State Agencies Lose Millions in Federal Reimbursements

Understanding SWCAP and Its Two Cost Categories

Every state that receives federal funds is required to prepare a Statewide Cost Allocation Plan (SWCAP) in accordance with 2 CFR Part 200, Appendix V, which governs central service cost allocation. SWCAP identifies the costs of central services provided by the state and how those costs should be allocated to benefiting agencies.

SWCAP divides central services into two primary categories:

• Section I – Allocated Costs: Costs allocated to agencies based on a statistical methodology (e.g., General Services, Budget, Legal).
• Section II – Billed Costs: Costs billed directly to state agencies through internal service funds (ISFs) or similar mechanisms. These include:
  
  • Data centers
  • Telecommunications
  • Financial and payroll systems
  • Risk management
  • Mail and printing services

While Section I costs are often incorporated into indirect cost proposals by default, Section II costs are frequently ignored — and that's where the problem begins.

Why Billed Costs Matter in Indirect Cost Recovery

Billed costs are typically associated with mission-support services that benefit the entire agency. Because these services often cannot be directly tied to a single federal program or grant, they should be classified as indirect costs. The federal government allows agencies to recover these costs, provided they are:

• Properly allocated
• Not directly charged to the federal award
• Included in an approved agency-level Cost Allocation Plan (CAP) or Indirect Cost Rate Proposal (ICRP)
• Supported by the SWCAP

When billed services are excluded, agencies understate their actual indirect cost base, which lowers the rate or dollar value of recovery — effectively leaving federal funds unclaimed.

Why Agencies Fail to Include Billed Costs

There are several reasons state agencies routinely exclude billed costs from their cost recovery strategies:

1. Misunderstanding of 2 CFR 200 Rules
2. Lack of Visibility into SWCAP Section II
3. Fear of Double Charging
4. Over-reliance on Direct Charging Models

Consequences of Excluding Billed Costs

Omitting billed costs from indirect cost recovery plans can have several downstream effects:

• Reduced federal reimbursement
• Strained general funds
• Distorted program cost data
• Audit risk

Best Practices for Including Billed Costs

To improve recovery and ensure compliance, state agencies should adopt the following practices:

• Coordinate with the SWCAP Preparer
• Review Internal Service Fund Statements
• Document Appropriately
• Update Your Indirect Cost Model
• Train Your Finance and Grant Staff

Case in Point: Missed IT Cost Recovery

Consider a state human services agency that pays $2 million annually to the state’s central IT department for services like cloud hosting, user support, and enterprise software. Because these costs are billed through an ISF, the agency assumes they are ineligible for inclusion in its indirect cost proposal. As a result, the full $2 million — much of which supports grant-funded activities — is absorbed by state general funds rather than recovered from the federal government.

Had the agency included these billed costs in its indirect cost pool, it could have recovered 60–75% of the total depending on its grant portfolio — an annual missed opportunity of $1.2–$1.5 million.

Conclusion

State agencies cannot afford to ignore billed costs defined in SWCAP Section II when preparing their indirect cost recovery plans. These services, while often hidden behind internal billings, represent real costs incurred to support federally funded activities. By aligning cost allocation practices with federal guidelines and leveraging the full value of the SWCAP, agencies can maximize reimbursement, strengthen financial sustainability, and improve cost transparency.

Need help recovering overlooked billed costs or integrating them into your CAP or ICRP? We can help you model your costs, justify your inclusion, and navigate federal approval.