costing government goods and services a seminar by dr. clifford mccue associate professor school of...
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COSTING GOVERNMENT GOODS AND SERVICES
A Seminar by Dr. Clifford McCue
Associate ProfessorSchool of Public Administration
Florida Atlantic university
Introductory Disclaimer
This presentation is meant to convey general and explicit ideas consistent with the manner in which they would be discussed in a traditional classroom setting
Some ideas and slides were lifted without change or attribution from other presentations and material from the web
Since it is not meant to be disseminated or used outside of the intended purposes for this Webinar, ideas and actual slides used in this presentation are not cited as to their original sources or presentations and should not be used for any other purpose than relaying information within this setting.
We will cover in this course The difference between financial, managerial, and cost
accounting;
COSTING GOVERNMENT GOODS AND SERVICES
This Webinar is about BASIC issues and GENERAL principles It does NOT profess any specific legal or statutory
requirements Consult your particular jurisdiction for any and all
requisite mandates or injunctions
Basic Costing Principles
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Comparison of cost, management and financial accounting
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Meanings
Financial accounting Cost accounting Management accounting
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Financial accounting
Provides information to users who are external to the government
It reports on past transactions to draw up financial statements
Their format is typically determined by law and accounting standards established by the professional accounting policies (GASB/GFOA)
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Cost accounting
Is concerned with internal users of accounting information, such as division/operations managers
The generated reports are specific to the requirement of the management
The reporting can be in any format which suits the user
Management accounting
Comprises all cost accounting functions The accounting for product and service costs,
management accounting extends to use various internal accounting reports for planning, control and decision making
Cost and management accountingVs.
Financial accounting
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Management (cost)accounting
Financial accounting
Nature Records material, labor and overhead costs in product or jobReports produced are for internal management and control
Records government transaction eventsExternal financial statements are produced
Accounting system
Not based on the double entry system
Follows the double entry system
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Management (cost)accounting
Financial accounting
Accounting principles
No need to use accounting principlesAdopt any accounting techniques that generates useful accounting information
Use Generally Accepted Accounting Principles for recording transactions
Users of information
Used by different levels of management or departments responsible for respective activities
Used by external parties: bond rating companies, citizens, elected officials, etc.
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Management (cost)accounting
Financial accounting
Operation guidelines or standards
Based on management instructions and requirements
Conforms to local ordinances, state law, and GAAP
Time span Reports are prepared whenever neededThey may be prepared on a weekly or daily basis
Reports are prepared for a definite period, usually yearly
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Management (cost)accounting
Financial accounting
Time focus Future orientation: forecasts, estimates and historic data for management actions
Past orientation: use of historic data for reporting and evaluation
Perspective Detailed analysis of programs/activities of the government
Financial summary of the whole organization, including all funds
Cost accountingvs.
Management accounting
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Management accounting
Cost accounting
Objective To provide information for planning and decision making by the management
To ascertain and control cost
Basic of recording
Concerned with transactions related to the future
Based on both present and future transactions for cost ascertainment
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Management accounting
Cost accounting
Coverage Covers a wider area: financial accounts, cost accounts, etc.
Covers matters relating to ascertainment and control of cost of programs, services, or activities
Utility Only the needs of internal management
The needs of both internal and external interested groups
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Management accounting
Cost accounting
Types of transactions
Deals with both monetary any non-monetary transactions, covering both quantitative and qualitative aspects
Deals only with monetary transactions, covering only quantitative aspect
Costing Government Activities
Not surprising, we actually know what it costs to run a government, both what we anticipated to spend and what we actually spent. What we anticipate to spend: Budgeting What we actually spend: Financial reporting (CAFR)
So what is the Costing Issue
The issue is assigning costs to programmatic levels within departments. Typically we can isolate costs for specific items within
a department, normally identified on the accounting ledger (object of expenditure code).
But that does not really help us identify costs associated with a specific program, activity or function.
So what do we need to do?
The fundamental issue in cost accounting (notice how we did not mention management account – that can only be done once the cost accounting system is in place) is determining at what level of the organization do you want to relate costs to goods and services provided? For example, the budget assigns costs to the
departmental level, and some budgets, such as a program budget, can assign costs to specific programs – but what about overhead costs?.
How to choose a cost center
A cost center is often a department/agency but for costing purposes it should drill down to the activity level. The manager and employees of a cost center are responsible for its costs but are not typically responsible for revenues or other financing decisions, like investment decisions.
Cost centers include each governmental department/agency that generates a good or a service to its customers. Other examples of cost centers include the human resource department, the IT department, the accounting department, and so on.
Cost centers are not limited to departments/agencies. There might be several cost centers within a department. For example, each program within a department could be a cost center. Even a special machine in Public Works could be a cost center.
Cost centers are usually associated with the topic of decentralization, responsibility accounting, and planning and control.
Cost Centers
Cost centers are used for two reasons: planning and controlling costs in government.
Cost centers help identify ways for departments/agencies to improve performance (financial) by staying within their budgets.
Cost centers provide a vehicle to analyze all expenses for a particular ACTIVITY and finding ways to decrease the costs in the future.
The job of a cost center is to control costs and increase performance.
Costing Techniques
The basic types of cost estimates
Outline
Introduction Costing Techniques Using Costing Techniques Comparison of Techniques ABC Summary
Introduction
The three essential cost estimating techniques (or methodologies) are: Analogy Parametric Build-Up
Other topics we will discussed in relation to the three essential techniques are: Expert Opinion Extrapolation from Actuals
Costing Techniques Analogy Parametric Build-Up Other Topics
Costing Techniques Overview
Costing Techniques provide the structure of your cost estimate They’re what enable you to predict future costs based
on historical data Techniques rely on statistical properties, logical
relationships, and emotional appeal Three essential types
Analogy: “It’s like one of these” Parametric: “This pattern holds” Build-Up: “It’s made up of these”
Analogy - Method
Comparative analysis of similar systems Adjust costs of an analogous system to estimate the
new system Adjustments could be based on:
Programmatic information Physical characteristics Performance Government vs. Commercial practices Contract specifics Economic trends
Analogy - Application
Used early in the program life cycle Data is not available to support using more detailed
methods Not enough data exists for a number of similar systems, but
can find cost data from a single similar system The best results are achieved when
Similarities between old and new systems are high Adjustments can be quantified Subjective adjustments are minimized
Can be used as a cross check for other methods
Analogy – Advantages /Disadvantages
Advantage Can be used early in programs before detailed requirements
are known Difficult to refute if there is strong resemblance
Disadvantage Introduces subjectivity in the adjustment Difficult to obtain cost/technical data on old/new systems
for comparison No objective test of validity
Analogy – Fighter Example
Attribute Old System New System
Engine: F-100 F-200
Thrust: 12,000 lbs 16,000 lbs
Cost: $5.2M ?
Q: What is the unit cost of the F-200?
A: $5.2M * (16,000/12,000) = $6.9M
Tip: The mischief in analogy most
often arises in the adjustment. Why do we so readily believe a linear
relationship which passes through the
origin?
Parametric Estimating - Method
A mathematical relationship between a parameter and cost Parameter may be physical, performance, operational,
programmatic, or cost Uses multiple systems to develop relationship Allows statistical inferences to be made
Parametric could also be called Cost Estimating Relationships (CERs), Rates, Factors, Ratios
Parametric could also be called Cost Estimating Relationships (CERs), Rates, Factors, Ratios 0
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Parametric Estimating - Application
Use of Parametrics Requires a good database which is relevant to the system
being estimated Excellent for use early in program life cycle before a
detailed design exists Used as the design progresses to capture changes
Good as a cross-check for other methods
Parametric Estimating –Advantages/Disadvantages
Advantages Can be easily adjusted for changes by modifying input parameters Sensitivity Analysis - Can show how changes to certain
parameters impact the cost Objective measures of validity Statistical measures for risk
Disadvantages Difficult to ensure consistency and validity of data Must constantly review relationships to ensure that relationships
reflect current status of relevant programs, technology, and other factors
“Black box syndrome” with pre-existing CERs, commercial models
Parametric Estimating - Example
CER for Site Activation as a function of Number of Workstations: Site Act ($K) = 82.8 + 26.5 * Num Wkstn
Estimated based on 11 data points for installations ranging from 7 to 47 workstations
Build-Up - Method
Estimating is done at lower levels and results rolled up to produce higher-level estimates Often the lowest definable level at which data exist
Elements of this method could include Standards Time and Motion Studies Well defined work flow Variance Factors Parts List Lot Size and Program Schedule Considerations Program Stage Support Labor
Build-Up could also be called Engineering Build-Up, Industrial Engineering (IE), Catalog/Handbook
Build-Up could also be called Engineering Build-Up, Industrial Engineering (IE), Catalog/Handbook
Build-Up - Application
Used when you know detailed product/service information at the lowest level (i.e., hours, material, etc.)
Used in a environment where labor can be accurately estimated
Build-Up – Advantages/Disadvantages
Advantages Easy to see exactly what the estimate includes Can include Time and Motion Study of actual process Variance Factors based on historical data for a given program
or a specific manufacturer Disadvantages
Expensive and requires detailed data to be collected, maintained, and analyzed
Detailed specifications required and changes must be reflected Small errors can be magnified Omissions are likely
Build-Up - Example
Problem: Estimate hours for the sheet metal element of the signage for traffic division Similar to other sign manufacturing which has a 20%
variance factor (actual to standards) and a support labor factor of 48% of the labor hours
The standard to produce the sheet metal element of the new signage is 2000 touch labor hours
Solution: Apply factors to the standard touch labor hours 2000 hrs x 1.2 = 2400 labor hours Add the support factor of 48% to get the total hours estimate
of 2,400 x 1.48 = 3,552 hours
Other Topics
Expert OpinionExtrapolation from
Actuals
Expert Opinion - Method
Uses an expert or a group of experts to estimate the cost of a system One-on-one interviews Round-table discussions Delphi Technique
Expert Opinion could also be called Engineering Judgment, Round Table, or Delphi Technique
Expert Opinion could also be called Engineering Judgment, Round Table, or Delphi Technique
Expert Opinion - Application
Only used when more objective techniques are not applicable
Used to corroborate or adjust objective data Cross check historical based estimate
Use for high level, low fidelity estimating Last resort
Tip: Expert opinion is the least regarded and most dangerous
method, but it is seductively easy. Most lexicons do not even admit it as a technique, but it is included here for
completeness.
Expert Opinion – Advantages/Disadvantages
Advantages Good cross check of other estimate from Subject
Matter Expert (SME) point of view Allows perspective to an estimate that may be
overlooked without SME Disadvantages
Completely subjective without use of other techniques Low-to-nil credibility
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Quantity
Cost
Extrapolation from actuals is not a method, it is a subset of some methods Using actual costs to predict the cost of future items of
the same system Extrapolation is used in several areas, which
include: Averages Learning Curves Estimate at Completion
Extrapolation from Actuals
Extrapolation from Actuals could also be called Averages, Learning Curves, Cost Improvement Curves, Cost/Quantity Curve, Estimate at Completion (EAC), and Earned Value (EV)
Extrapolation from Actuals could also be called Averages, Learning Curves, Cost Improvement Curves, Cost/Quantity Curve, Estimate at Completion (EAC), and Earned Value (EV)
Extrapolation fromActuals - Application
Best application is for follow-on production units/lots
Requires accurate cost database At an appropriate level of cost detail Validate and normalize data
Extrapolation fromActuals – Advantages/Disadvantages
Advantages Utilizes actual costs to predict future costs Can be applied to hours, materials, total costs Highest credibility and greatest accuracy Many government bodies require or encourage the use of this technique
Possible complications: Unknown events affecting bookkeeping of actuals Changes in cost accounting methods Contract changes affecting actuals Configuration changes, process changes all have impacts
Disadvantages: Extrapolating beyond a reasonable range
Using Costing Techniques
Estimate Requirements Top Down vs. Bottom Up Cost Element Structure (CES) Technique Selection Checking Results Documentation
Estimate Requirements
Why are we developing this estimate? What will it be used for? Milestone A, B, or C decision Developing a budget Developing a “ball park” or rough order of magnitude
(ROM) estimate Comparing alternatives Evaluating proposals
Top Down vs. Bottom Up
There are two general ways to structure an estimate Top Down Bottom Up
Top Down is generally associated with the Parametric or Analogy techniques
Bottom Up frequently uses more than one method at the lowest level but is generally associated with the Build-Up technique
Cost Element Structure
Determine what needs to be estimated and develop an appropriate Cost Element Structure (CES) CES Dictionary defines what is included in each element Characteristics associated with cost elements that are
routinely used to classify costs • Program Phase: Development, Production, O&S• “Color of Money”: RDT&E, Procurement, O&M• Funding Source• Non-Recurring or Recurring• Direct or Indirect
Technique Selection
Review available techniques Compare alternatives Select or develop appropriate technique Identify primary and secondary techniques
Each costing technique has strengths and weaknesses and can be applied at
different times in the life cycle of a cost estimate
Each costing technique has strengths and weaknesses and can be applied at
different times in the life cycle of a cost estimate
Checking Results
Cross Checking your results greatly increases credibility Example: A parametric-based estimate can also show an analogy as a
“reasonableness test” Doesn’t necessarily result in the exact same number, but should be a
similar number (same order of magnitude)
An independent* estimate is more detailed than a cross check and attempts to get the same result using a different technique Example: Use the results from one commercial software estimating
package to validate the results of another
*Note: “Independent” has many meanings. The most stringent meaning is in Title 10 USC Section 2434 and involves an organization out of the chain of command of the acquiring agency. A looser meaning is an estimate done by an organization unbeholden to the program manager in funding or accountability. The loosest meaning is a separate estimate.
Documentation
Within reason, more information is better than less
Any information that is used in the analysis must be included in the documentation
Documentation should be adequate for another cost analyst to replicate your technique
Like they used to tell you in math class….
If You Don’t Show Your Work,You Don’t Get Any Credit!
If You Don’t Show Your Work,You Don’t Get Any Credit!
Comparison of Techniques
Comparison – Advocacy Advocates of Build-Up drink beer and say:
More detailed = more accurate Analogy is prey to invalid comparisons Parametric is too “theoretical”
Advocates of Analogy drink bourbon and say: Like things cost like amounts Build-Up is prey to omission and duplication Parametric is “diluted” by less applicable systems
Advocates of Parametric drink wine and say: Most thoroughly based on historical data Analogy is just a one-point CER through the origin! Build-Up is prey to omission and duplication
Hey, it’s a joke, lighten
up!
Hey, it’s a joke, lighten
up!
Refining a Costing System
More Direct-cost tracing
Indirect-cost pools
(More homogeneous)
Better cost-allocation bases
Activity-Based Costing System
No. ofSetupHours
LensesNL
LensesCL
LensesOther
CostAllocationBase
ProductCostObjects
No. ofShipments
Parts-Square
feet
SetupDesign ShippingActivityIndirect CostPool
Activity-Based Management
ABM describes management decisions that useactivity-based costing information to satisfy
customers and improve profits.
Product pricing and mix decisions
Cost reduction and process improvement decisions
Design decisions