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Direct and indirect costs (administrative state)
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In the contexts of administrative law and regulatory economics, the terms direct costs and indirect costs can be used in several different ways:[1][2][3]
- In administrative law, to refer to a set of cost accounting principles that the government requires organizations to use, including on tax forms and when accounting for government grant spending
- In the economic study of regulation, as a method of classifying the social costs of a regulation
Background
Several federal laws and regulations governing tax accounting and the spending of federal grants and awards require businesses and nonprofit organizations to report their direct and indirect costs separately and according to specific definitions. In this context, direct costs are costs taken on by an organization specifically to produce a good, offer a service or accomplish a goal such as completing the research objectives of a federal grant award. These may include the costs of the resources and personnel dedicated to a particular project. Indirect costs are the costs of operating an organization that are not attributable to a specific activity, and may include the costs of utilities, maintenance, distribution, operations, and other factors.[1][2]
These terms have also been employed in regulatory economics to differentiate the costs of administering a regulation or program (direct costs) from the costs of altered economic behavior in response to the regulation or program (indirect costs).[3]
Direct and indirect costs in federal administrative law
Cost principles for federal grants and awards
Title 2, Subtitle A of the Code of Federal Regulations contains guidance from the White House Office of Management and Budget for the administration of grants and agreements by federal agencies.[4] This part of the code includes provisions on cost principles, and requires costs charged to federal awards to be classified as direct or indirect. It defines direct costs in the following way:[1]
| “ | Direct costs are those costs that can be identified specifically with a particular final cost objective, such as a Federal award, or other internally or externally funded activity, or that can be directly assigned to such activities relatively easily with a high degree of accuracy. Costs incurred for the same purpose in like circumstances must be treated consistently as either direct or indirect (F&A) costs.[5] | ” |
| —2 CFR 200.413[1] | ||
Indirect costs are also known as facilities and administrative (F&A) costs, and can be classified as belonging to one of those two categories:[1][6]
| “ | 'Facilities' is defined as depreciation on buildings, equipment and capital improvement, interest on debt associated with certain buildings, equipment and capital improvements, and operations and maintenance expenses. 'Administration' is defined as general administration and general expenses such as the director's office, accounting, personnel and all other types of expenditures not listed specifically under one of the subcategories of 'Facilities' (including cross allocations from other pools, where applicable).[5] | ” |
| —2 CFR 200.414[1] | ||
Cost accounting and federal taxes
According to online guidance offered by QuickBooks, an accounting software developed by the firm Intuit, both government grant programs and federal tax policies require companies to account for and report their direct and indirect costs:[2]
| “ | Cost tracking is crucial for companies that receive government grants or other types of funding. Many government grant programs stipulate that funding be allocated to direct and indirect costs in specific quantities. Violating these policies can put a business’ funding in jeopardy.
Finally, cost tracking can affect a company’s cash flow by raising or lowering its tax burden. After categorizing costs as direct or indirect, a business can deduct certain expenses. In the long run, a reduced tax bill means increased cash flow for your company. On the other hand, misclassifying direct costs as indirect and vice versa can cause issues with the IRS down the line. To comply with federal regulations and avoid audits and tax penalties, an organization needs to report indirect and direct costs separately and on the proper forms.[5] |
” |
| —April Maguire, Quickbooks[2] | ||
As of September 2017, QuickBooks provided the following guidance for classifying costs as direct or indirect:
| “ | Companies classify costs as direct or indirect based on whether or not they are used to produce goods and services. Direct costs refer to costs related to producing goods and can be tracked back to a specific object. ... Most of a company’s direct costs can be separated into direct labor (i.e., the cost of paying employees to produce a product) and direct materials, which include all the raw materials needed to manufacture a particular item. ... Indirect costs are less about product creation and more about overall company maintenance and growth, and usually not traceable to a single department or product. ... A company’s indirect costs may include electricity and utilities, distribution and sales, building maintenance and other expenses related to running an office.[5] | ” |
| —April Maguire, Quickbooks[2] | ||
Direct and indirect costs in regulatory economics
- See also: Compliance costs
Jerry Ellig, a senior research fellow at the Mercatus Center specializing in the federal regulatory process and economic and telecommunications regulation, wrote about the direct and indirect costs of regulation in a 2011 post. He defined the direct costs of regulation as the costs of administering a regulatory agency or government program, such as the cost of paying personnel to enforce a particular rule. Ellig defined the indirect costs of regulation in the following way:[3]
| “ | Indirect costs are the costs to society that occur when people change their behavior in response to incentives created by the regulation. Major indirect costs include value lost when people cut back purchases in response to regulation-induced price increases, reductions in quality or convenience caused by regulation, and risk/risk tradeoffs.[5] | ” |
| —Jerry Ellig (2011)[3] | ||
Ellig has served as chief economist for the Federal Communications Commission, deputy director and acting director of the Office of Policy Planning at the Federal Trade Commission, and senior economist for the Joint Economic Committee of Congress.[7]
See also
External links
- Code of Federal Regulations, "Title 2 - Grants and Agreements, Subtitle A - OMB Guidance for Grants and Agreements
- Search Google News for this topic
Footnotes
- ↑ 1.0 1.1 1.2 1.3 1.4 1.5 Electronic Code of Federal Regulations, "Direct and Indirect (F&A) Costs," accessed September 14, 2017
- ↑ 2.0 2.1 2.2 2.3 2.4 QuickBooks, "What's the Difference Between Direct and Indirect Costs," accessed September 15, 2017
- ↑ 3.0 3.1 3.2 3.3 Mercatus Center, "What Are the indirect Costs of Regulation?" December 1, 2011
- ↑ Electronic Code of Federal Regulations, "Title 2, Subtitle A, Chapter II, Part 200," accessed September 14, 2017
- ↑ 5.0 5.1 5.2 5.3 5.4 Note: This text is quoted verbatim from the original source. Any inconsistencies are attributable to the original source.
- ↑ National Institutes of Health, "7.3 Direct Cost and Facilities and Administrative Costs," accessed September 18, 2017
- ↑ Mercatus Center, "Jerry Ellig," accessed September 15, 2017
