Cost Principles for Federal Grants

The Foundation: Allowability of Costs

Subpart E (§200.400–475) establishes the cost principles that apply to all non-federal entities receiving federal awards. These principles answer a deceptively simple question: can this expense be charged to the grant? The answer depends on a framework that every grants manager and CFO must internalize, because cost disallowances are among the most common — and most financially painful — audit findings.

Before the Uniform Guidance, cost principles were split across three circulars: A-21 for universities, A-87 for governments, and A-122 for nonprofits. Subpart E unified these into a single set of rules. While the consolidation eliminated most differences, certain provisions still recognize that different entity types have different cost structures — particularly around compensation and indirect cost rates.

The Three-Part Allowability Test

Section §200.403 establishes the fundamental test. Every cost charged to a federal award must satisfy all three criteria simultaneously. Failing any one makes the cost unallowable.

1. Reasonable (§200.404)

A cost is reasonable if, in its nature and amount, it does not exceed what a prudent person would incur under the same circumstances. The regulation applies an objective standard: would someone spending their own money make the same decision? Factors include whether the cost is ordinary and necessary for the operation, whether the organization followed its own policies, whether market prices were considered, and whether the individual acted with prudence given their responsibilities.

In practice, reasonableness challenges often arise around compensation levels (is a $200,000 salary reasonable for this position in this labor market?), travel costs (was business class airfare necessary?), and consultant rates (does $350/hour reflect market rates for this expertise?). Document the basis for cost decisions at the time they are made — not after an auditor asks.

2. Allocable (§200.405)

A cost is allocable to a federal award if it is incurred specifically for that award, benefits both the award and other work and can be distributed in reasonable proportion, or is necessary to the overall operation of the organization and is assigned to the award in accordance with cost principles. The key requirement is proportionality: if a staff member spends 60% of their time on a federal grant, only 60% of their salary and benefits may be charged to that grant.

Allocability requires a defensible methodology. Time-and-effort reporting, cost allocation plans, and indirect cost rate proposals all serve as mechanisms for demonstrating that costs are allocated to awards in proportion to the benefit received. The most common allocability issue is charging 100% of a shared cost to a single award because it is the most available funding source.

3. Consistent (§200.403(c))

Costs must be treated consistently across all funding sources. If your organization treats a particular expense as indirect for non-federal activities, you cannot classify it as a direct cost on a federal award. If you require competitive bidding for purchases over $5,000 on your state contracts, you should apply the same threshold to federal awards. Consistency applies both over time and across awards.

This principle prevents “cost shifting” — the practice of classifying costs differently depending on which funding source is most advantageous. Auditors specifically test for consistency by comparing how costs are classified across your organization's portfolio of awards.

Direct Costs vs. Indirect (F&A) Costs

Direct Costs (§200.413)

Direct costs are expenses that can be identified specifically with a particular federal award, project, or activity with a high degree of accuracy. Common examples include salaries and wages of staff working directly on the project, fringe benefits for those staff, supplies consumed by the project, travel for project purposes, and subcontract costs for project-specific work.

The Uniform Guidance permits charging certain normally indirect costs as direct costs when there is a clear, documented justification. For example, if a project requires dedicated IT support that is not typically charged directly, the organization may charge it directly provided the cost is treated consistently across all federal awards and the methodology is documented.

Indirect (Facilities & Administrative) Costs (§200.414)

Indirect costs are expenses incurred for common or joint objectives that cannot be readily identified with a specific award. They include facilities costs (depreciation, rent, utilities, maintenance) and administrative costs (general administration, accounting, HR, executive leadership). These costs benefit multiple programs and activities and are recovered through an indirect cost rate applied to a base of direct costs.

Organizations recover indirect costs through one of two mechanisms:

• Negotiated Indirect Cost Rate Agreement (NICRA) — a rate negotiated with your cognizant federal agency, based on audited actual costs. This rate is applied to modified total direct costs (MTDC) and must be accepted by all federal awarding agencies. The process typically involves submitting an indirect cost rate proposal documenting your cost allocation methodology, which the cognizant agency reviews and approves.
• De minimis rate — organizations that have never had a negotiated rate may elect to use the de minimis rate of 15% of MTDC (increased from 10% in the 2024 revisions). This rate may be used indefinitely and does not require a NICRA. It is a practical option for smaller organizations that lack the resources to develop a full indirect cost proposal, but it may significantly underrecover actual indirect costs for organizations with higher overhead structures.

Modified Total Direct Costs (MTDC)

MTDC (§200.1) is the base against which indirect cost rates are applied. It includes all direct salaries and wages, applicable fringe benefits, materials and supplies, services, travel, and up to the first $25,000 of each subaward. It excludes equipment, capital expenditures, rental costs of real property, patient care charges, tuition remission, scholarships and fellowships, participant support costs, and the portion of each subaward in excess of $25,000. Understanding what is and is not included in MTDC is essential for accurate budget preparation and indirect cost recovery.

Selected Items of Cost (§200.420–475)

Sections 200.420 through 200.475 address 55 specific cost categories, providing detailed guidance on whether and how each may be charged to federal awards. These “selected items of cost” are the provisions that grants managers reference most frequently. Below are the categories that most commonly affect healthcare organizations and nonprofits.

Compensation — Personal Services (§200.430)

Compensation for personnel services — salaries, wages, and fringe benefits — is typically the largest cost category on federal awards. The Uniform Guidance requires that compensation be reasonable for the services rendered and consistent with the organization's established policies. For nonprofits, compensation must reflect the labor market in the organization's geographic area for comparable positions.

Time distribution (time-and-effort reporting) is required for all employees whose compensation is charged to federal awards. The system must reasonably reflect the total activity for which the employee is compensated, including federal and non-federal activities. Under the 2024 revisions, OMB has provided additional flexibility for how organizations document time distribution, moving away from rigid after-the-fact certifications toward systems that produce records that accurately reflect work performed.

Travel Costs (§200.475)

Travel costs are allowable when the travel is directly related to the federal award. Airfare must be at the lowest available commercial rate (coach/economy class). The organization must follow its own travel policy, and if the policy is less restrictive than the federal requirements, the federal requirements apply. Per diem rates for lodging and meals must not exceed the rates published by the General Services Administration (GSA) for domestic travel or the State Department for international travel.

Equipment and Supplies (§200.439, §200.474)

Equipment is defined as tangible personal property with a useful life of more than one year and a per-unit acquisition cost of $5,000 or more (or the organization's capitalization threshold, whichever is less). Equipment purchases generally require prior written approval from the federal awarding agency. Supplies are tangible personal property below the equipment threshold. Computing devices are treated as supplies if they are essential and allocable to the project, regardless of unit cost.

Conferences and Meetings (§200.432)

Conference costs are allowable when the primary purpose is the dissemination of technical information related to the federal award. Costs must be reasonable and not include entertainment or social activities with no programmatic purpose. Organizations should document the programmatic justification for each conference, the relationship to the award objectives, and why the conference format was the most cost-effective means of achieving the purpose.

Commonly Disallowed Costs

The Uniform Guidance explicitly prohibits certain cost categories from being charged to federal awards under any circumstances. Grants managers should be intimately familiar with these provisions to prevent disallowances.

Costs Requiring Prior Written Approval

Several cost categories are allowable only with prior written approval from the federal awarding agency. Charging these costs without obtaining approval first is a compliance violation — even if the cost is otherwise reasonable and allocable.

• Pre-award costs (§200.458) — costs incurred before the start of the period of performance, up to 90 days before the award date
• Equipment purchases (§200.439) — tangible personal property with per-unit cost of $5,000+ and useful life exceeding one year
• Foreign travel (§200.475) — travel outside the United States and its territories
• Participant support costs (§200.456) — stipends, travel allowances, and registration fees paid to participants (not employees) in conferences or training
• Capital expenditures (§200.439) — expenditures for the acquisition or improvement of land, buildings, or equipment
• Rearrangement and reconversion costs (§200.462) — costs of rearranging facilities or restoring them to pre-award condition

Practical Guidance for Healthcare Organizations

Healthcare nonprofits and Federally Qualified Health Centers (FQHCs) face distinct cost principle challenges because of the complexity of their funding streams and cost structures.

Multiple Funding Streams

A typical community health center may simultaneously manage a HRSA Section 330 grant, one or more SAMHSA behavioral health grants, state contracts, Medicaid revenue, and sliding-fee-scale patient payments. Each staff member may serve patients across multiple programs. The cost allocation methodology must accurately distribute costs across all funding sources — not just the federal awards. Inconsistencies in how costs are allocated between federal grants and other revenue sources are a primary audit risk area.

Compensation Documentation

Clinical staff compensation is often the largest cost category. Organizations must be able to demonstrate that compensation levels are reasonable for the geographic area and role, that time distribution records accurately reflect work performed across all activities, and that fringe benefit costs are allocated consistently. Compensation surveys from organizations like MGMA, NACHC, or state primary care associations provide defensible market comparisons.

Indirect Cost Rate Considerations

Healthcare organizations with significant facility costs, administrative infrastructure, and compliance overhead often have actual indirect cost rates well above 15%. Organizations relying on the de minimis rate may be leaving substantial federal revenue on the table. If your actual indirect costs exceed 20% of MTDC, developing a negotiated rate is almost always worth the investment. HHS is the cognizant agency for most healthcare nonprofits, and the rate negotiation process typically takes 3–6 months.

For procurement-specific cost guidance, see our procurement standards guide. For audit implications of cost principle violations, see the audit requirements chapter.