Cost Allocation Plans for Nonprofit Grants: A Step-by-Step Guide

What Is a Cost Allocation Plan?

A cost allocation plan is a formal document that describes how an organization identifies, measures, and distributes shared costs across its various programs, grants, and funding sources. For nonprofits managing multiple grants, a well-constructed cost allocation plan is not merely a best practice but a compliance requirement. The Uniform Guidance at 2 CFR 200.416 requires that organizations receiving federal awards maintain cost allocation plans or indirect cost rate proposals that accurately reflect the distribution of costs to benefiting activities.

Without a cost allocation plan, organizations face the risk of charging costs disproportionately to one grant while under-charging another, creating compliance issues with multiple funders simultaneously. Auditors look for consistent, documented, and defensible methodologies for distributing shared costs, and the absence of a plan is itself a finding.

Step 1: Identify Your Cost Categories

The first step in building a cost allocation plan is categorizing every cost your organization incurs into one of three categories:

• Direct costs: Costs that can be specifically identified with a particular grant, project, or activity. Examples include salaries of staff who work exclusively on one grant, supplies purchased specifically for a program, and travel for grant-specific activities.
• Indirect costs: Costs incurred for common objectives that benefit multiple programs and cannot be readily attributed to a specific project. Examples include executive director salary, rent for shared office space, accounting services, and general liability insurance.
• Shared or joint costs: Costs that benefit more than one program but could potentially be allocated directly if a reasonable methodology exists. Examples include a program director who oversees two grants, a vehicle used by multiple programs, or shared printing and copying expenses.

The distinction between indirect costs recovered through a rate and shared costs allocated directly is important. Your cost allocation plan should address both categories and explain the methodology used for each. For a detailed understanding of how federal cost principles classify expenses, review our guide on grant budget fundamentals and federal cost principles.

Step 2: Select Allocation Bases

An allocation base is the metric used to distribute a shared cost across benefiting programs. The base you choose must bear a reasonable and measurable relationship to the cost being allocated. Common allocation bases include:

• Direct labor hours or salaries: Appropriate for costs that vary with the amount of staff effort, such as supervisory time, human resources costs, and payroll processing.
• Square footage: Appropriate for facility-related costs such as rent, utilities, maintenance, and janitorial services, allocated based on the space each program occupies.
• Number of transactions: Appropriate for costs like accounting or IT support that are driven by the volume of activity rather than the size of the program.
• Direct costs or modified total direct costs: A common base for distributing general administrative costs proportionally across programs based on their relative size.
• FTE count or headcount: Appropriate for costs that scale with the number of employees, such as HR administration or employee benefits processing.

Choosing the Right Base

The key principle is that the allocation base must produce a result that reasonably approximates the actual benefit each program receives from the shared cost. Using square footage to allocate rent is logical because programs that occupy more space consume more of that resource. Using square footage to allocate accounting costs would be less defensible because accounting workload is not related to physical space.

Step 3: Document Your Methodology

Your cost allocation plan must be a written document that any auditor, program officer, or new finance staff member can understand and apply. At a minimum, the plan should include:

• Purpose and scope: A statement describing what the plan covers and which funding sources are affected.
• Organizational description: A brief overview of the organization's structure, programs, and funding sources.
• Cost classification criteria: How the organization determines whether a cost is direct, indirect, or shared.
• Allocation methodologies: For each category of shared cost, the specific base used and the rationale for selecting it.
• Data sources and calculations: Where the allocation data comes from and how percentages are computed.
• Review and update schedule: How often the plan is reviewed and updated to reflect changes in organizational structure or activities.

Understanding how to present your organizational capacity and financial infrastructure to funders strengthens both your cost allocation practices and your proposals. See our guide on organizational capacity and partnerships in grant proposals for more context.

Step 4: Implement and Monitor

A cost allocation plan is only as good as its implementation. Once the plan is documented, train your finance staff on how to apply it in daily operations. Every journal entry for a shared cost should reference the allocation methodology and produce a distribution that matches the plan's prescribed percentages.

Monitor allocation results monthly. Look for anomalies that might indicate the methodology needs updating, such as a significant change in program size, a new grant that alters the mix of activities, or a relocation that changes space utilization. When changes occur, update the allocation percentages and document the rationale for the revision.

Annual Review and Updates

At a minimum, review and update your cost allocation plan annually. Many organizations tie this review to their fiscal year-end close process, using actual data from the completed year to refine allocations for the coming year. This annual refresh ensures your plan remains current and defensible.

Step 5: Prepare for Auditor Review

During a Single Audit or program-specific audit, auditors will evaluate whether your cost allocation methodology is reasonable, consistently applied, and adequately documented. They will test individual transactions to verify that allocated costs match the plan's methodology and that the allocations produce equitable results across programs.

Prepare for these reviews by maintaining organized files that include the current cost allocation plan, supporting calculations, source data for allocation bases, and records of any changes made during the year. Being able to walk an auditor through your methodology step by step demonstrates the kind of internal control environment that leads to clean audit opinions. For a broader view of audit readiness and compliance management, see our guide on post-award grant management and compliance.

Learn more about grant writing strategies at Subthesis.

Build Professional Grant Management Skills

Cost allocation is a foundational competency for anyone managing nonprofit grants. The Complete Grant Architect course covers cost allocation, budgeting, financial reporting, and the full range of skills needed to manage federal awards effectively. Enroll today and gain the structured training that transforms compliance challenges into organizational strengths.