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Contribution Fraud: Understanding Improper Cost Allocation

Every year, thousands of American consumers generously give to the charity of their choice; some have a few they make donations to.   The American Association of Fundraising Counsel reported that donations in 2003 totaled to more than $241 billion.  While these contributions are greatly appreciated for the most part, it is often difficult for a donor to determine if their funds were adequately used.  This was backed up by a recent survey by the Better Business Bureau Wise Giving Alliance that reported 70% of all donors surveyed found it difficult to determine whether or not their charity was actually legitimate. 

Though most charities tend to use donated funds appropriately, the growing rate of fraud has brought the subject of abuse to light.  Some organizations are simply lacking from a financial aspect; others are involved to raise funds for the enrichment of their personal party.  Many employ the strategy of improper cost allocation to not only establish a fraudulent charity, but to keep it thriving as well.                                         

A Legal Struggle

The fight to prove that cost allocation fraud is a federal crime has been controversial; the facts unclear at times.  In May of 2003, the United States Supreme Court reversed a decision of the Illinois Supreme Court which permitted a fraudulent act to proceed under state law.  A Justice of the Supreme Court stated that higher cost allocations, without more, do not constitute fraud.  He went on to state that the failure to disclose a fundraising fee when contacting potential donors, without more, is not enough evidence to claim fraud.  This ruling remains to conflict with states declaring that misleading or false information designed to deceive a potential donor on how their donation will be used constitutes fraud. 

There are however, other instances were improper cost allocation is viewed in a completely different light, a situation currently plaguing the U.S. government.  When a particular company or contractor has commercial contracts and government contracts, they are required to allocate or spread their costs between both assignments.   If the proper guidelines are followed, this is a simple process and the funds are distributed accordingly.  When costs aren't directly associated with a specific project, figuring the appropriate allocation is a bit more complex.  Many contractors are tempted to  pawn more of their own costs off on the government.  This occurs when a cost-plus contract is signed in which the government pays for the project and additional profits.  A cost-plus contract is separate from the private commercial client, who merely pays market price for their items.  Such cost allocation enables the contractor to quote a much lower price to the commercial client without enduring significant losses for the reduction.   

When contractors and companies knowingly employ improper cost allocation to disproportionate the share of overhead or indirect costs to the United States federal government, they are committing fraud under the False Claims Act. 

The Verdict

Unless you're employed by a federal agency or involved in the manufacturing of defense items, it's very difficult to positively impact the rate of improper cost allocation used to commit government fraud.  You can however, protect yourself against questionable charities.  If an organization doesn't have much of a verifiable history or fails to disclose important information, you may want to contribute your donation elsewhere.

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