In this article, we offer some actions that an institution can take to reduce the possibility of falling into some of the pitfalls that can happen at institutions that operate service centers for federal grants. Service centers are units within research institutions that charge the institution’s federal and non-federal grants for goods and services. Billing grant sponsors for the goods and services provided by service centers can support the recovery of the cost of the research enterprise, however, these billings also open the institution to audit risks.
Service center charges to grants are accounted for as direct costs and thus are subject to direct cost audits by federal sponsoring agencies. In the past, service centers themselves were the subject of a U.S. Department of Health and Human Services (HHS) – Office of the Inspector General (OIG) audit. In addition, “whistle blowers” can and have raised concerns with the operation of service centers which has led to investigations by the U.S. Department of Justice and large monetary settlements paid by research institutions. It is the resulting findings from these audits and investigations that we are calling “pitfalls”.
We begin by explaining what we mean when we use the term “service center” in this article. We then list some of the key issues that service centers must follow to be compliant with federal guidance and regulations. With this background, we delve into some of the past audit findings and offer suggestions on how to avoid similar situations at your institution.
What is a Service Center?
One of the key tools within the research enterprise is the service center, sometimes called, recharge center, or core facility. A service center is essentially a self-funded unit within the University that
- provides a good/service (or) groups of goods/services
- on a recurring basis
- to users primarily within the University
- charges or fees to users to recover the costs of providing the good/service
Specialized service facilities are one type of service center. The federal definition is found in Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards, Title 2 of the Code of Federal Regulations Part 200, more commonly referred to as the Uniform Guidance or 2 CFR Part 200. Section 2 CFR 200.468, describes specialized service facilities as, “highly complex or specialized facilities operated by the non-Federal entity, such as computing facilities, wind tunnels, and reactors.” 200.468 goes on to describe conditions under which the charges from the specialized service facility would be allowable on federal grants.
As described in the Cost Accounting Standards Board Disclosure Statement Instructions for the DS-2, Part III, item 3.2.0, “Service centers are departments or functional units which perform specific technical or administrative services primarily for the benefit of other units within a reporting unit. Service Centers include ‘recharge centers’ and the ‘specialized service facilities’ defined in Section J of Circular A-21.” [Now 2 CFR 200.468].
From the Summary Report on Audits of Recharge Centers fat 12 Universities - HHS Office of Inspector General, January 1994, (A-09-92-04020): “Recharge centers at universities, also known as specialized service centers, operate as in-house enterprises that provide goods or services to individual users or other operating units. These centers function as non-profit businesses, funding operations through fees from users.”
The terminology used at any one institution is likely to vary from other institutions. Just as the federal government has several terms they use for “service centers”, research institutions use terminology specific to that institution.
For this article, we have chosen to use the term “service center” as a generic term referring to activities that broadly meet the descriptions in the three federal documents referenced above.
Key Compliance Issues for Operating Service Centers
Charges from a service center will typically be posted to a sponsored project, therefore administrators must be aware of critical compliance issues. These include the following:
- Rates for the service center can include salaries and wages plus fringe benefits costs, materials, supplies, equipment maintenance expense, etc., but should recover no more than the actual cost of the good or service.
- Surpluses must and deficits may be incorporated into subsequent rates.
- A surplus from service center operations is not allowed to be used to fund unrelated activities.
- The service center must breakeven over time (minimal cumulative surplus or deficit) and the rates should be reviewed and adjusted at least every other year.
- The rates must not discriminate between users, especially those paying with federal funds. In practice, this means that the federal rate must be the lowest rate.
- Charges must be based on actual usage. A “Flat User Fee” unrelated to actual usage is not allowed.
- An official published price list should be maintained.
- Equipment depreciation expense may be included in service center rates. That is to say that the actual total acquisition cost of a depreciable asset is not allowable, instead, the cost must be spread out over the useful life of the asset.
- Depreciation expense included in service center rates should be excluded from the F&A Calculation.
- Service center subventions must not be included in the F&A rate. From, Summary Report on Audits… (A-09-92-04020), “Some universities had inadequate controls to prevent costs of recharge centers from being incorrectly included in the calculation of the indirect cost rate.”
- General costing principles that apply to all grants and contract costs apply to service centers. Costs charged to service centers must be:
- Consistently applied
- Necessary and Reasonable
Audit Findings Equals “Pitfalls”
The following are descriptions of three federal audits or investigations where service center operations resulted in one or more findings.
NIH Direct Cost Audit (A-04-11-01095) July 2012
- The animal facility computed rates by averaging rates that other universities charged
- The University did not perform biennial reviews to adjust the rates based on actual costs
- The telecommunications center did not charge based on actual usage of the service provided
- It charged administrative fees that were not part of the aggregate cost of providing the service
- Originally $5.8 million findings, eventually reduced U.S. Department of Justice - False Claims Investigation Settlement
- Specialized Service Centers: Overstated anticipated expenses, overcharged the government and billed for items not covered by the grants
- Billing Rates: Failure to revise and appropriately set its rate structure resulted in submission of numerous false claims
- $2.5 Million Whistleblower settlement
- Newsday, January 9, 2006 (Associated Press); Hartford Current, January 10, 2006 HHS-OIG Audit – Summary Report of Audits of Recharge Centers at 12 Universities (A-09-92-04020) January 1994
- Billing rates were not adjusted for accumulated surplus and deficit fund balances
- Included duplicate or unallowable costs in the calculation of billing rates
- Included recharge costs in the calculation of indirect cost rates
- Used funds of recharge center account for unrelated purposes
- Billed some users at reduced rates
- Individual reviews identified a total of $3.2 million in overcharges to the Federal Government and related indirect costs.
The Summary Report of Audits (A-09-92-04020) goes on to say, “We believe that these overcharges primarily resulted because universities did not: (1) establish or adhere to policies and procedures for recharge centers; and (2) maintain adequate accounting systems and records. Specifically, universities did not analyze and adjust billing rates, conduct annual cost studies, or monitor recharge centers on a regular basis. Furthermore, OMB Circular A-21 does not provide specific instructions for when and how to adjust for surpluses and deficits in fund balances.” [Note that OMB Circular A-21 has been superseded by 2 CFR Part 200.]
In addition to the key compliance issues listed in the previous section of this article, the government concerns include the following:
- Inadequate policies, procedures and/or oversight
- Unallowable costs are included in the billing rates
- Fund balances not properly monitored; lack of evidence of at least biennial rate adjustment / reconciliation
- Duplicate costs included in rates and F&A rate calculation
Avoiding Pitfalls – A Sound Policy on Service Centers is Essential
A sound policy on service centers is the backbone of service center compliance. The topics that we like to see addressed in all policies include:
- Background / Purpose / Introduction
- Roles and Responsibilities
Specific to Service center policies we generally include the following:
- Criteria for Establishing and Continued Operation
- Operational Requirements
- Allowable Cost
- Rate Setting
- Proper Handling of Equipment Costs
- Tax Implications
- Record Retention
The definitions section of a service center policy is vital as it specifies the characteristics of the units that must follow the stringent service center compliance policy and the units that are not required to. If there will be more than one type of service center, say recharge centers and specialized service facilities, then the policy is a good place to specify the definitions.
Some institutions will set a dollar threshold for annual revenue/expenses/ budget where units that exceed the threshold must comply with the service center policy. This threshold may be expressed as a threshold of federal usage, as the federal audits often pose the greatest exposure to audit risk for an institution, regarding service centers.
Policy definitions should include the definition of internal users, external users and any other category of users that will have usage rates distinct from the other categories of users. In setting rates for users that are not part of the institution’s accounting system, such that their payment for usage fees cannot be made through cost transfers/journal entries, the rates should generally be higher than for users that are part of the institution’s accounting system. External user rates may use market prices, may include a fee in excess of cost, and usually will include F&A costs as part of the rate in order to avoid unfair competition allegations by commercial enterprises offering similar services or goods. The institution must define the users to which these different rates will apply. If other institutions of higher education will receive special rates, then this should be defined in the policy definitions.
In addition to the policy on service centers, the institution should establish procedures pertinent to service centers. Some institutions will publish a “handbook”.
The procedures might include:
- Establishing a New Service Center
- How to Close a Service Center
- Rate Setting for Service Centers
- Annual Service Center Review
- Responsibilities and Roles
- Rate setting templates or examples
- Review templates or examples
- Where or how to get help or training
- References to existing polices/procedures
- Billing and Cash Handling
- Record Retention
- Unrelated Business Activity (UBIT)
- Sales Tax
- Setting up a new activity code (project code, org code, cost center, etc.)
Avoiding Pitfalls – Accounting Processes Can Reduce Risk
There are accounting practices that can help avoid audit findings, lost revenue, and the appearance of non-compliance plus enhance efficiencies in rate setting and the periodic review.
Service centers must bill their users in a timely manner based on actual usage
- Bill everyone (even if just billing to a subsidy account) – this avoids the appearance of discriminatory rates in that entries are made into the system for all usage. If there are users that should not be charged, for example, student usage for a course, then a cost center/fund/project should be set up to charge the fees to. Let’s say the department has a cost center where the student lab fee revenue is recorded, and these lab fees are meant to cover costs such as using the service center. Then the service center should charge the student lab fee cost center for the student usage. In this manner, the students do not receive a bill or pay for their actual usage, but the service center recovers the cost of providing the usage and the federal auditors can see that all users were charged.
- Best practice is to bill at least monthly – With federal grants being a significant portion of the usage for many service centers, it is important to process the cost transfers in a timely manner so that the grants are still open at the time they are billed. This is true for external users as well.
- Receivables from external users – a system must be put into place to account for receivables from external users if external usage is allowed
- If the service center must maintain stocks of supplies to be used in providing services, it may be necessary to conduct and record inventory of such within the accounting system. From Summary Report of Audits (A-09-92-04020), “For example, one university classified $722,179 in year-end purchases as expenditures rather than inventory, thus reducing surplus cash and the ending fund balance.”
Create a natural account (expense) code specifically for internal recovery of cost (credit). The credit for billing users should be recorded in the same activity code (project/org/cost center) as the operating expenses. The specific account code aids in identifying the service centers within the accounting system. This is important for the periodic review of service centers and for the proper treatment during the calculation of the F&A cost rates for the institution. Payments from external users are revenue. It is recommended to create a separate activity code (project/org/cost center) for billing external users. In doing so, the “fee in excess of cost”, the additional mark up for “market pricing”, or other revenue greater than expense will be recorded distinctly separate from the operating expenses and recoveries of the service center. This will avoid the appearance of the service center “making a profit”.
Avoiding Pitfalls – Avoid Duplicate Costs and Unallowable
Costs When a service center includes the depreciation on their equipment in the rates charged for usage, the institution must have a system in place to ensure that the same depreciation is not included in the F&A rate calculation. One way to avoid this pitfall is to not allow equipment depreciation in the service center rates.
Unallowable costs should be identified in the same manner as for federal grants. If it is desirable that service centers are allowed to incur federally unallowable costs then the suggestion is that these costs be incurred in a separate activity code (project/org/cost center), perhaps the same one used to record the external fee revenue in excess of cost. Another option is to create a separate category of users for federal users versus other sponsored users and have separate rates, one set of rates with and the other without the unallowable costs.
Avoiding Pitfalls – Identify Subsidies/Subventions
The reality is that most service centers do not break even, i.e. they do not cover their annual expenses with the annual recovery and revenue. Most service centers receive a subvention from an institutional funding source to cover the annual expenses. This situation is recognized in the “FAQs for Costing of NIH-Funded Core Facilities”, NOT-OD-13-053, issued by the National Institutes of Health, April 8, 2013 where they state, “A core facility can share similar operating principles with other service (or recharge) centers, which also may provide resources necessary to support the research objectives of an institution…the institution may decide to utilize institutional funds to support the operation of a core facility.”
These institutionally provided funds cannot be included in the F&A cost pools when calculating the F&A rate and must be allocated their fair share of F&A costs, thus these costs properly belong in the Other Institutional Activities, direct base. However, keep in mind that, if formally committed in an NIH grant proposal budget for the operation of the core, then these costs would be considered “voluntary committed cost sharing” when the project is awarded, thus belonging in the Organized Research base in the F&A rate calculation. When a service center ends their rate period in a deficit position, the deficit can sometimes be included in the subsequent rate calculation as an additional cost to recover in the subsequent rate period. If the deficit is not treated in this manner, then the proper treatment is to include the expense as an Other Institutional Activity, direct base cost, in the F&A rate calculation.
As noted in the section on Accounting Processes, recording subsidies to users who get reduced or no fee services in a subsidy fund will avoid the appearance of discriminatory pricing.
Avoiding Pitfalls – Charge Payroll Appropriately
Charging the payroll of the persons who perform the work of the service center to the service center operating activity code (project/org/cost center) is the best practice. In this way, the costs of operating the center are easily identified for rate setting and during review.
If the payroll is being covered from a different source, it is best to create a separate subvention activity (project/org/cost center) code to record the expense rather than to combine with non-service center costs. While this does create yet another code in the accounting system, it facilitates identifying all the costs of the service center, even if in multiple activity (project/org/cost center) codes.
Avoiding Pitfalls – Retain Documentation
From the Summary Report on Audits… (A-09-92-04020), “Each university should establish and maintain accounting systems and recordkeeping procedures applicable to recharge centers for capturing all financial, operating, and statistical data that is: (1) necessary for good internal control; (2) necessary for development and maintenance of billing rates; and (3) not available from the university’s main accounting system. If accounting systems and records are inadequate, then billing rates used to charge Federal projects may be overstated. It may also be impossible to make retroactive adjustments to correct ending fund balances.”
The document goes on to state, “Examples of records that should be maintained include: (1) financial records that track revenues, expenditures and surplus/deficit to specific goods and services within a cost center; (2) statistical records necessary for allocating costs or accumulating units of service available and used (e.g., vehicle miles, central processing units, or animal care days); (3) effort reporting records that identify employee work-time (in hours or percentage of time) to goods or services within a cost center; (4) background information that defines cost pools and terminology, describes allocation algorithms, and documents the basis for choosing a particular algorithm; (5) depreciation schedules; and (6) inventory systems.”
Additionally, we recommend that institutions:
- Publish and retain price (rate) lists
- Retain approval to establish the center documentation
- Retain documentation for the life of the grants plus audit eligibility
Avoiding Pitfalls – Check in with the Tax Office
If the institution allows the service center to sell to external users there are some tax considerations. It is recommended that the service center consult with the institutional tax office to determine what, if any issues may arise.
- If the goods or services sold are subject to sales tax, then the service center will need to understand the processes for charging and recording sales tax.
- Depending on the good or service, there may be unrelated business income tax (UBIT) considerations.
If unrelated business activity is a consideration, an additional issue may be the “private business use test” required when tax exempt governmental bonds are used to finance the space or equipment used by the service center. It may be prudent to consult the office at the institution that handles the capital bond financing if unrelated business activity is determined.
Avoiding Pitfalls – Central Oversight is Essential
From the Summary Report on Audits… (A-09-92-04020), “We found that universities with; adequate internal controls over recharge operations had established a governing body such as a recharge committee or a component in the controller’s office to oversee the operations of recharge centers. The recharge committees generally helped centers develop billing rates, adjust rates to eliminate surpluses and deficits, analyze cost studies to eliminate unallowable costs and transfers, and ensure that centers captured all necessary data, such as annual units of service, to establish billing rates.” Central oversight of service centers is essential to maintain compliance, i.e. avoid the pitfalls. The central oversight unit should keep the following in mind:
- Review of rates is required only every other year, but annual review will enhance oversight
- Positive, effective communication with the centers is key to maintaining compliance
- Regular meetings or forums, where service centers can get together to share ideas and solutions, as well as to hear from central oversight will enhance compliance
- Templates for requesting approval to establish a new center or service, setting rates, performing annual reviews, and for billing are helpful, but only if they are usable. Training must be provided to service centers.
- A structured training program for service centers will avoid many pitfalls.
Training might include:
- A useful and informative website
- Pre-recorded training videos
- Instructor-led, hands-on workshop-style training
- Accessible, usable standardized reports will facilitate rate setting and reviews. These might include any of the following:
- Standard reports from the financial system
- Custom reports from reporting tools
- Access to financial system/reports to validate charge codes
- Monthly financial balance/financial position (surplus/deficit) reports
- Fixed asset reports to determine depreciation on equipment
- Usage reports for billing, from a service center billing system
- Billing reports for receivables and collection
Operating service centers can put the institution at risk of tumbling into one of many pitfalls. We have suggested ways to avoid the pitfalls including: having a solid policy and procedures; setting up processes to identify duplicate charging and unallowable costs as well as subsidies and subventions; charging payroll accurately; retaining documentation; consulting with the institutional tax office when considering allowing external usage; and establishing strong central oversight. One last tip – The fewer audit target, the lower the audit risk, therefore, use policy definitions to narrowly define service centers to mitigate risk.