Key Takeaways:
- Indirect cost errors can lead to under-recovery, audit findings, repayments, and compliance risk, making proactive monitoring essential for helping safeguard funding and credibility.
- State, local, and Tribal governments must develop compliant indirect cost rate proposals and monitor subrecipients early and consistently, using a risk-based approach aligned with Uniform Guidance requirements.
- Effective monitoring goes beyond collecting reports — it requires reviewing documentation, verifying proper rate application, following up on findings, and driving corrective action in a shifting federal funding environment.
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If you’re a state, local, or Tribal government managing federal awards, indirect costs are probably not the first thing that keeps you up at night. But they should be on your radar — because errors in this area can trigger audit findings, jeopardize funding, and create compliance headaches that are far more painful to untangle after the fact than to prevent in the first place.
Here’s the good news: with the right processes in place, many of the most common indirect cost pitfalls are entirely avoidable. Let’s walk through the why, the when, and the how of indirect cost monitoring — so your organization can recover what you’re entitled to, support compliant recovery of allowable costs, and manage risk with confidence.
Why Does This Matter?
Indirect costs — those real costs of running your organization that aren’t directly tied to a single program or project — represent money your entity has legitimately spent in support of federal awards. Failing to recover them, or recovering them improperly, has consequences in both directions. Under-recovery leaves money on the table. Over-recovery or improper recovery can result in repayments, audit findings, and damage to your organization’s credibility.
Three risks rise to the top when it comes to indirect costs:
- Eligibility: Are the costs you’re claiming actually allowable under the applicable rules?
- Cost pool integrity: Is your indirect cost pool free from unallowable costs, duplicated charges, and items that belong elsewhere?
- Inconsistent treatment of costs: Are costs classified consistently as either direct or indirect, and are you applying that treatment uniformly across awards?
Any one of these, left unaddressed, can contaminate your indirect cost pool, skew your rate, and land your organization in noncompliance territory. Add in workforce turnover, the increasing complexity of multi-award management, and the pressure of the current federal funding environment, and the stakes become even clearer.
There’s also the matter of mandatory disclosure. Under 2 CFR Part 200.113, you are obligated to address issues you know — or should know — about when it comes to noncompliance, potential fraud, or illegal acts. Ignoring indirect cost problems isn’t a neutral choice. It’s a risk multiplier.
Getting the Foundation Right: Indirect Cost Rate Proposals
Before you can monitor indirect costs effectively, your organization needs to understand its own obligations. For state, local, and Tribal governments, the requirements are spelled out in Appendices V and VII of the Uniform Guidance (2 CFR Part 200):
- More than $35 million in direct federal funding? You are required to submit your indirect cost rate proposal (ICRP) to your cognizant agency for indirect costs.
- $35 million or less? You still must develop an ICRP — you just retain it for audit purposes rather than submitting it.
- Thinking about using the de minimis rate? State, local, and Tribal governments are not eligible. That option is reserved for other entity types without a current negotiated rate agreement.
The de minimis rate itself changed effective October 1, 2024, increasing from 10 percent to up to 15 percent, and the modified total direct cost (MTDC) base definition was also updated. If your subrecipients use the de minimis rate, make sure they’re applying it correctly to the updated MTDC base.
Common errors auditors and reviewers consistently flag include:
- Missing or inadequate certifications (or certifications signed by someone without sufficient seniority)
- Failure to develop or submit the ICRP at all
- Duplicated costs or costs treated as both direct and indirect
- Inclusion of unallowable costs in the indirect cost pool
- Totals that don’t reconcile to audited financial statements
- Misapplication of the rate to the wrong direct cost base during billing
If any of these sound familiar, it’s time to revisit your procedures.
When to Monitor — and Who’s Responsible
Monitoring isn’t optional. Federal agencies are required to monitor their prime recipients. As a prime recipient, you are required to monitor your subrecipients. And as a pass-through entity, you are responsible for negotiating indirect cost rates with subrecipients who don’t use the de minimis rate and don’t already have an active negotiated indirect cost rate agreement (NICRA).
Timing matters as much as the monitoring itself. Best practice is to start early in the fiscal year — when there’s still time to provide technical assistance, make corrections, and avoid year-end financial reporting complications. Monitoring that wraps up in the final weeks of the year with unresolved findings doesn’t protect you; it just documents problems too late to fix them.
A practical and defensible approach: select subrecipients and contractors using a risk-based methodology. Classify your population as low, moderate, or high risk based on factors like prior findings, award size, organizational capacity, and indirect cost complexity — then conduct random selections within each category. This approach can support extrapolation where permitted and appropriate, controls for volume, and can be combined with other monitoring activity, such as reviewing child nutrition and IDEA simultaneously during a single engagement.
How to Monitor Indirect Costs in Practice
Effective indirect cost monitoring can take many forms. Options include desk reviews, on-site reviews, agreed-upon procedures engagements performed by a CPA, standing program status meetings, and regular review of financial status reports. The key word is acting upon — it’s not enough to require and obtain reports. You need to review them and follow up. Monitoring that produces findings but no corrective action is monitoring in name only.
When reviewing a subrecipient’s indirect costs, focus on:
- Source documentation supporting the ICRP
- Internal controls and whether policies and procedures are actually being implemented
- Correct application of the indirect cost rate to the right direct cost base during invoicing
- Compliance with program budgets and required budget transfers
- Status of any prior corrective action
- The subrecipient’s own oversight of their subrecipients and contractors
For contractors, ensure they are performing in accordance with the terms, conditions, and specifications of their contracts or purchase orders — and verify that indirect costs included in contractor invoices are appropriate, supported, and consistently applied.
A Note on the Current Environment
The federal funding landscape is shifting in ways that add urgency to all of this. Award terminations, agency-specific restrictions, and evolving regulatory guidance have created real uncertainty. Many organizations are managing significant staff turnover, bandwidth constraints, and subrecipients with limited federal grant experience — all of which increase the likelihood of errors.
This environment calls for increased vigilance, not decreased. Errors will be made — the question is whether your monitoring program is positioned to catch them early, provide meaningful technical assistance, and drive corrective action before those errors become audit findings, repayments, or worse.
If your organization doesn’t have current, documented procedures for ICRP development, review, and submission — or if your monitoring program hasn’t been updated to reflect recent regulatory changes — now is the time to address that. The indirect cost requirements aren’t new, but the risk of getting them wrong has never been higher.
How MGO Can Help
Need help evaluating your indirect cost processes or building a monitoring plan? Our government consulting team can help you navigate the complexity and support the development of a monitoring approach tailored your organization. Contact us today to discuss how we can help you safeguard funding, mitigate compliance risk, and support a more sustainable indirect cost program.