Direct and indirect grant costs: how an NGO can justify them to a donor

An NGO justifies direct costs with documents that link the cost directly to the project, while indirect (administrative) costs in EU grants are usually covered by a flat rate which, under the EU Financial Regulation, does not exceed 7% of eligible direct costs unless a higher rate is authorised by a reasoned Commission decision. Shared costs that serve several projects are allocated using a method set out in the accounting policy and applied consistently.

It is at the boundary between direct and indirect costs that auditors most often find double funding: the same office rent or share of the accountant’s salary ends up both in the indirect cost rate and in the budget as a direct cost. Below we explain how to avoid this and what to show the donor.

What the EU rules say

Regulation (EU, Euratom) 2024/2509 of 23 September 2024 sets the financial rules for the EU budget, including grants. Text: EUR-Lex.

• Article 184(6). The beneficiary’s indirect costs may be funded at a flat rate of up to 7% of the total eligible direct costs of the action. A higher rate may be authorised by a reasoned Commission decision.
• Article 186(3). The conditions for paying lump sums, unit costs and flat rates do not require reporting on costs actually incurred. Under Article 186(4), however, this does not affect the right of access to the beneficiary’s statutory records for checks.
• Article 184(4). Methods for setting lump sums and flat rates must ensure compliance with the principles of co-financing and no double funding.
• Article 189(3). Actual costs are eligible if they are incurred during the action, indicated in the budget, necessary for the action, identifiable and verifiable (in particular recorded in the accounts under the applicable standards and the beneficiary’s usual cost accounting practices), compliant with tax and social legislation, and reasonable and justified.

The specific indirect cost rate for your project is set in the grant agreement. The auditor checks that rate, not the maximum in the Regulation.

Who this applies to

• civil society organisations and foundations running several grants at once with a shared office, accounting team and management;
• organisations whose budget contains both an indirect cost line and direct administrative lines (rent, communications, accounting);
• accountants who allocate salaries, rent and utilities between projects;
• directors who prepare grant applications and draw up budgets.

What to do

1. From each grant agreement, note the indirect cost rate, the base for calculating it and what the donor treats as direct costs.
2. Draw up an “organisation cost / where it goes” table across all projects. Each cost must be either direct in one project, or allocated across several, or covered by the indirect cost rate, and only one of these.
3. Set out the method for allocating shared costs in the accounting policy. Under Article 8 of the Accounting Law (zakon.rada.gov.ua) the organisation determines its own accounting policy, and Article 4 requires it to be applied consistently.
4. Keep timesheets for staff working on several projects. Without them, there is nothing to support the share of salary charged to a project.
5. For allocating rent and utilities, choose a clear base: floor area, number of project staff, hours. Make the calculation monthly and keep it.
6. In the report to the donor, show direct costs from documents and indirect costs at the rate in the agreement. Do not add to direct costs anything already covered by the rate.

Before submitting a new application, check how the new budget fits with grants already running. If the coordinator is already fully allocated between two projects, a third donor cannot pay for their time. A simple consolidated staffing plan for the year ahead removes most of these issues before the agreement is signed and gives you arguments when discussing the budget with the donor.

Direct, shared and indirect costs compared

Common errors

• Double funding. Office rent is covered by the indirect cost rate and at the same time partly charged to the project as a direct cost. This is the first thing an auditor looks for where budget lines meet.
• Shares adding up to more than 100%. The accountant is charged to three projects at 50% each. When the auditor adds up the shares across all grants, the error becomes obvious.
• The allocation method changes every quarter. Article 4 of the Accounting Law requires consistency, and a donor will find it hard to trust a method that changes whenever the budget needs closing.
• Allocation by guesswork. There is a percentage in the budget, but no table it comes from.
• The rate is applied to the wrong base. Indirect costs are calculated on the whole budget, although the agreement sets eligible direct costs as the base. When some direct costs are disallowed, the indirect amount falls automatically too.

We wrote more about the accounting policy of an NGO or foundation in accounting policy of a non-profit organisation, and about salaries in projects in staff costs in a donor project.

FAQ

How we help

We help NGOs set up an accounting policy and a method for allocating shared costs, and during a grant audit we check for double funding between projects. See NGO accounting, grant audit and NGO audit. For NGO accountants we run free webinars for NGOs. Write to us via contacts.

Prepared by the MK Audit team