· The Controller's Office annually prepares a County-wide cost allocation plan pursuant to federal Office of Management and Budget regulations that are contained in Circular A-87 and State guidelines. Local governments must comply with these regulations when charging indirect costs to grants or other programs that are funded by the federal and State governments.

· Pursuant to Circular A-87, certain costs cannot be charged to grants or programs funded by federal and State governments. Appropriately, the Controller's Office has identified certain costs as unallowable in the County-wide cost allocation plan. However, the City also applies Circular A-87 regulations when allocating indirect costs to programs that are not funded by federal or State governments. This is not required. In at least one other California jurisdiction, multi-tiered full cost plans have been developed and are used to ensure that the maximum amount of legitimate indirect costs are allocated to programs other than those governed by federal or State cost allocation regulations. This practice serves to maximize indirect cost reimbursement to the General Fund from user fees, enterprise fund and special fund activities, and is endorsed by the State Controller.

· As a result, the Controller's Office may have missed opportunities to maximize reimbursement for the legitimate cost of providing support services to programs that are not funded by the federal or State governments. If such costs are allocated to these programs, additional revenues could be recovered by the General Fund.

Pursuant to federal regulations authorized by the Budget and Accounting Act of 1921 and several other related acts, the federal Office of Management and Budget (OMB) has prepared OMB Circular A-87, entitled Cost Principles for State, Local and Indian Tribal Governments. The purpose of this circular is to standardize claims for the reimbursement of costs related to federal programs and grants, according to uniform principles of cost accounting and definitions of allowable indirect costs. The federal agency responsible for implementing OMB Circular A-87 is the Department of Health and Human Services (HHS). In that capacity, HHS designated the State Controller's Office as the cognizant agency to oversee implementation of A-87 cost plan procedures in California. Accordingly, the State Controller has developed and issued a handbook of procedures and requirements to be followed by counties.

In Section 8 of this report, the Budget Analyst discusses OMB Circular A-87 cost plan requirements and allowable costs. This Section discusses opportunities for maximizing General Fund reimbursements from programs that are not funded by the federal or State governments.

Unallowable Costs in an A-87 Conforming Plan

OMB Circular A-87 defines the tests to be used by local governments when determining those costs that can be charged to federal and State funded grants and programs. Four tests provide guidance regarding those costs that cannot be charged in an A-87 conforming plan:

· Costs must be necessary and reasonable for the proper and efficient performance and administration of the program.

· Costs must be permissible under A-87 guidelines (not a specific unallowable cost).

· Costs must not be prohibited by state or local laws or regulations.

· Costs must be consistent with policies, regulations and procedures that apply uniformly to both federal programs and grants, and other activities of the governmental unit.

Other tests related to the treatment of costs and program revenues guide preparers on other technical aspects of the plan.

OMB Circular A-87, Attachment B, identifies various specific items of cost that are unallowable. These include:

1. Advertising and public relations (certain exceptions apply);

2. Alcoholic beverages;

3. Bad debt losses;

4. Value of donated services;

5. Contingency appropriations and reserves;

6. Contributions and donations;

7. Defense and prosecution of civil and criminal proceedings and claims;

8. Entertainment, including tickets, travel, meals, lodging and gratuities;

9. Fines and penalties related to violations of federal, state or local laws;

10. Fund raising and investment management costs, except for pension fund investment management;

11. General government costs, including salaries and other costs of the legislative body and the executive office, all judicial branch costs and other general government services provided to the general public, such as fire and police protection;

12. Idle facilities and capacity, meaning unused buildings and equipment and the related costs of such idle facilities;

13. Interest related to the financing of operations;

14. Lobbying and membership costs in lobbying organizations; and,

15. Upgraded commercial air travel in excess of coach class.

Pursuant to A-87 restrictions regarding unallowable costs, the FY 2002-03 cost plan prepared by the Controller's Office accounted for $561 million of net indirect costs to be allocated to all of the programs and functions of the City and County. The Controller's Office identified $26.4 million of costs that it considered unallowable.

Multi-Tiered Full Cost Plans

The Controller's Office has identified certain costs as unallowable in the cost plan because such costs meet the A-87 test which excludes "general government costs, including salaries and other costs of the legislative body and the executive office, all judicial branch costs and other general government services provided to the general public, such as fire and police protection." Accordingly, many legitimate costs - such as those related to budget, audit and legal services - could be charged under a full cost plan. The Controller's Office has not identified which of these costs could be allocated under a full cost plan nor the revenue gain to the City by allocating costs under a full cost plan.

The distinction between an A-87 cost plan and a full cost plan is based on the differences in the programs and functions to which indirect costs can be allocated. A-87 cost plans are required for all federal and State grants and programs, and must comply with the cost criteria and limitations of the A-87 regulations. Full cost plans are based on the policies and criteria of a governmental unit's governing board. Therefore, a board of supervisors can establish the criteria to be followed when deciding which costs should be included in a full cost plan, even if such costs are not allowable or allocable under A-87 cost allocation regulations. Unlike A-87 cost plans, full cost plans can only be used to allocate costs to programs and functions that do not receive federal or State funding, and for purposes of developing user fees and charges for services.

The practice of developing multiple cost plans for differing applications is recommended by the State Controller in the Handbook of Cost Plan Procedures for California Counties. Section 1430 of the handbook states, in relation to federal and State grants, that:

" . . . counties should monitor the reimbursement process to ensure that maximum reimbursements have been received for all program costs, including indirect overhead. Additionally, any departments that charge outside agencies for their services should be monitored to ensure that the billing structures used recover all applicable costs, including indirect overhead."

Further, Section 1460 of the State Controller's cost plan handbook states that county departments that do not receive federal and State funds and who are:

". . . charging for their services can utilize the cost plan in determining their billing rate structures. If a department charges the public a fee for the service it provides, the board of supervisors should be aware of the total cost of providing that service, including all applicable indirect costs. This will allow the supervisors to establish fees at the appropriate level to recover the true costs associated with the services provided. Even if the department is not charging a fee for the service, this concept can be employed as a management tool in identifying countywide overhead costs to all applicable departments."

Section 1470 states in part:

"A county could prepare a `fullcosting plan' to identify all county overhead costs to the appropriate departments, including those costs that are currently considered unallowable (e.g., general government costs)."

The practice of preparing multiple cost plans is used by other counties in order to maximize the appropriate allocation of all indirect costs among funds within the County and governmental units that receive services from the County. As an example, Los Angeles County reports that it annually prepares four cost plans, including (1) an A-87 plan for State and federal programs and grants; (2) an enterprise fund plan; (3) a plan for internal use with other County funds; and, (4) a plan for use when charging non-County government entities.

The City and County of San Francisco currently prepares a single plan which generally conforms with the regulations contained in OMB Circular A-87. According to the Controller, the preparation of a full cost plan would yield very little benefit to the County, since much of the A-87 unallocated cost is either recovered through direct charges to departments or would be charged to General Fund departments or other funds which are incapable of reimbursing the General Fund. While there is some merit to the Controller's comments, these assertions were not convincingly demonstrated during the course of this management audit. For example, if the full cost allocation were to yield an average increase of only one percent on the $81.2 million in fees collected by the City each year, over $800,000 in additional income would be realized.

Accordingly, the Controller should identify unallocated costs that could be allocated through a full cost plan. Once such costs have been identified, a test allocation should be conducted to clearly establish the net General Fund benefit that would be derived from implementing such a plan in the City. Until such testing is comprehensively completed, the revenue benefits to the City will not be known. If a multi-tiered cost plan approach could be employed, as suggested by the State Controller and as is done by other jurisdictions such as the County of Los Angeles, the General Fund of the City and County of San Francisco potentially could recover additional annual revenues.

Conclusions

The Controller's Office annually prepares a County-wide cost allocation plan pursuant to federal Office of Management and Budget regulations that are contained in Circular A-87 and State guidelines. Local governments must comply with these regulations when charging indirect costs to grants or other programs that are funded by the federal and State governments.

Pursuant to Circular A-87, certain costs cannot be claimed on grants or programs funded by the federal and State governments. Appropriately, the Controller's Office has appropriately identified certain costs as unallowable in the County-wide cost allocation plan.

However, the City also applies Circular A-87 regulations when allocating indirect costs to programs that are not funded by federal or State governments. This is not required. In other California jurisdictions, full cost plans have been developed and are used to ensure that the maximum amount of legitimate indirect costs are allocated to programs other than those governed by federal or State cost allocation regulations. This practice serves to maximize indirect cost reimbursement to the General Fund from user fee, enterprise and special fund activities, and is endorsed by the State Controller.

As a result, the Controller's Office may have missed opportunities to maximize reimbursement for the legitimate cost of providing support services to programs that are not funded by the federal or State governments. If such costs are allocated to these programs in FY 2002-2003, additional revenues could be recovered by the General Fund.

Recommendations

The San Francisco Controller should:

9.1 Direct staff to conduct a test allocation of A-87 unallocated costs to determine potential General Fund revenues that could be realized from implementing a multi-tiered cost plan;

9.2 If appropriate based on the results of the test plan, direct staff to prepare multi-tiered full cost plans, in accordance with State Controller guidelines and modeled after similar plans in other jurisdictions; and,

9.3 Allocate full costs to departments and non-General Fund activities in order to maximize reimbursement to the General Fund.

The Board of Supervisors should:

9.4 Based on the results of the Controller's test plan, consider adoption of legislation that would require the Controller to annually prepare multi-tiered full cost plans, which appropriately allocates costs to departments and non-General Fund activities. The full cost plans would include allocations of costs that are not allocable for federal or State claiming purposes under Circular A-87 regulations.

Costs and Benefits

The Controller will incur some additional staff time during the development of the full cost plan models. Staff from the Internal Audit Division or City Projects Division can be temporarily diverted to assist the Cost Plan Accountant during the development phase. Accordingly, there will be no incremental costs associated with the implementation of these recommendations.

The General Fund will recover additional revenue annually in reimbursements from user fees and charges to other funds, although the actual amount of revenue can not be know until the Controller's Office identifies and distributes unallocated costs.