Cost Principles for State, Local, and Indian Tribal Governments (OMB Circular A-87), 51910-51927 [05-16649]

Agencies

• Office of Management and Budget
• Management and Budget Office

[Federal Register Volume 70, Number 168 (Wednesday, August 31, 2005)]
[Rules and Regulations]
[Pages 51910-51927]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-16649]



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OFFICE OF MANAGEMENT AND BUDGET

2 CFR Part 225


Cost Principles for State, Local, and Indian Tribal Governments 
(OMB Circular A-87)

AGENCY: Office of Management and Budget

ACTION: Relocation of policy guidance to 2 CFR chapter II.

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SUMMARY: The Office of Management and Budget (OMB) is relocating 
Circular A-87, ``Cost Principles for State, Local, and Indian Tribal 
Governments,'' to Title 2 in the Code of Federal Regulations (2 CFR), 
Subtitle A, Chapter II, part 225 as part of an initiative to provide 
the public with a central location for Federal government policies on 
grants and other financial assistance and nonprocurement agreements. 
Consolidating the OMB guidance and co-locating the agency regulations 
provides a good foundation for streamlining and simplifying the policy 
framework for grants and agreements as part of the efforts to implement 
the Federal Financial Assistance Management Improvement Act of 1999 
(Pub. L. 106-107).

DATES: This document is effective August 31, 2005. This document 
republishes the existing OMB Circular A-87, which already is in effect.

FOR FURTHER INFORMATION CONTACT: Gil Tran, Office of Federal Financial 
Management, Office of Management and Budget, telephone 202-395-3052 
(direct) or 202-395-3993 (main office) and e-mail: Hai--M.--
Tran@omb.eop.gov.

SUPPLEMENTARY INFORMATION: On May 10, 2004 [69 FR 25970], we revised 
the three OMB circulars containing Federal cost principles. The purpose 
of those revisions was to simplify the cost principles by making the 
descriptions of similar cost items consistent across the circulars 
where possible, thereby reducing the possibility of misinterpretation. 
Those revisions, a result of OMB and Federal agency efforts to 
implement Public Law 106-107, were effective on June 9, 2004.
    In this document, we relocate OMB Circular A-87 to the CFR, in 
Title 2 which was established on May 11, 2004 [69 FR 26276] as a 
central location for OMB and Federal agency policies on grants and 
agreements.
    Our relocation of OMB Circular A-87 does not change the substance 
of the circular. Other than adjustments needed to conform to the 
formatting requirements of the CFR, this notice relocates in 2 CFR the 
version of OMB Circular A-87 as revised by the May 10, 2004 notice.

List of Subjects in 2 CFR Part 225

    Accounting, Grant administration, Grant programs, Reporting and 
recordkeeping requirements, State, local, and Indian tribal 
governments.

    Dated: August 8, 2005.
Joshua B. Bolten,
Director.

Authority and Issuance

0
For the reasons set forth above, the Office of Management and Budget 
amends 2 CFR Subtitle A, Chapter II, by adding a part 225 as set forth 
below.

PART 225--COST PRINCIPLES FOR STATE, LOCAL, AND INDIAN TRIBAL 
GOVERNMENTS (OMB CIRCULAR A-87)

Sec.
225.5 Purpose.
225.10 Authority
225.15 Background
225.20 Policy.
225.25 Definitions.
225.30 OMB responsibilities.
225.35 Federal agency responsibilities.
225.40 Effective date of changes.
225.45 Relationship to previous issuance.
225.50 Policy review date.
225.55 Information Contact.
Appendix A to Part 225--General Principles for Determining Allowable 
Costs
Appendix B to Part 225--Selected Items of Cost
Appendix C to Part 225--State/Local-Wide Central Service Cost 
Allocation Plans
Appendix D to Part 225--Public Assistance Cost Allocation Plans
Appendix E to Part 225--State and Local Indirect Cost Rate Proposals

    Authority: 31 U.S.C. 503; 31 U.S.C. 1111; 41 U.S.C. 405; 
Reorganization Plan No. 2 of 1970; E.O. 11541, 35 FR 10737, 3 CFR, 
1966-1970, p. 939.


Sec.  225.5  Purpose.

    This part establishes principles and standards for determining 
costs for Federal awards carried out through grants, cost reimbursement 
contracts, and other agreements with State and local governments and 
federally-recognized Indian tribal governments (governmental units).


Sec.  225.10  Authority.

    This part is issued under the authority of the Budget and 
Accounting Act of 1921, as amended; the Budget and Accounting 
Procedures Act of 1950, as amended; the Chief Financial Officers Act of 
1990; Reorganization Plan No. 2 of 1970; and Executive Order No. 11541 
(``Prescribing the Duties of the Office of Management and Budget and 
the Domestic Policy Council in the Executive Office of the 
President'').


Sec.  225.15  Background.

    As part of the government-wide grant streamlining effort under 
Public Law 106-107, Federal Financial Award Management Improvement Act 
of 1999, OMB led an interagency workgroup to simplify and make 
consistent, to the extent feasible, the various rules used to award 
Federal grants. An interagency task force was established in 2001 to 
review existing cost principles for Federal awards to State, local, and 
Indian tribal governments; colleges and universities; and non-profit 
organizations. The task force studied ``Selected Items of Cost'' in 
each of the three cost principles to determine which items of costs 
could be stated consistently and/or more clearly.


Sec.  225.20  Policy.

    This part establishes principles and standards to provide a uniform 
approach for determining costs and to promote effective program 
delivery, efficiency, and better relationships between governmental 
units and the Federal Government. The principles are for determining 
allowable costs only. They are not intended to identify the 
circumstances or to dictate the extent of Federal and governmental unit 
participation in the financing of a particular Federal award. Provision 
for profit or other increment above cost is outside the scope of this 
part.


Sec.  225.25  Definitions.

    Definitions of key terms used in this part are contained in 
Appendix A to this part, Section B.


Sec.  225.30  OMB responsibilities.

    The Office of Management and Budget (OMB) will review agency 
regulations and implementation of this part, and will provide policy 
interpretations and assistance to insure effective and efficient 
implementation. Any exceptions will be subject to approval by OMB. 
Exceptions will only be made in particular cases where adequate 
justification is presented.


Sec.  225.35  Federal agency responsibilities.

    Agencies responsible for administering programs that involve cost 
reimbursement contracts, grants, and other agreements with governmental 
units shall issue regulations to implement the provisions of this part 
and its appendices.


Sec.  225.40  Effective date of changes.

    This part is effective August 31, 2005.


Sec.  225.45  Relationship to previous issuance.

    (a) The guidance in this part previously was issued as OMB Circular

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A-87. Appendix A to this part contains the guidance that was in 
Attachment A (general principles) to the OMB circular; Appendix B 
contains the guidance that was in Attachment B (selected items of 
cost); Appendix C contains the information that was in Attachment C 
(state/local-wide central service cost allocation plans); Appendix D 
contains the guidance that was in Attachment D (public assistance cost 
allocation plans); and Appendix E contains the guidance that was in 
Attachment E (state and local indirect cost rate proposals).
    (b) This part supersedes OMB Circular A-87, as amended May 10, 
2004, which superseded Circular A-87, as amended and issued May 4, 
1995.


Sec.  225.50  Policy review date.

    This part will have a policy review three years from the date of 
issuance.


Sec.  225.55  Information contact.

    Further information concerning this part may be obtained by 
contacting the Office of Federal Financial Management, Financial 
Standards and Reporting Branch, Office of Management and Budget, 
Washington, DC 20503, telephone 202-395-3993.

Appendix A to Part 225--General Principles for Determining Allowable 
Costs

Table of Contents

A. Purpose and Scope
    1. Objectives
    2. Policy guides
    3. Application
B. Definitions
    1. Approval or authorization of the awarding or cognizant 
Federal agency
    2. Award
    3. Awarding agency
    4. Central service cost allocation plan
    5. Claim
    6. Cognizant agency
    7. Common rule
    8. Contract
    9. Cost
    10. Cost allocation plan
    11. Cost objective
    12. Federally-recognized Indian tribal government
    13. Governmental unit
    14. Grantee department or agency
    15. Indirect cost rate proposal
    16. Local government
    17. Public assistance cost allocation plan
    18. State
C. Basic Guidelines
    1. Factors affecting allowability of costs
    2. Reasonable costs
    3. Allocable costs
    4. Applicable credits
D. Composition of Cost
    1. Total cost
    2. Classification of costs
E. Direct Costs
    1. General
    2. Application
    3. Minor items
F. Indirect Costs
    1. General
    2. Cost allocation plans and indirect cost proposals
    3. Limitation on indirect or administrative costs
G. Interagency Services
H. Required Certifications
General Principles for Determining Allowable Costs

    A. Purpose and Scope
    1. Objectives. This Appendix establishes principles for 
determining the allowable costs incurred by State, local, and 
federally-recognized Indian tribal governments (governmental units) 
under grants, cost reimbursement contracts, and other agreements 
with the Federal Government (collectively referred to in this 
appendix and other appendices to 2 CFR part 225 as ``Federal 
awards''). The principles are for the purpose of cost determination 
and are not intended to identify the circumstances or dictate the 
extent of Federal or governmental unit participation in the 
financing of a particular program or project. The principles are 
designed to provide that Federal awards bear their fair share of 
cost recognized under these principles except where restricted or 
prohibited by law. Provision for profit or other increment above 
cost is outside the scope of 2 CFR part 225.
    2. Policy guides.
    a. The application of these principles is based on the 
fundamental premises that:
    (1) Governmental units are responsible for the efficient and 
effective administration of Federal awards through the application 
of sound management practices.
    (2) Governmental units assume responsibility for administering 
Federal funds in a manner consistent with underlying agreements, 
program objectives, and the terms and conditions of the Federal 
award.
    (3) Each governmental unit, in recognition of its own unique 
combination of staff, facilities, and experience, will have the 
primary responsibility for employing whatever form of organization 
and management techniques may be necessary to assure proper and 
efficient administration of Federal awards.
    b. Federal agencies should work with States or localities which 
wish to test alternative mechanisms for paying costs for 
administering Federal programs. The Office of Management and Budget 
(OMB) encourages Federal agencies to test fee-for-service 
alternatives as a replacement for current cost-reimbursement payment 
methods in response to the National Performance Review's (NPR) 
recommendation. The NPR recommended the fee-for-service approach to 
reduce the burden associated with maintaining systems for charging 
administrative costs to Federal programs and preparing and approving 
cost allocation plans. This approach should also increase incentives 
for administrative efficiencies and improve outcomes.
    3. Application.
    a. These principles will be applied by all Federal agencies in 
determining costs incurred by governmental units under Federal 
awards (including subawards) except those with (1) publicly-financed 
educational institutions subject to, 2 CFR part 220, Cost Principles 
for Educational Institutions (OMB Circular A-21), and (2) programs 
administered by publicly-owned hospitals and other providers of 
medical care that are subject to requirements promulgated by the 
sponsoring Federal agencies. However, 2 CFR part 225 does apply to 
all central service and department/agency costs that are allocated 
or billed to those educational institutions, hospitals, and other 
providers of medical care or services by other State and local 
government departments and agencies.
    b. All subawards are subject to those Federal cost principles 
applicable to the particular organization concerned. Thus, if a 
subaward is to a governmental unit (other than a college, university 
or hospital), 2 CFR part 225 shall apply; if a subaward is to a 
commercial organization, the cost principles applicable to 
commercial organizations shall apply; if a subaward is to a college 
or university, 2 CFR part 220 (Circular A-21) shall apply; if a 
subaward is to a hospital, the cost principles used by the Federal 
awarding agency for awards to hospitals shall apply, subject to the 
provisions of subsection A.3.a. of this Appendix; if a subaward is 
to some other non-profit organization, 2 CFR part 230, Cost 
Principles for Non-Profit Organizations (Circular A-122), shall 
apply.
    c. These principles shall be used as a guide in the pricing of 
fixed price arrangements where costs are used in determining the 
appropriate price.
    d. Where a Federal contract awarded to a governmental unit 
incorporates a Cost Accounting Standards (CAS) clause, the 
requirements of that clause shall apply. In such cases, the 
governmental unit and the cognizant Federal agency shall establish 
an appropriate advance agreement on how the governmental unit will 
comply with applicable CAS requirements when estimating, 
accumulating and reporting costs under CAS-covered contracts. The 
agreement shall indicate that 2 CFR part 225 (OMB Circular A-87) 
requirements will be applied to other Federal awards. In all cases, 
only one set of records needs to be maintained by the governmental 
unit.
    e. Conditional exemptions.
    (1) OMB authorizes conditional exemption from OMB administrative 
requirements and cost principles for certain Federal programs with 
statutorily-authorized consolidated planning and consolidated 
administrative funding, that are identified by a Federal agency and 
approved by the head of the Executive department or establishment. A 
Federal agency shall consult with OMB during its consideration of 
whether to grant such an exemption.
    (2) To promote efficiency in State and local program 
administration, when Federal non-entitlement programs with common 
purposes have specific statutorily-authorized consolidated planning 
and consolidated administrative funding and where most of the State 
agency's resources come from non-Federal sources, Federal agencies 
may exempt these covered State-administered, non-entitlement grant 
programs from certain OMB grants management requirements. The

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exemptions would be from all but the allocability of costs 
provisions of Appendix A subsection C.3 of 2 CFR part 225, Cost 
Principles for State, Local, and Indian Tribal Governments (OMB 
Circular A-87); Appendix A, Section C.4 of 2 CFR 220, Cost 
Principles for Educational Institutions (Circular A-21); Appendix A, 
subsection A.4 of 2 CFR 230 Cost Principles for Non-Profit 
Organizations (Circular A-122); and from all of the administrative 
requirements provisions of 2 CFR part 215, Uniform Administrative 
Requirements for Grants and Agreements with Institutions of Higher 
Education, Hospitals, and Other Non-Profit Organizations (Circular 
A-110), and the agencies' grants management common rule.
    (3) When a Federal agency provides this flexibility, as a 
prerequisite to a State's exercising this option, a State must adopt 
its own written fiscal and administrative requirements for expending 
and accounting for all funds, which are consistent with the 
provisions of 2 CFR part 225 (OMB Circular A-87), and extend such 
policies to all subrecipients. These fiscal and administrative 
requirements must be sufficiently specific to ensure that: Funds are 
used in compliance with all applicable Federal statutory and 
regulatory provisions, costs are reasonable and necessary for 
operating these programs, and funds are not used for general 
expenses required to carry out other responsibilities of a State or 
its subrecipients.
    B. Definitions
    1. ``Approval or authorization of the awarding or cognizant 
Federal agency'' means documentation evidencing consent prior to 
incurring a specific cost. If such costs are specifically identified 
in a Federal award document, approval of the document constitutes 
approval of the costs. If the costs are covered by a State/local-
wide cost allocation plan or an indirect cost proposal, approval of 
the plan constitutes the approval.
    2. ``Award'' means grants, cost reimbursement contracts and 
other agreements between a State, local and Indian tribal government 
and the Federal Government.
    3. ``Awarding agency'' means (a) with respect to a grant, 
cooperative agreement, or cost reimbursement contract, the Federal 
agency, and (b) with respect to a subaward, the party that awarded 
the subaward.
    4. ``Central service cost allocation plan'' means the 
documentation identifying, accumulating, and allocating or 
developing billing rates based on the allowable costs of services 
provided by a governmental unit on a centralized basis to its 
departments and agencies. The costs of these services may be 
allocated or billed to users.
    5. ``Claim'' means a written demand or written assertion by the 
governmental unit or grantor seeking, as a matter of right, the 
payment of money in a sum certain, the adjustment or interpretation 
of award terms, or other relief arising under or relating to the 
award. A voucher, invoice or other routine request for payment that 
is not a dispute when submitted is not a claim. Appeals, such as 
those filed by a governmental unit in response to questioned audit 
costs, are not considered claims until a final management decision 
is made by the Federal awarding agency.
    6. ``Cognizant agency'' means the Federal agency responsible for 
reviewing, negotiating, and approving cost allocation plans or 
indirect cost proposals developed under 2 CFR part 225 on behalf of 
all Federal agencies. OMB publishes a listing of cognizant agencies.
    7. ``Common Rule'' means the ``Uniform Administrative 
Requirements for Grants and Cooperative Agreements to State and 
Local Governments; Final Rule'' originally issued at 53 FR 8034-8103 
(March 11, 1988). Other common rules will be referred to by their 
specific titles.
    8. ``Contract'' means a mutually binding legal relationship 
obligating the seller to furnish the supplies or services (including 
construction) and the buyer to pay for them. It includes all types 
of commitments that obligate the government to an expenditure of 
appropriated funds and that, except as otherwise authorized, are in 
writing. In addition to bilateral instruments, contracts include 
(but are not limited to): Awards and notices of awards; job orders 
or task orders issued under basic ordering agreements; letter 
contracts; orders, such as purchase orders, under which the contract 
becomes effective by written acceptance or performance; and, 
bilateral contract modifications. Contracts do not include grants 
and cooperative agreements covered by 31 U.S.C. 6301 et seq.
    9. ``Cost'' means an amount as determined on a cash, accrual, or 
other basis acceptable to the Federal awarding or cognizant agency. 
It does not include transfers to a general or similar fund.
    10. ``Cost allocation plan'' means central service cost 
allocation plan, public assistance cost allocation plan, and 
indirect cost rate proposal. Each of these terms is further defined 
in this section.
    11. ``Cost objective'' means a function, organizational 
subdivision, contract, grant, or other activity for which cost data 
are needed and for which costs are incurred.
    12. ``Federally-recognized Indian tribal government'' means the 
governing body or a governmental agency of any Indian tribe, band, 
nation, or other organized group or community (including any native 
village as defined in Section 3 of the Alaska Native Claims 
Settlement Act, 85 Stat. 688) certified by the Secretary of the 
Interior as eligible for the special programs and services provided 
through the Bureau of Indian Affairs.
    13. ``Governmental unit'' means the entire State, local, or 
federally-recognized Indian tribal government, including any 
component thereof. Components of governmental units may function 
independently of the governmental unit in accordance with the term 
of the award.
    14. ``Grantee department or agency'' means the component of a 
State, local, or federally-recognized Indian tribal government which 
is responsible for the performance or administration of all or some 
part of a Federal award.
    15. ``Indirect cost rate proposal'' means the documentation 
prepared by a governmental unit or component thereof to substantiate 
its request for the establishment of an indirect cost rate as 
described in Appendix E of 2 CFR part 225.
    16. ``Local government'' means a county, municipality, city, 
town, township, local public authority, school district, special 
district, intrastate district, council of governments (whether or 
not incorporated as a non-profit corporation under State law), any 
other regional or interstate government entity, or any agency or 
instrumentality of a local government.
    17. ``Public assistance cost allocation plan'' means a narrative 
description of the procedures that will be used in identifying, 
measuring and allocating all administrative costs to all of the 
programs administered or supervised by State public assistance 
agencies as described in Appendix D of 2 CFR part 225.
    18. ``State'' means any of the several States of the United 
States, the District of Columbia, the Commonwealth of Puerto Rico, 
any territory or possession of the United States, or any agency or 
instrumentality of a State exclusive of local governments.
    C. Basic Guidelines
    1. Factors affecting allowability of costs. To be allowable 
under Federal awards, costs must meet the following general 
criteria:
    a. Be necessary and reasonable for proper and efficient 
performance and administration of Federal awards.
    b. Be allocable to Federal awards under the provisions of 2 CFR 
part 225.
    c. Be authorized or not prohibited under State or local laws or 
regulations.
    d. Conform to any limitations or exclusions set forth in these 
principles, Federal laws, terms and conditions of the Federal award, 
or other governing regulations as to types or amounts of cost items.
    e. Be consistent with policies, regulations, and procedures that 
apply uniformly to both Federal awards and other activities of the 
governmental unit.
    f. Be accorded consistent treatment. A cost may not be assigned 
to a Federal award as a direct cost if any other cost incurred for 
the same purpose in like circumstances has been allocated to the 
Federal award as an indirect cost.
    g. Except as otherwise provided for in 2 CFR part 225, be 
determined in accordance with generally accepted accounting 
principles.
    h. Not be included as a cost or used to meet cost sharing or 
matching requirements of any other Federal award in either the 
current or a prior period, except as specifically provided by 
Federal law or regulation.
    i. Be the net of all applicable credits.
    j. Be adequately documented.
    2. Reasonable costs. A cost is reasonable if, in its nature and 
amount, it does not exceed that which would be incurred by a prudent 
person under the circumstances prevailing at the time the decision 
was made to incur the cost. The question of reasonableness is 
particularly important when governmental units or components are 
predominately federally-funded. In determining reasonableness of a 
given cost, consideration shall be given to:
    a. Whether the cost is of a type generally recognized as 
ordinary and necessary for the operation of the governmental unit or 
the performance of the Federal award.

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    b. The restraints or requirements imposed by such factors as: 
Sound business practices; arm's-length bargaining; Federal, State 
and other laws and regulations; and, terms and conditions of the 
Federal award.
    c. Market prices for comparable goods or services.
    d. Whether the individuals concerned acted with prudence in the 
circumstances considering their responsibilities to the governmental 
unit, its employees, the public at large, and the Federal 
Government.
    e. Significant deviations from the established practices of the 
governmental unit which may unjustifiably increase the Federal 
award's cost.
    3. Allocable costs.
    a. A cost is allocable to a particular cost objective if the 
goods or services involved are chargeable or assignable to such cost 
objective in accordance with relative benefits received.
    b. All activities which benefit from the governmental unit's 
indirect cost, including unallowable activities and services donated 
to the governmental unit by third parties, will receive an 
appropriate allocation of indirect costs.
    c. Any cost allocable to a particular Federal award or cost 
objective under the principles provided for in 2 CFR part 225 may 
not be charged to other Federal awards to overcome fund 
deficiencies, to avoid restrictions imposed by law or terms of the 
Federal awards, or for other reasons.
    d. Where an accumulation of indirect costs will ultimately 
result in charges to a Federal award, a cost allocation plan will be 
required as described in Appendices C, D, and E to this part.
    4. Applicable credits.
    a. Applicable credits refer to those receipts or reduction of 
expenditure-type transactions that offset or reduce expense items 
allocable to Federal awards as direct or indirect costs. Examples of 
such transactions are: Purchase discounts, rebates or allowances, 
recoveries or indemnities on losses, insurance refunds or rebates, 
and adjustments of overpayments or erroneous charges. To the extent 
that such credits accruing to or received by the governmental unit 
relate to allowable costs, they shall be credited to the Federal 
award either as a cost reduction or cash refund, as appropriate.
    b. In some instances, the amounts received from the Federal 
Government to finance activities or service operations of the 
governmental unit should be treated as applicable credits. 
Specifically, the concept of netting such credit items (including 
any amounts used to meet cost sharing or matching requirements) 
should be recognized in determining the rates or amounts to be 
charged to Federal awards. (See Appendix B to this part, item 11, 
``Depreciation and use allowances,'' for areas of potential 
application in the matter of Federal financing of activities.)
    D. Composition of Cost
    1. Total cost. The total cost of Federal awards is comprised of 
the allowable direct cost of the program, plus its allocable portion 
of allowable indirect costs, less applicable credits.
    2. Classification of costs. There is no universal rule for 
classifying certain costs as either direct or indirect under every 
accounting system. A cost may be direct with respect to some 
specific service or function, but indirect with respect to the 
Federal award or other final cost objective. Therefore, it is 
essential that each item of cost be treated consistently in like 
circumstances either as a direct or an indirect cost. Guidelines for 
determining direct and indirect costs charged to Federal awards are 
provided in the sections that follow.
    E. Direct Costs
    1. General. Direct costs are those that can be identified 
specifically with a particular final cost objective.
    2. Application. Typical direct costs chargeable to Federal 
awards are:
    a. Compensation of employees for the time devoted and identified 
specifically to the performance of those awards.
    b. Cost of materials acquired, consumed, or expended 
specifically for the purpose of those awards.
    c. Equipment and other approved capital expenditures.
    d. Travel expenses incurred specifically to carry out the award.
    3. Minor items. Any direct cost of a minor amount may be treated 
as an indirect cost for reasons of practicality where such 
accounting treatment for that item of cost is consistently applied 
to all cost objectives.
    F. Indirect Costs
    1. General. Indirect costs are those: Incurred for a common or 
joint purpose benefiting more than one cost objective, and not 
readily assignable to the cost objectives specifically benefitted, 
without effort disproportionate to the results achieved. The term 
``indirect costs,'' as used herein, applies to costs of this type 
originating in the grantee department, as well as those incurred by 
other departments in supplying goods, services, and facilities. To 
facilitate equitable distribution of indirect expenses to the cost 
objectives served, it may be necessary to establish a number of 
pools of indirect costs within a governmental unit department or in 
other agencies providing services to a governmental unit department. 
Indirect cost pools should be distributed to benefitted cost 
objectives on bases that will produce an equitable result in 
consideration of relative benefits derived.
    2. Cost allocation plans and indirect cost proposals. 
Requirements for development and submission of cost allocation plans 
and indirect cost rate proposals are contained in Appendices C, D, 
and E to this part.
    3. Limitation on indirect or administrative costs.
    a. In addition to restrictions contained in 2 CFR part 225, 
there may be laws that further limit the amount of administrative or 
indirect cost allowed.
    b. Amounts not recoverable as indirect costs or administrative 
costs under one Federal award may not be shifted to another Federal 
award, unless specifically authorized by Federal legislation or 
regulation.
    G. Interagency Services. The cost of services provided by one 
agency to another within the governmental unit may include allowable 
direct costs of the service plus a pro rate share of indirect costs. 
A standard indirect cost allowance equal to ten percent of the 
direct salary and wage cost of providing the service (excluding 
overtime, shift premiums, and fringe benefits) may be used in lieu 
of determining the actual indirect costs of the service. These 
services do not include centralized services included in central 
service cost allocation plans as described in Appendix C to this 
part.
    H. Required Certifications. Each cost allocation plan or 
indirect cost rate proposal required by Appendices C and E to this 
part must comply with the following:
    1. No proposal to establish a cost allocation plan or an 
indirect cost rate, whether submitted to a Federal cognizant agency 
or maintained on file by the governmental unit, shall be acceptable 
unless such costs have been certified by the governmental unit using 
the Certificate of Cost Allocation Plan or Certificate of Indirect 
Costs as set forth in Appendices C and E to this part. The 
certificate must be signed on behalf of the governmental unit by an 
individual at a level no lower than chief financial officer of the 
governmental unit that submits the proposal or component covered by 
the proposal.
    2. No cost allocation plan or indirect cost rate shall be 
approved by the Federal Government unless the plan or rate proposal 
has been certified. Where it is necessary to establish a cost 
allocation plan or an indirect cost rate and the governmental unit 
has not submitted a certified proposal for establishing such a plan 
or rate in accordance with the requirements, the Federal Government 
may either disallow all indirect costs or unilaterally establish 
such a plan or rate. Such a plan or rate may be based upon audited 
historical data or such other data that have been furnished to the 
cognizant Federal agency and for which it can be demonstrated that 
all unallowable costs have been excluded. When a cost allocation 
plan or indirect cost rate is unilaterally established by the 
Federal Government because of failure of the governmental unit to 
submit a certified proposal, the plan or rate established will be 
set to ensure that potentially unallowable costs will not be 
reimbursed.

Appendix B to Part 225--Selected Items of Cost

Table of Contents

1. Advertising and public relations costs
2. Advisory councils
3. Alcoholic beverages
4. Audit costs and related services
5. Bad debts
6. Bonding costs
7. Communication costs
8. Compensation for personal services
9. Contingency provisions
10. Defense and prosecution of criminal and civil proceedings, and 
claims
11. Depreciation and use allowances
12. Donations and contributions
13. Employee morale, health, and welfare costs
14. Entertainment costs
15. Equipment and other capital expenditures
16. Fines and penalties
17. Fund raising and investment management costs
18. Gains and losses on disposition of depreciable property and 
other capital

[[Page 51914]]

assets and substantial relocation of Federal programs
19. General government expenses
20. Goods or services for personal use
21. Idle facilities and idle capacity
22. Insurance and indemnification
23. Interest
24. Lobbying
25. Maintenance, operations, and repairs
26. Materials and supplies costs
27. Meetings and conferences
28. Memberships, subscriptions, and professional activity costs
29. Patent costs
30. Plant and homeland security costs
31. Pre-award costs
32. Professional service costs
33. Proposal costs
34. Publication and printing costs
35. Rearrangement and alteration costs
36. Reconversion costs
37. Rental costs of building and equipment
38. Royalties and other costs for the use of patents
39. Selling and marketing
40. Taxes
41. Termination costs applicable to sponsored agreements
42. Training costs
43. Travel costs

    Sections 1 through 43 provide principles to be applied in 
establishing the allowability or unallowability of certain items of 
cost. These principles apply whether a cost is treated as direct or 
indirect. A cost is allowable for Federal reimbursement only to the 
extent of benefits received by Federal awards and its conformance 
with the general policies and principles stated in Appendix A to 
this part. Failure to mention a particular item of cost in these 
sections is not intended to imply that it is either allowable or 
unallowable; rather, determination of allowability in each case 
should be based on the treatment or standards provided for similar 
or related items of cost.
    1. Advertising and public relations costs.
    a. The term advertising costs means the costs of advertising 
media and corollary administrative costs. Advertising media include 
magazines, newspapers, radio and television, direct mail, exhibits, 
electronic or computer transmittals, and the like.
    b. The term public relations includes community relations and 
means those activities dedicated to maintaining the image of the 
governmental unit or maintaining or promoting understanding and 
favorable relations with the community or public at large or any 
segment of the public.
    c. The only allowable advertising costs are those which are 
solely for:
    (1) The recruitment of personnel required for the performance by 
the governmental unit of obligations arising under a Federal award;
    (2) The procurement of goods and services for the performance of 
a Federal award;
    (3) The disposal of scrap or surplus materials acquired in the 
performance of a Federal award except when governmental units are 
reimbursed for disposal costs at a predetermined amount; or
    (4) Other specific purposes necessary to meet the requirements 
of the Federal award.
    d. The only allowable public relations costs are:
    (1) Costs specifically required by the Federal award;
    (2) Costs of communicating with the public and press pertaining 
to specific activities or accomplishments which result from 
performance of Federal awards (these costs are considered necessary 
as part of the outreach effort for the Federal award); or
    (3) Costs of conducting general liaison with news media and 
government public relations officers, to the extent that such 
activities are limited to communication and liaison necessary keep 
the public informed on matters of public concern, such as notices of 
Federal contract/grant awards, financial matters, etc.
    e. Costs identified in subsections c and d if incurred for more 
than one Federal award or for both sponsored work and other work of 
the governmental unit, are allowable to the extent that the 
principles in Appendix A to this part, sections E. (``Direct 
Costs'') and F. (``Indirect Costs'') are observed.
    f. Unallowable advertising and public relations costs include 
the following:
    (1) All advertising and public relations costs other than as 
specified in subsections 1.c, d, and e of this appendix;
    (2) Costs of meetings, conventions, convocations, or other 
events related to other activities of the governmental unit, 
including:
    (a) Costs of displays, demonstrations, and exhibits;
    (b) Costs of meeting rooms, hospitality suites, and other 
special facilities used in conjunction with shows and other special 
events; and
    (c) Salaries and wages of employees engaged in setting up and 
displaying exhibits, making demonstrations, and providing briefings;
    (3) Costs of promotional items and memorabilia, including 
models, gifts, and souvenirs;
    (4) Costs of advertising and public relations designed solely to 
promote the governmental unit.
    2. Advisory councils. Costs incurred by advisory councils or 
committees are allowable as a direct cost where authorized by the 
Federal awarding agency or as an indirect cost where allocable to 
Federal awards.
    3. Alcoholic beverages. Costs of alcoholic beverages are 
unallowable.
    4. Audit costs and related services.
    a. The costs of audits required by , and performed in accordance 
with, the Single Audit Act, as implemented by Circular A-133, 
``Audits of States, Local Governments, and Non-Profit 
Organizations'' are allowable. Also see 31 U.S.C. 7505(b) and 
section 230 (``Audit Costs'') of Circular A-133.
    b. Other audit costs are allowable if included in a cost 
allocation plan or indirect cost proposal, or if specifically 
approved by the awarding agency as a direct cost to an award.
    c. The cost of agreed-upon procedures engagements to monitor 
subrecipients who are exempted from A-133 under section 200(d) are 
allowable, subject to the conditions listed in A-133, section 230 
(b)(2).
    5. Bad debts. Bad debts, including losses (whether actual or 
estimated) arising from uncollectable accounts and other claims, 
related collection costs, and related legal costs, are unallowable.
    6. Bonding costs.
    a. Bonding costs arise when the Federal Government requires 
assurance against financial loss to itself or others by reason of 
the act or default of the governmental unit. They arise also in 
instances where the governmental unit requires similar assurance. 
Included are such bonds as bid, performance, payment, advance 
payment, infringement, and fidelity bonds.
    b. Costs of bonding required pursuant to the terms of the award 
are allowable.
    c. Costs of bonding required by the governmental unit in the 
general conduct of its operations are allowable to the extent that 
such bonding is in accordance with sound business practice and the 
rates and premiums are reasonable under the circumstances.
    7. Communication costs. Costs incurred for telephone services, 
local and long distance telephone calls, telegrams, postage, 
messenger, electronic or computer transmittal services and the like 
are allowable.
    8. Compensation for personal services.
    a. General. Compensation for personnel services includes all 
remuneration, paid currently or accrued, for services rendered 
during the period of performance under Federal awards, including but 
not necessarily limited to wages, salaries, and fringe benefits. The 
costs of such compensation are allowable to the extent that they 
satisfy the specific requirements of this and other appendices under 
2 CFR Part 225, and that the total compensation for individual 
employees:
    (1) Is reasonable for the services rendered and conforms to the 
established policy of the governmental unit consistently applied to 
both Federal and non-Federal activities;
    (2) Follows an appointment made in accordance with a 
governmental unit's laws and rules and meets merit system or other 
requirements required by Federal law, where applicable; and
    (3) Is determined and supported as provided in subsection h.
    b. Reasonableness. Compensation for employees engaged in work on 
Federal awards will be considered reasonable to the extent that it 
is consistent with that paid for similar work in other activities of 
the governmental unit. In cases where the kinds of employees 
required for Federal awards are not found in the other activities of 
the governmental unit, compensation will be considered reasonable to 
the extent that it is comparable to that paid for similar work in 
the labor market in which the employing government competes for the 
kind of employees involved. Compensation surveys providing data 
representative of the labor market involved will be an acceptable 
basis for evaluating reasonableness.
    c. Unallowable costs. Costs which are unallowable under other 
sections of these principles shall not be allowable under this 
section solely on the basis that they constitute personnel 
compensation.
    d. Fringe benefits.
    (1) Fringe benefits are allowances and services provided by 
employers to their

[[Page 51915]]

employees as compensation in addition to regular salaries and wages. 
Fringe benefits include, but are not limited to, the costs of leave, 
employee insurance, pensions, and unemployment benefit plans. Except 
as provided elsewhere in these principles, the costs of fringe 
benefits are allowable to the extent that the benefits are 
reasonable and are required by law, governmental unit-employee 
agreement, or an established policy of the governmental unit.
    (2) The cost of fringe benefits in the form of regular 
compensation paid to employees during periods of authorized absences 
from the job, such as for annual leave, sick leave, holidays, court 
leave, military leave, and other similar benefits, are allowable if: 
They are provided under established written leave policies; the 
costs are equitably allocated to all related activities, including 
Federal awards; and, the accounting basis (cash or accrual) selected 
for costing each type of leave is consistently followed by the 
governmental unit.
    (3) When a governmental unit uses the cash basis of accounting, 
the cost of leave is recognized in the period that the leave is 
taken and paid for. Payments for unused leave when an employee 
retires or terminates employment are allowable in the year of 
payment provided they are allocated as a general administrative 
expense to all activities of the governmental unit or component.
    (4) The accrual basis may be only used for those types of leave 
for which a liability as defined by Generally Accepted Accounting 
Principles (GAAP) exists when the leave is earned. When a 
governmental unit uses the accrual basis of accounting, in 
accordance with GAAP, allowable leave costs are the lesser of the 
amount accrued or funded.
    (5) The cost of fringe benefits in the form of employer 
contributions or expenses for social security; employee life, 
health, unemployment, and worker's compensation insurance (except as 
indicated in section 22, Insurance and indemnification); pension 
plan costs (see subsection e.); and other similar benefits are 
allowable, provided such benefits are granted under established 
written policies. Such benefits, whether treated as indirect costs 
or as direct costs, shall be allocated to Federal awards and all 
other activities in a manner consistent with the pattern of benefits 
attributable to the individuals or group(s) of employees whose 
salaries and wages are chargeable to such Federal awards and other 
activities.
    e. Pension plan costs. Pension plan costs may be computed using 
a pay-as-you-go method or an acceptable actuarial cost method in 
accordance with established written policies of the governmental 
unit.
    (1) For pension plans financed on a pay-as-you-go method, 
allowable costs will be limited to those representing actual 
payments to retirees or their beneficiaries.
    (2) Pension costs calculated using an actuarial cost-based 
method recognized by GAAP are allowable for a given fiscal year if 
they are funded for that year within six months after the end of 
that year. Costs funded after the six month period (or a later 
period agreed to by the cognizant agency) are allowable in the year 
funded. The cognizant agency may agree to an extension of the six 
month period if an appropriate adjustment is made to compensate for 
the timing of the charges to the Federal Government and related 
Federal reimbursement and the governmental unit's contribution to 
the pension fund. Adjustments may be made by cash refund or other 
equitable procedures to compensate the Federal Government for the 
time value of Federal reimbursements in excess of contributions to 
the pension fund.
    (3) Amounts funded by the governmental unit in excess of the 
actuarially determined amount for a fiscal year may be used as the 
governmental unit's contribution in future periods.
    (4) When a governmental unit converts to an acceptable actuarial 
cost method, as defined by GAAP, and funds pension costs in 
accordance with this method, the unfunded liability at the time of 
conversion shall be allowable if amortized over a period of years in 
accordance with GAAP.
    (5) The Federal Government shall receive an equitable share of 
any previously allowed pension costs (including earnings thereon) 
which revert or inure to the governmental unit in the form of a 
refund, withdrawal, or other credit.
    f. Post-retirement health benefits. Post-retirement health 
benefits (PRHB) refers to costs of health insurance or health 
services not included in a pension plan covered by subsection 8.e. 
of this appendix for retirees and their spouses, dependents, and 
survivors. PRHB costs may be computed using a pay-as-you-go method 
or an acceptable actuarial cost method in accordance with 
established written polices of the governmental unit.
    (1) For PRHB financed on a pay as-you-go method, allowable costs 
will be limited to those representing actual payments to retirees or 
their beneficiaries.
    (2) PRHB costs calculated using an actuarial cost method 
recognized by GAAP are allowable if they are funded for that year 
within six months after the end of that year. Costs funded after the 
six month period (or a later period agreed to by the cognizant 
agency) are allowable in the year funded. The cognizant agency may 
agree to an extension of the six month period if an appropriate 
adjustment is made to compensate for the timing of the charges to 
the Federal Government and related Federal reimbursements and the 
governmental unit's contributions to the PRHB fund. Adjustments may 
be made by cash refund, reduction in current year's PRHB costs, or 
other equitable procedures to compensate the Federal Government for 
the time value of Federal reimbursements in excess of contributions 
to the PRHB fund.
    (3) Amounts funded in excess of the actuarially determined 
amount for a fiscal year may be used as the government's 
contribution in a future period.
    (4) When a governmental unit converts to an acceptable actuarial 
cost method and funds PRHB costs in accordance with this method, the 
initial unfunded liability attributable to prior years shall be 
allowable if amortized over a period of years in accordance with 
GAAP, or, if no such GAAP period exists, over a period negotiated 
with the cognizant agency.
    (5) To be allowable in the current year, the PRHB costs must be 
paid either to:
    (a) An insurer or other benefit provider as current year costs 
or premiums, or
    (b) An insurer or trustee to maintain a trust fund or reserve 
for the sole purpose of providing post-retirement benefits to 
retirees and other beneficiaries.
    (6) The Federal Government shall receive an equitable share of 
any amounts of previously allowed post-retirement benefit costs 
(including earnings thereon) which revert or inure to the 
governmental unit in the form of a refund, withdrawal, or other 
credit.
    g. Severance pay.
    (1) Payments in addition to regular salaries and wages made to 
workers whose employment is being terminated are allowable to the 
extent that, in each case, they are required by law, employer-
employee agreement, or established written policy.
    (2) Severance payments (but not accruals) associated with normal 
turnover are allowable. Such payments shall be allocated to all 
activities of the governmental unit as an indirect cost.
    (3) Abnormal or mass severance pay will be considered on a case-
by-case basis and is allowable only if approved by the cognizant 
Federal agency.
    h. Support of salaries and wages. These standards regarding time 
distribution are in addition to the standards for payroll 
documentation.
    (1) Charges to Federal awards for salaries and wages, whether 
treated as direct or indirect costs, will be based on payrolls 
documented in accordance with generally accepted practice of the 
governmental unit and approved by a responsible official(s) of the 
governmental unit.
    (2) No further documentation is required for the salaries and 
wages of employees who work in a single indirect cost activity.
    (3) Where employees are expected to work solely on a single 
Federal award or cost objective, charges for their salaries and 
wages will be supported by periodic certifications that the 
employees worked solely on that program for the period covered by 
the certification. These certifications will be prepared at least 
semi-annually and will be signed by the employee or supervisory 
official having first hand knowledge of the work performed by the 
employee.
    (4) Where employees work on multiple activities or cost 
objectives, a distribution of their salaries or wages will be 
supported by personnel activity reports or equivalent documentation 
which meets the standards in subsection 8.h.(5) of this appendix 
unless a statistical sampling system (see subsection 8.h.(6) of this 
appendix) or other substitute system has been approved by the 
cognizant Federal agency. Such documentary support will be required 
where employees work on:
    (a) More than one Federal award,
    (b) A Federal award and a non-Federal award,
    (c) An indirect cost activity and a direct cost activity,
    (d) Two or more indirect activities which are allocated using 
different allocation bases, or
    (e) An unallowable activity and a direct or indirect cost 
activity.

[[Page 51916]]

    (5) Personnel activity reports or equivalent documentation must 
meet the following standards:
    (a) They must reflect an after-the-fact distribution of the 
actual activity of each employee,
    (b) They must account for the total activity for which each 
employee is compensated,
    (c) They must be prepared at least monthly and must coincide 
with one or more pay periods, and
    (d) They must be signed by the employee.
    (e) Budget estimates or other distribution percentages 
determined before the services are performed do not qualify as 
support for charges to Federal awards but may be used for interim 
accounting purposes, provided that:
    (i) The governmental unit's system for establishing the 
estimates produces reasonable approximations of the activity 
actually performed;
    (ii) At least quarterly, comparisons of actual costs to budgeted 
distributions based on the monthly activity reports are made. Costs 
charged to Federal awards to reflect adjustments made as a result of 
the activity actually performed may be recorded annually if the 
quarterly comparisons show the differences between budgeted and 
actual costs are less than ten percent; and
    (iii) The budget estimates or other distribution percentages are 
revised at least quarterly, if necessary, to reflect changed 
circumstances.
    (6) Substitute systems for allocating salaries and wages to 
Federal awards may be used in place of activity reports. These 
systems are subject to approval if required by the cognizant agency. 
Such systems may include, but are not limited to, random moment 
sampling, case counts, or other quantifiable measures of employee 
effort.
    (a) Substitute systems which use sampling methods (primarily for 
Temporary Assistance to Needy Families (TANF), Medicaid, and other 
public assistance programs) must meet acceptable statistical 
sampling standards including:
    (i) The sampling universe must include all of the employees 
whose salaries and wages are to be allocated based on sample results 
except as provided in subsection 8.h.(6)(c) of this appendix;
    (ii) The entire time period involved must be covered by the 
sample; and
    (iii) The results must be statistically valid and applied to the 
period being sampled.
    (b) Allocating charges for the sampled employees' supervisors, 
clerical and support staffs, based on the results of the sampled 
employees, will be acceptable.
    (c) Less than full compliance with the statistical sampling 
standards noted in subsection 8.h.(6)(a) of this appendix may be 
accepted by the cognizant agency if it concludes that the amounts to 
be allocated to Federal awards will be minimal, or if it concludes 
that the system proposed by the governmental unit will result in 
lower costs to Federal awards than a system which complies with the 
standards.
    (7) Salaries and wages of employees used in meeting cost sharing 
or matching requirements of Federal awards must be supported in the 
same manner as those claimed as allowable costs under Federal 
awards.
    i. Donated services.
    (1) Donated or volunteer services may be furnished to a 
governmental unit by professional and technical personnel, 
consultants, and other skilled and unskilled labor. The value of 
these services is not reimbursable either as a direct or indirect 
cost. However, the value of donated services may be used to meet 
cost sharing or matching requirements in accordance with the 
provisions of the Common Rule.
    (2) The value of donated services utilized in the performance of 
a direct cost activity shall, when material in amount, be considered 
in the determination of the governmental unit's indirect costs or 
rate(s) and, accordingly, shall be allocated a proportionate share 
of applicable indirect costs.
    (3) To the extent feasible, donated services will be supported 
by the same methods used by the governmental unit to support the 
allocability of regular personnel services.
    9. Contingency provisions. Contributions to a contingency 
reserve or any similar provision made for events the occurrence of 
which cannot be foretold with certainty as to time, intensity, or 
with an assurance of their happening, are unallowable. The term 
``contingency reserve'' excludes self-insurance reserves (see 
section 22.c. of this appendix), pension plan reserves (see section 
8.e.), and post-retirement health and other benefit reserves 
(section 8.f.) computed using acceptable actuarial cost methods.
    10. Defense and prosecution of criminal and civil proceedings, 
and claims.
    a. The following costs are unallowable for contracts covered by 
10 U.S.C. 2324(k), ``Allowable costs under defense contracts.''
    (1) Costs incurred in defense of any civil or criminal fraud 
proceeding or similar proceeding (including filing of false 
certification brought by the United States where the contractor is 
found liable or has pleaded nolo contendere to a charge of fraud or 
similar proceeding (including filing of a false certification).
    (2) Costs incurred by a contractor in connection with any 
criminal, civil or administrative proceedings commenced by the 
United States or a State to the extent provided in 10 U.S.C. 
2324(k).
    b. Legal expenses required in the administration of Federal 
programs are allowable. Legal expenses for prosecution of claims 
against the Federal Government are unallowable.
    11. Depreciation and use allowances.
    a. Depreciation and use allowances are means of allocating the 
cost of fixed assets to periods benefiting from asset use. 
Compensation for the use of fixed assets on hand may be made through 
depreciation or use allowances. A combination of the two methods may 
not be used in connection with a single class of fixed assets (e.g., 
buildings, office equipment, computer equipment, etc.) except as 
provided for in subsection g. Except for enterprise funds and 
internal service funds that are included as part of a State/local 
cost allocation plan, classes of assets shall be determined on the 
same basis used for the government-wide financial statements.
    b. The computation of depreciation or use allowances shall be 
based on the acquisition cost of the assets involved. Where actual 
cost records have not been maintained, a reasonable estimate of the 
original acquisition cost may be used. The value of an asset donated 
to the governmental unit by an unrelated third party shall be its 
fair market value at the time of donation. Governmental or quasi-
governmental organizations located within the same State shall not 
be considered unrelated third parties for this purpose.
    c. The computation of depreciation or use allowances will 
exclude:
    (1) The cost of land;
    (2) Any portion of the cost of buildings and equipment borne by 
or donated by the Federal Government irrespective of where title was 
originally vested or where it presently resides; and
    (3) Any portion of the cost of buildings and equipment 
contributed by or for the governmental unit, or a related donor 
organization, in satisfaction of a matching requirement.
    d. Where the depreciation method is followed, the following 
general criteria apply:
    (1) The period of useful service (useful life) established in 
each case for usable capital assets must take into consideration 
such factors as type of construction, nature of the equipment used, 
historical usage patterns, technological developments, and the 
renewal and replacement policies of the governmental unit followed 
for the individual items or classes of assets involved. In the 
absence of clear evidence indicating that the expected consumption 
of the asset will be significantly greater in the early portions 
than in the later portions of its useful life, the straight line 
method of depreciation shall be used.
    (2) Depreciation methods once used shall not be changed unless 
approved by the Federal cognizant or awarding agency. When the 
depreciation method is introduced for application to an asset 
previously subject to a use allowance, the annual depreciation 
charge thereon may not exceed the amount that would have resulted 
had the depreciation method been in effect from the date of 
acquisition of the asset. The combination of use allowances and 
depreciation applicable to the asset shall not exceed the total 
acquisition cost of the asset or fair market value at time of 
donation.
    e. When the depreciation method is used for buildings, a 
building's shell may be segregated from the major component of the 
building (e.g., plumbing system, heating, and air conditioning 
system, etc.) and each major component depreciated over its 
estimated useful life, or the entire building (i.e., the shell and 
all components) may be treated as a single asset and depreciated 
over a single useful life.
    f. Where the use allowance method is followed, the following 
general criteria apply:
    (1) The use allowance for buildings and improvements (including 
land improvements, such as paved parking areas, fences, and 
sidewalks) will be computed at an annual rate not exceeding two 
percent of acquisition costs.

[[Page 51917]]

    (2) The use allowance for equipment will be computed at an 
annual rate not exceeding 6\2/3\ percent of acquisition cost.
    (3) When the use allowance method is used for buildings, the 
entire building must be treated as a single asset; the building's 
components (e.g., plumbing system, heating and air condition, etc.) 
cannot be segregated from the building's shell. The two percent 
limitation, however, need not be applied to equipment which is 
merely attached or fastened to the building but not permanently 
fixed to it and which is used as furnishings or decorations or for 
specialized purposes (e.g., dentist chairs and dental treatment 
units, counters, laboratory benches bolted to the floor, 
dishwashers, modular furniture, carpeting, etc.). Such equipment 
will be considered as not being permanently fixed to the building if 
it can be removed without the destruction of, or need for costly or 
extensive alterations or repairs, to the building or the equipment. 
Equipment that meets these criteria will be subject to the 6\2/3\ 
percent equipment use allowance limitation.
    g. A reasonable use allowance may be negotiated for any assets 
that are considered to be fully depreciated, after taking into 
consideration the amount of depreciation previously charged to the 
government, the estimated useful life remaining at the time of 
negotiation, the effect of any increased maintenance charges, 
decreased efficiency due to age, and any other factors pertinent to 
the utilization of the asset for the purpose contemplated.
    h. Charges for use allowances or depreciation must be supported 
by adequate property records. Physical inventories must be taken at 
least once every two years (a statistical sampling approach is 
acceptable) to ensure that assets exist, and are in use. 
Governmental units will manage equipment in accordance with State 
laws and procedures. When the depreciation method is followed, 
depreciation records indicating the amount of depreciation taken 
each period must also be maintained.
    12. Donations and contributions.
     a. Contributions or donations rendered. Contributions or 
donations, including cash, property, and services, made by the 
governmental unit, regardless of the recipient, are unallowable.
    b. Donated services received:
    (1) Donated or volunteer services may be furnished to a 
governmental unit by professional and technical personnel, 
consultants, and other skilled and unskilled labor. The value of 
these services is not reimbursable either as a direct or indirect 
cost. However, the value of donated services may be used to meet 
cost sharing or matching requirements in accordance with the Federal 
Grants Management Common Rule.
    (2) The value of donated services utilized in the performance of 
a direct cost activity shall, when material in amount, be considered 
in the determination of the governmental unit's indirect costs or 
rate(s) and, accordingly, shall be allocated a proportionate share 
of applicable indirect costs.
    (3) To the extent feasible, donated services will be supported 
by the same methods used by the governmental unit to support the 
allocability of regular personnel services.
    13. Employee morale, health, and welfare costs.
    a. The costs of employee information publications, health or 
first-aid clinics and/or infirmaries, recreational activities, 
employee counseling services, and any other expenses incurred in 
accordance with the governmental unit's established practice or 
custom for the improvement of working conditions, employer-employee 
relations, employee morale, and employee performance are allowable.
    b. Such costs will be equitably apportioned to all activities of 
the governmental unit. Income generated from any of these activities 
will be offset against expenses.
    14. Entertainment. Costs of entertainment, including amusement, 
diversion, and social activities and any costs directly associated 
with such costs (such as tickets to shows or sports events, meals, 
lodging, rentals, transportation, and gratuities) are unallowable.
    15. Equipment and other capital expenditures.
    a. For purposes of this subsection 15, the following definitions 
apply:
    (1) ``Capital Expenditures'' means expenditures for the 
acquisition cost of capital assets (equipment, buildings, land), or 
expenditures to make improvements to cap