House Committee on Veterans' Affairs

RESPONSE TO QUESTIONS FOR THE RECORD

Committee on Veterans Affairs

Subcommittee on Oversight & Investigations

Hearing on VA Research & Nonprofit Research Corporations

and Educational Foundations

September 19, 2002

Addressed to and Submitted by

Henry G. Kirschenmann, Jr.

Question:

Would an offer by NIH to cover "incremental" costs cover "indirect" costs associated with NIH research at VA facilities?

Response:

As stated in my response to the following question, reimbursement of "incremental" costs, assuming they could be measured, would not cover the costs of those VA support activities commonly referred to as "indirect"..

Question:

What is the difference between incremental and indirect costs? How are each determined? What is the reliability of each determination?.

Response:

Indirect costs are those costs commonly referred to as `general and administrative' and ` `facilities' costs. `General and administrative' include the costs of such support activities as procurement, personnel, accounting & budgeting, information technology, research administration, general management, etc. In large organizations, such as the VA, these costs are grouped by organizational tiers; for example, costs incurred at the medical center level, those at the VHA level, those at the VA level, etc. `Facilities' include such costs as maintenance & repairs, utilities, janitorial services, etc. Only the costs of the facilities used for research at the medical centers were included in the rate calculation for VHA research.

The term incremental cost is used to describe those additional costs which an organization might incur as a consequence of undertaking a particular (invariably a new) project, or activity, or function. Essentially, it is used to estimate the likely out of pocket expenses that would be (are) incurred by an organization in performing the new undertaking. It is a useful measurement in those instances in which a new endeavor of significant size is to be undertaken, especially when the endeavor is unique and/or independent from other activities of the organization. It is a helpful management tool in that it can quantify the impact of such an undertaking upon an organization's available resources particularly its cash needs. It is unrealistic in other situations, however, in that it assumes the endeavor has no work impact and does not draw upon an organization's normal support activities. Thus, incremental costing has utility in assessing the cost impact of a research function of an entity in comparison to an entity's other functions (like patient care), or for measuring the cost impact of a major, unique research project to be conducted within an entity's on-going research function and which will entail the need for a material increase in an organization's current resources to support it. Its use is problematic and subject to arbitrary judgements in situations in which the additional research is a project(s) akin to other comparable projects performed by an organization as part of its ongoing research function.

Incremental costing was considered, and rejected as impractical, when the OMB was developing its cost principles for colleges & universities, other nonprofit institutions, and state & local governments (Circulars A-21, A-122, and A-87, respectively). Instead, the OMB cost principles incorporate/apply the universally accepted rule that the costs of an organization's support services should be allocated to all those other activities of the organization in proportion to the estimated, reasonable benefit an activity derives from the service. The allocation rule is also adopted in the Federal Acquisition Regulations, the costing of patient care and other hospital activities under Medicare, the costing guide for hospitals published by the American Hospital Association, and those cost principles applicable to the costing of programs conducted within Federal agencies (which I cited in my testimony).

A very simple example of the difference between the two costing approaches. Assume an organization receives an award to produce some product, say to conduct a research project. To conduct the project, supplies must be procured; checks must be written to pay the suppliers and to pay the researchers and technicians who are involved in it; payroll and other personnel services for these people is involved; space in which to conduct experiments must also be provided and maintained; security and fire services need to be provided: people might need to be hired; staff supervision/oversight is required; project costs need to be controlled and accounted for; reports to sponsors need to be prepared and submitted; etc. Say also that the organization conducts numerous research projects.

Under an incremental costing system, if these services were provided within the existing resource of the organization, they would not be recognized as a cost of the project. They would only be recognized if a new employee had to be hired to write the checks, new space had to be procured to conduct the research, new personnel department staff had to be employed to hire and service the project staff; new accounting staff had to be hired to control and report on the project's costs; etc. What would be recognized would be the costs of the additions. If a second research project were undertaken the same rules would apply to it; that is, only the costs of any additions caused by the project would be recognized as a cost of the project. Incremental costing thus becomes the more impractical as more research projects are undertaken. And it can lead to the adding of otherwise unnecessary staff and space, and manipulations, as organizations are faced with a potential loss of reimbursement because of it.

Under the allocation concept, one would identify those support services from which a (research) project would derive benefit and apportion the costs of the services between the project and all the other activities which also receive benefit from them. The apportionment would be calculated using some generally accepted measure, say for example, square feet of research space occupied, the number of total new hires, the total number of checks written or invoices paid, etc. or some more general approach as provided for in the cited costing principles.

If we assume, as was asserted at the hearing, that the requirement that VA cover indirect costs associated with NIH research at VA facilities is having unwanted impact on veterans healthcare, and that NIH is concerned that any "add-on" for indirect costs may be used for veterans healthcare, how would one resolve his conflict fairly?

If one were to apply the allocation concept contained in the Federal cost principles, the amount of indirect costs associated with the research activity would be deemed to represent only research costs and would not include any medical care costs. This is the methodology/concept used under Medicare and the American Hospital Association guide, for example, to separate medical care costs from the costs of other activities (including research) conducted by hospitals and medical care centers.

As noted in my prior response, in large organizations, operations and support activities are typically performed at several tiers. At the VA, those tiers are the medical centers, and the regional, VHA, and VA headquarters tiers. The involvement of some of these tiers are, of course, more immediate to the research projects performed than others. One approach to reaching an agreement could be to exclude the costs of the less immediate tiers, e.g.; the VA headquarter tier, from consideration and recognizing the costs associated with the more immediate tier(s). The end result would be a compromise between both costing approaches. This could be done through agreement between the parties or, if agreement is not possible, through mandate by some empowered third party. The methodology I employed and the rates I calculated and submitted, would allow such a compromise.