COMPLIANCE TEST OF USE OF FEDERAL FUNDS   REF: FINANCIAL ANALYSIS
                                               OFFICE

All charges to Federal awards must meet the tests of reasonableness, 
allowability and allocability in accordance with the provision of 
OMB Circular A-21 and the terms and conditions of the grant or other 
agreement.  The draft Department of Health and Human Services 
"Guidelines for Audits of Federal Awards to Educational Institutions" 
details the following determinations to assist the non-Federal 
auditor in testing specific charges:

1.	DETERMINE WHETHER THE CHARGES ARE NECESSARY AND REASONABLE.

	The purpose, authorization and timing of transactions should 
be examined in relation to whether such transactions are generally 
recognized as ordinary, prudent, relevant, and necessary within 
established practices.

	A-21 has defined "reasonable costs" as reasonable if the 
nature of the goods or services acquired and the amount involved 
reflect the action that a prudent person would have taken under 
the circumstances.

	The provision of A-21, which defines allowable and 
unallowable costs, and costs requiring approval of Federal 
agencies is particularly pertinent to this determination.

2.	DETERMINE WHETHER THE CHARGES CONFORM TO ANY LIMITATIONS 
OR EXCLUSION IN THE AWARD. (ALLOWABLE)

	Violations of the terms and conditions of an award will 
result in the related costs being classified as questionable by 
the auditor regardless of whether such costs meet other aspects 
of A-21.  For example, one Federal award may have a limitation 
on the amount of indirect costs that may be charged to it.

3.	DETERMINE WHETHER THE CHARGES WERE GIVEN CONSISTENT 
ACCOUNTING TREATMENT AND APPLIED UNIFORMLY TO BOTH FEDERAL AWARDS 
AND OTHER ACTIVITIES OF THE INSTITUTION.

	Consistency relates not only to applying an accounting 
treatment in a similar manner within a period and from one reporting 
period to another; it also requires that both the accounting methods 
and practices be uniformly applied to Federal, non-Federal and all 
other institution activities with and between reporting periods.

4.	DETERMINE WHETHER THE CHARGES WERE NET OF APPLICABLE CREDITS.

	The phrase "applicable credits" refers to those receipts or 
negative expenditures that operate to offset or reduce direct or 
indirect costs (purchase discounts, rebates, trade-ins, etc.)
                       
	The Intent of this requirement is to assure that the Federal 
awards are being charged for the actual cost or net cash disbursed 
for charges.
	
5.	DETERMINE THAT CHARGES ARE ALLOCABLE TO THE FEDERAL AWARD.

	A cost is allocable to a particular cost objective (i.e., 
a specific function, project, sponsored agreement, department or 
the like) if the goods or services involved are chargeable or 
assignable to such cost objective in accordance with relative 
benefits received or other equitable relationship.

	A cost is allocable to a Federal Award if:

      * it is incurred solely to advance the work under the award.

      *	it benefits the award agreement jointly with other activities 
        of the institution and can be documented, or

      * it is necessary for the overall operation of the institution 
        and is assignable in part (under A-21) to Federal awards.

6.	DETERMINE WHETHER THE CHARGES WERE PROPERLY RECORDED i.e., 
CORRECT AMOUNT, DATE, AND SUPPORTED BY SOURCE DOCUMENTATION.

	To satisfy the source documentation requirement, the auditor 
needs to examine the existence and evidence supporting the type of 
cost, the purpose for which it was incurred, the time period incurred, 
the amount of such cost (itemized to the extent necessary), and 
approvals in accordance with management's directives.

7.	DETERMINE WHETHER THE CHARGES WERE APPROVED IN ADVANCE, IF 
SUBJECT TO PRIOR APPROVAL IN ACCORDANCE WITH CIRCULAR A-21 OR TERMS 
OF THE AWARD.

	Circular A-21 indicates that prior approval is required with 
respect to specific types of expenditures.  In addition, an award 
agreement may require advance approval for other specific costs.

8.	DETERMINE WHETHER THE CHARGES WERE INCURRED IN ACCORDANCE 
WITH COMPETITIVE PURCHASING PROCEDURES, IF COVERED BY OMB A-110, 
ATTACHMENT O - PROCUREMENT STANDARDS.

	Attachment O established standards and guidelines for the 
procurement of supplies, equipment, construction and services for 
Federal awards programs.
                       
9.	DETERMINE WHETHER INDIRECT COST RECOVERY WAS BASED ON THE 
PROPER INDIRECT COST RATE, PROPERLY DISTRIBUTED AND NOT MISSTATED 
BY PROCESSING ERRORS.
                       
						                              
	Institutions are required to file an indirect cost proposal 
annually with their respective Federal cognizant agency to establish 
a basis (subject to negotiation) for the recovery of indirect costs.  
Institutions may negotiate single or multiple indirect cost rates for 
Federal award.

SELECTED PROVISIONS OF OMB CIRCULAR A-21

A. Pre-existing Language

The basic considerations of allowability of cost have been in place 
since at least the 1974 re-issuance of OMB Circular A-21.  They include 
the following:

	C.2. Factors affecting allowability of costs.  The test of 
allowability of costs under these principles are: (a) they must 
reasonable; (b) they must be allocable to sponsored agreements under 
the principles and methods provided herein; (c) they must be given 
consistent treatment through application of those generally accepted 
accounting principles appropriate to the circumstances; and (d) they 
must conform to any limitations or exclusions set forth in these 
principles or in the sponsored agreement as to types or amounts of 
cost items.

	C.3. Reasonable costs.  A cost may be considered reasonable 
if the nature of the good or services acquired or applied, and the 
amount involved therefore, reflect the action that a prudent person 
would have taken under the circumstances prevailing at the time the 
decision to incur the cost was made.  Major considerations involved 
in the determination of the reasonableness of a cost are: (a) whether 
or not the cost is of a type generally recognized as necessary for 
the operation of the institution or the performance of the sponsored 
agreement; (b) the restraints or requirements imposed by such factors 
as arm's-length bargaining, Federal and State Laws and regulations, 
and sponsored agreement terms and conditions: (c) whether or not the 
individuals concerned acted with due prudence in the circumstances, 
considering their responsibilities to the institution, its employees, 
its students, the Government, and the public at large; and (d) the 
extent to which the actions taken with respect to the incurrence of 
the cost are consistent with established institutional policies and 
practices applicable to the work of the institution generally, 
including sponsored agreements.
                                
	C.4. A cost is allocable to a particular cost objective 
(i.e., a specific function, project, sponsored agreement, department, 
or the like) if the goods or services involved are chargeable or 
assignable to such cost objective in accordance with relative benefits 
received or other equitable relationship.  Subject to the foregoing, 
a cost is allocable to a sponsored agreement if (1) it is incurred 
solely to advance the work under the sponsored agreement; (2) it 
benefits both the sponsored agreement and other work of the 
institution, in proportions that can be approximated through use 
of reasonable methods, or (3) it is necessary to the overall 
operation of the institution and, in light of the principles 
provided in this Circular, is deemed to be assignable in part 
to sponsored projects.  Where the purchase of equipment or other 
capital items is specifically authorized under a sponsored 
agreement, the amounts thus authorized for such purchases are 
assignable to the sponsored agreement regardless of the use that 
may subsequently be made of the equipment or other capital items 
involved.

	C.4b. Any costs allocable to a particular sponsored 
agreement under the standards provided in this Circular may 
not be shifted to other sponsored agreements in order to meet 
deficiencies caused by overruns or other fund considerations, 
to avoid restrictions imposed by law or by terms of the 
sponsored agreement, or for other reasons of convenience.


The core principles for distinguishing between direct and 
indirect costs are as follows:


	Direct Costs

	D.1. General.  Direct costs are those costs that can 
be identified specifically with a particular sponsored project, 
an instructional activity, or any other institutional activity;
or that can be directly assigned to such activities relatively 
easily with a high degree of accuracy...


	Indirect costs

	E.1. General.  Indirect costs are those that are incurred 
for common or joint objectives and therefore cannot be identified 
readily and specifically with a particular sponsored project, an 
instructional activity, or any other institutional activity...