culliton: In Fiscal 1990, MIT received $311 million in research grants and contracts from private and federal sponsors (excluding awards to Lincoln Laboratory). Of that amount, $292 million was spent for research conducted on the Cambridge campus, with the balance for research conducted at off-campus locations, such as the Haystack Observatory. The $292 million consisted of two components. The first $203 million was spent on direct costs of research and the balance, $89 million, is the portion of the total indirect or overhead costs which are allocable to the on-campus research program. TT: How did you arrive at $89 million ? Culliton: Because of government rules, certain direct expenses are not charged with indirect cost. .Therefore, in order to recover the allowable $89 million in indirect cost, MIT applied an indirect cost rate of 62% to a subset of direct cost, referred to as the "modified total direct cost (MTDC) base. Indirect costs actually amounted to only 30 cents of each dollar of on-campus research grants in Fiscal 1990. TT: What are the factors that determine whether indirect costs are recoverable? Culliton: The amount recovered from research sponsors depends on the nature of the expense and who benefits. Recovery ratios for specific cost items are developed in certain mandated pooled costs in accordance with Circular A-21. 8 COST POOLS TT: How many of these cost pools are there? Culliton: Eight. TT: Could you describe them, and also give the allocated percentage of MTDC to each pool created the 62% rate in Fiscal 1990)? Culliton: We'll start with Building Use, at 6.5%, and Equipment Depreciation, at 6.7%. Circular A-21 states, "These expenses are the portion of the costs of the institution's buildings, capital improvements to land and buildings, and equipment provided they are used, needed in the institution's activities, and properly allocable to sponsored agreements. Compensation shall be made by computing either depreciation or use allowance." At MIT, the formula used for allocating buildings to research is an annual Building Use of 2% of the non-federal capital cost of each building, multiplied by the ratio of net assignable square feet supporting research to the building's total net assignable square feet, done on a building-by-building approach. (A-21 establishes use charge on an assumed 50-year building life.) TT: And the Equipment Depreciation charge? Culliton: At MIT, the formula used for allocating equipment to research is an annual depreciation charge (varying for specific equipment, but averaging 7.5 years) to sponsors of the non-federal capital cost of equipment in each building, on the same ratio as indicated above for buildings. TT: Why is there a depreciation, rather than use,charge for equipment? Culliton: MIT switched to depreciation in 1985 because of the growing rapid obsolescent of equipment used by MIT. One example is the the increased use of computers. Under the "use basis," we are required to use a 15-year life for all equipment, including personal computers. On the "depreciation basis," we use a six-year life for computers. Over the past few years, depreciation of equipment charges has accounted for a large portion of the increase in the indirect cost rate. MIT has established and maintains a very comprehensive inventory of all equipment through the MIT Property Office. TT: What is the next cost pool? Culliton: Operations and Maintenance, at 23.3% Circular A-21 states, "These expenses are those that have been incurred by a central service organization or at the department level for the administration, supervision, operation, maintenance, preservation, and protection of the institution's physical plant--including janitorial and utility services; repairs and ordinary or normal alterations of buildings, furniture and equipment; and care of grounds and maintenance and operation of buildings and other plant facilities." At MIT, the formula used for allocating Operations and Maintenance is the ratio of net assignable square feet supporting research to the building's total net assignable square feet, done on a building-by- building approach. In addition, MIT has performed a number of studies of utility and other costs to assure that the allocation to research is properly accountable on usage. TT: Does this hold true both on and off campus? Culliton: The major difference between the allocation of indirect costs between on-campus research and off-campus research--primarily Lincoln Laboratory--.is that off-campus operations and maintenance costs are charged directly to the research projects off-campus. Therefore, most operations and maintenance indirect costs are not allocated to off- campus activities, nor are certain other categories of indirect cost. TT: Can there be any recovery on interest paid for money borrowed for construction purposes? Culliton:In 1979, an amendment to A-21 permitted the inclusion for recovery purposes of the costs incurred for interest on borrowed capital. This has enabled MIT to accomplish much of its construction program since 1979 --for buildings such as the Building 39 renovation for the VLSI laboratory and others-- by issuing tax-exempt bonds and recovering from sponsors the interest allocable to research in each construction project through the indirect cost rate. The major pressure on the indirect cost rate in future years is increased costs for new capital projects, such as the science complex, including a new biology building and renovations to Buildings 16 and 56. TT: These first two pools you've mentioned seem to account for a large portion of indirect cost charges. Culliton: The overhead or indirect cost for Operations and Maintenance, Interest, Use Charge and Depreciation --which we lump together as Facilities--is 37.8%, or three-fifths of the 62 percent rate. TT: Next? Culliton: The next cost pool is Departmental Administration, at 7.7%. Circular A-21 states, "These expenses are those that have been incurred for administrative and supporting services that benefit common or joint departmental objectives ... in academic departments and divisions and organized research institutes, study centers, and research centers, subject to certain limitations." At MIT, the formula used for allocating Departmental Administration, which includes laboratory directors, is department-by-department ratio of the modified total direct costs of research (MTDC) to the modified total direct costs of research and instruction. MIT SAVED U.S. $8M TT: Haven't you used this category to illustrate MIT's policy of not establishing or using procedures that would take advantage of latitude in interpreting A-21 or other government rules? Culliton: Yes. Exactly. While MIT research policy has always been to assure full cost recovery for properly allocable research expense, we have not taken advantage of regulations that would have favored a reimbursement in excess of the cost incurred .In this cost pool, for example, the government in 1988, in an effort to reduce costs to the government, set a fixed rate for faculty and selected professional personnel's administrative effort in Departmental Administration at 3.6% of MTDC. If we had implemented this percentage ,which required no documentation, we would have experienced a windfall increase in recovery of over $2 million that year (the amount by which the 3.6% rate yields an amount exceeding the cost incurred. We did not implement the fixed rate because it did not appear proper to take advantage of a government change designed in principle to save costs of research paid by the government. To date, this decision by MIT has meant that a total of over $8 million of allowable reimbursement has not been recovered from research sponsors for the Fiscal years 1988, 1989 and 1990. TT: Has this MIT policy been formalized in any way? Culliton: MIT's agreement to forego this "windfall" is outlined in a Memorandum of Understanding (MOU) between MIT and the Office of Naval Research, one of the six active MOU's between MIT and the government. The number of MOU's between each university and the government and the issue of who benefits from each MOU was a major topic of controversy during the Stanford investigation. TT: What's the next cost pool? Culliton: The fifth cost pool is General Administration, at 10.1.% Circular A-21 states, "These expenses are those that have been incurred for the general executive and administrative offices of educational institutions and other expenses of a general character which do not relate solely to any major function of the institution, that is, solely to instruction, organized research, other sponsored activities, or other institutional activities." At MIT, the formula used for allocating General Administration is primarily the ratio of the total modified costs of research to the institute's modified total costs. General Administration expenses includes many of the costs of the central administration including the costs associated with most members of the Academic Council, as well as other central support services. TT: Next? Culliton: We have Sponsored Projects Administration, at 2.3%. Circular A-21 states, "These expenses are those that have been incurred by a separate organization(s) established primarily to administer sponsored research projects, including such functions as grant and contract administration (federal and non-federal), special security, purchasing, personnel administration, and editing and publishing of research and other reports." At MIT, the formula used for allocating Sponsored Projects Administration is 100% to research. As an example, the Office of Sponsored Programs at MIT is allocated at 100% research, except for the director and those associate directors who are involved in matters other than strictly research related. TT: A seventh cost pool? Culliton: That's the Library, at 2.9%. Circular A-21 states,."These expenses are those that have been incurred for the operation of the library, including the cost of books, and library materials purchased for the Library, less any items of Library income that qualify as applicable credits." At MIT, the formula used for allocating the Library has been a contractual Memorandum of Understanding between ONR and MIT , based on a negotiated rate for the Fiscal years 1986-1990. The MOU is no longer active and a new study will be undertaken to establish the costs to be recovered in future fiscal years. The library recovery was approved at 49% by ONR in the 1986 MOU as the result of a decision by ONR to establish a rate between MIT's proposed rate and the Defense Contract Audit Agency (DCAA) developed rate. (A recent review concluded that the actual rate was higher than 49%). The major difference in the MIT proposed rate and the DCAA proposed rate was whether non-employed graduate students should be considered a part of the organized research effort. MIT said, and was supported by ONR in the view, that all graduate students are part of the organized research effort at MIT. TT: The eighth, and final, cost pool? Culliton : That's Student Administration, at 2.5%. Circular A-21 states, "These expenses are those that have been incurred for the administration of student affairs and for services to students, including expenses of such activities as deans of students, admissions, registrar, counselling and placement services, student advisors, student health and infirmary services, catalogs, and commencement and convocations." At MIT, the formula used for allocating Student Administration has been a negotiated ratio between ONR and MIT for the Fiscal years 1986-1990 and, like Library costs. was the subject of a MOU between the government and MIT. This MOU also is no longer active and a new study will be undertaken to establish the costs to be recovered each year. The ONR approved recovery ratio for the last five fiscal years was 24.5%, based on the ratio of student research hours to total student hours. TT: These cost elements seem quite straightforward. Culliton: They are. While each has further details associated with implementation, I hope the description gives a better understanding of the elements of indirect cost and how each is developed at MIT. THE BENEFIT TO THE NATION TT: You started by speaking of the benefits to the nation of university- based scientific research. Perhaps you want to conclude on the same note. Culliton. I'm happy to. It's important to keep in mind the tremendous underlying value of university research to the nation in discussing any cost/benefit review of results. As an example, a 1981 report, "Basic Research Returns," prepared by Bruce S. Old Association, Inc., for the Office of Naval Research, selected three projects at MIT, "to attempt to discover for each project what new knowledge had been created, where it had been utilized to the benefit of the nation, what people were trained, and what contributions they had made to society." The three projects chosen were Project Whirlwind, which was the development of a high speed computer; the development of the Laboratory for Nuclear Science; and the impact of a single professor,in this case, Morris Cohen, who from 1947 to 1981 had 40 consecutive graduate theses funded by ONR. The report outlines the "truly amazing series of paybacks" in regard to the the knowledge created and utilized, the people trained, and their contributions The report said that this was "only the tip of the iceberg," and added "even so, the small sample of basic research events studied has already given birth to an indescribably large tip." Finally, the report emphasizes the importance of joint government- university research and states that the partnership should not be viewed by the nation as support, but investment. In the report's words, "We invest in basic research because we expect returns in the future from the knowledge developed and the people trained. The vast returns demonstrated--in these three projects --are just a few examples which should serve to notify our citizenry that some Congresses and defense officials have indeed acted with great wisdom."