mongolia output costing and budgeting-tarun das

8/14/2019 Mongolia Output Costing and Budgeting-Tarun Das

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Output Budgeting Tarun Das

Output Costing and Output Budgeting Basic Concepts and Methodology

Prof. Tarun Das 1, Ph.D.

Government of MongoliaMinistry of Finance30 September 2007

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1 Glocoms Inc. (USA) Strategic Planning Expert, ADB Capacity Building Project onGovernance Reforms. For any clarifications contact [email protected] .

Glocoms Inc. (USA) MOF, Govt. of Mongolia
mailto:[email protected]:[email protected]


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It is reasonable to introduce a simpler costing system initially and then to move tofull activity based costing in the future. Initially costing and budgeting may bedone on cash basis, and costing of accrual expenses should not be considereduntil the movement to accrual accounting and budgeting system has been fully

tested and completed. In the initial phase it might be better to exclude major capital expenditure from the output costs, but at the second phase it is desirableto include capital costs and depreciation as a part of total cost.

Major requirements for an output costing system include the identification of thefollowing items:

Outcomes, outputs and activities, Resources used in terms of direct and indirect costs, Relationship between resources and activities, including main cost drivers, Attribution matrix for attributing resource costs to activity costs, and then

activity costs to output costs and contribution to outcomes (linking outputcosts to outcomes could be optional in the initial phase),

A new chart of accounts that links revenues and expenses to activities,outputs and outcomes,

Agreement on the costing framework.

2. Requirements for Moving to Output Budgeting

A. Move towards Output Costing and Output Budgeting by the lineministries and agencies require the following steps :

1. To establish an integrated planning, costing, budgeting and reportingframework containing outcome, output, activities, inputs, performanceand evaluation parameters. The task would include the followingmeasures:

(a) Preparation of Strategic Business Plans with specification of thePortfolio Ministrys outputs and outcomes;

(b) Specification of performance indicators for measurement of quality,quantity and cost of outputs and outcomes; performance indicatorsshould be clear, relevant, economic, adequate and monitorable(CREAM).

(c) Specification of appropriate indicators for monitoring the contribution of outputs to their desired outcomes; and

(d) Evaluation of the performance of the previous SBP.

2. To establish a comprehensive costing framework that links theresources used with activities, outputs and outcomes . This will require



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the design and implementation of a new chart of accounts, with codes for activities, outputs and outcomes, and an attribution matrix for recording alldirect and indirect costs to the appropriate items or to the General Ledger.This could be achieved in a phased manner. Initially there may bereporting of direct costs plus broad allocation of indirect costs until a more

precise costing framework is established through a new chart of accountsand more accurate measurement of actual costs for all activities leading tooutputs.

3. To prepare annual output budgets as a part of the Portfolio Budget, andactual results compared to budget estimates for the previous year. Allthese information should be provided in the same set of documents asfinancial statements.

4. To strengthen the internal audit service to include performanceaudits along with normal financial and compliance audits.

5. Ideally, a fully automated financial accounting and reporting system needto be developed. If a new financial accounting system is fullyimplemented, initial processing of data may be assigned to individual costcentres, subject to proper training, and documentation of procedures andestablishment of cross validation arrangements.

6. A proper risk management system also needs to be developed to takecare of accounting risk, political risk, operational risks and systemsfailures.

7. There are a number of areas where the central agencies need to changerequirements for line agencies to reduce the burden of compliance, allowgreater internal administrative efficiency and improve transparency andaccountability. These include the following:

(a) To develop a clear and uniform framework for governmentbudget planning for individual agencies. The framework shouldexplain how budgets will be prepared and negotiated, whattransactions to be covered, and how performance will bemeasured, monitored and reported. Without this framework there isa risk that agencies may develop practices that are not uniform andconsistent with each other and thereby create undue complexityand confusion in the budget for both parliament and the public.

(b) Central asset reporting arrangements may be reviewed to focuson major assets only and should adopt good practices on assetmanagement. Assets will be included in financial reporting as partof accrual reporting.



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3: Recommendations and Desired Action Plan

1. Budget Planning

1.1 MOF should develop a new budget framework based on outcomes,outputs, activities, inputs and performance parameters to measurequantity, quality and timeliness of outputs and outcomes.

1.2 Budget should provide estimated expenditure for the previous year, andforward estimates for the budget year and three forward years using thebudget outcomes and outputs framework.

1.3 A Strategic Business Plan should be prepared indicating priorities for thebudget year and three forward years.

1.4 Information on relevant recent performance (e.g. last full year and year todate) should be given for comparisons and to optimize efficiency andeffectiveness.

1.5 Budgets for agencies should indicate the responsibilities of each unit for executing outputs and outcomes. Individual performance agreements for managers should refer to the outputs they are responsible for producingor contributing to.

1.6 A new budget preparation and approval cycle should be established thatallows explicit consideration of reliable information on financial and non-financial performance during at least first three quarters (i.e. January-September) of the current year prior to deciding the allocation of resources for the budget year and three forward years.

1.7 A new chart of accounts should be established that links revenues andexpenses to activities, outputs and outcomes. This should be

underpinned by an activity based cost attribution model.1.8 The role of Accounting and Audit Divisions in recording, maintaining andreporting financial accounts and the systems coordination should bestrengthened.

1.9 There will be greater responsibility and accountability for operationsmanagers to ensure efficient and effective use of resources. It can beachieved by specifying performance parameters on outputs andoutcomes at the operational level in addition to more accurate costinginformation for each activity and output.

1.10MOF should provide estimates of budgetary resources, allocations for allportfolio ministries for the budget year and three forward estimates as

early as possible, so that line ministries can prepare comprehensivestrategic plans.2. Output Costing and Output Budgeting

2.1 There is a need to move to an output and outcome budgeting andplanning framework to facilitate use of outputs and outcomes instead of inputs as the basis of priority setting.



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1. Budget Planning




2.2 The new framework should include a system for monitoring and reportingcost information on a timely and accurate basis. Ideally the system shouldbe fully computer based to improve speed and efficiency.

2.3 A new costing system should be developed within an outcome and outputframework, linked to an attribution matrix for activities and resources.

2.4 Costs will include both direct and indirect costs (including maintenance

costs), but major capital costs (i.e. depreciation and capital charges) maybe excluded from calculations until the accrual accounting and budgetingsystem is fully developed and tested. There should be some attempts tomeasure depreciation and attribute it to outputs in the second phase of the new costing system.

2.5 Specification of outputs should include definition of quantity and quality sothat unit costs can be measured where it is practical to do so.

2.6 There should be specific staff with responsibility for maintaining andanalyzing cost data as part of their duties. This should also be a priorityarea to be monitored by internal audit.

2.7 Cost information should be a major element of reporting on outputs.

When accurate cost data is produced on a uniform basis for a number of years or for alternative providers, agencies should consider providingbenchmarks for costing goods and services.

3. New Accounting Heads and Codes

3.1 There is a need to develop a new chart of accounts to facilitatemovement to output budgeting and accrual accounting. The chart of accounts should include coding to facilitate attribution of costs toactivities, outputs and outcomes.

3.2 Purchase of a standard software package for Financial Management

Information System (FMIS) may help to automate many of theprocesses for entry, checking, verification and authorization of transactions. This may be examined by the IT experts engaged indeveloping the Budget Process Information System (BPIS).

3.3 Selection of a new FMIS also provides the checklist of standardsrequired for accounting platforms.

3.4 Some changes to existing procedures and standards may be required tobe made if there is a move to a new FMIS and accrual accounting and



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1. Budget Planning




reporting.

4. Financial and Performance Reporting

4.1 Outputs and outcomes need to be defined and specified clearly.Performance measures and indicators need to be developed for

monitoring outputs and outcomes.4.2 Senior management should support the move to an outcomes andoutputs framework and participate in design and specification of theoutputs and outcomes.

4.3 Reporting to senior managers should be streamlined to reduce theamount of details and provide information at a higher level of aggregation. Emphasis should be placed on improving accuracy andtimeliness of information.

4.4 Procedures continue to be applied for ensuring consistency of reportingacross agencies and line ministries.

5. Asset Management

5.1 Changes are required to be made in the register for asset managementas part of the move to multi-year budgeting, accrual accounting andreporting.

5.2 The asset register should be maintained, retained and expanded torecord initial value, current value, depreciation and cost attribution of each asset.

5.3 The cost of assets (comprising depreciation and capital charges) for each output should be identified and attributed accordingly.

5.4 Managers should be aware of the role of cost of assets as part of their total production costs.

5.5 HQ of the line ministry should continue to analyze lease or buy or saleoptions as part of asset management decision making. This may includeconsideration of insourcing, outsourcing, sale and purchaser/ provider options.

6. Internal Audit

6.1 Internal audit and accounting systems need to be strengthened after



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1. Budget Planning




examining whether there are sufficient resources and skills to undertakethe required works relating to output costing, output budgeting andaccrual accounting.

6.2 It needs to be ensured that the accounting and auditing staff haveadequate qualifications, skills, knowledge and experience. There shouldbe a system of continual capacity building and proper succession plan.

As these works generally require higher highly technical persons, whichare not only scarce but highly competitive, there may be need for flexible or negotiable salary scales for these personnel.

6.3 Ministry of Finance may prepare regulations and procedures on the roleand functions of various audit authorities.

6.4 There should be close alignment between the accounting and auditingstaff to address issues relating to performance and systems integrity inaddition to standard financial and compliance audits. This can beachievable only when objectives, outcomes and outputs are moreclearly specified and costed.

6.5 Performance indicators for the audit unit should be reviewed to ensure

that they provide an adequate and balanced assessment of performance.



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4. Benefits of Output Budgeting and An Overview

4.1Role of output budgeting in Public Administration of Mongolia

The Government of Mongolia is implementing a set of governance reforms whichconsist of a collective package of strategic business planning, output budgetingand accrual accounting. The Government will fund agencies for the efficientaccrual cost of an agreed set of outputs to be delivered to the government and tothe people, under agreed performance standards. Consequently, the agenciesare required to cost all of their outputs as the basis for budget allocation. Theaccurate costing of outputs is vital for strategic planning, output budgeting andperformance evaluation.

There are a number of other reasons for costing outputs, which include thefollowing:

To identify the nature, quantity and quality of outputs that can be producedwithin the Governments fiscal limits;

To identify strategies to reduce costs; for example, to eliminate or privatizenon-essential or non-value-adding activities;

To monitor performance of each activity; To project the future costs of outputs for the medium term; To renegotiate the quantity of the outputs to ensure budget constraints;

4.2An overview of output costing and output budgeting

There are seven key steps for the implementation of output costing and outputbudgeting for an agency. These include the following

(a) Determine the outputs to be budgeted(b) Define the required costing structure.(c) Review the existing costing systems.(d) Select costing methods and techniques.(e) Design costing system changes.(f) Cost outputs and prepare reports.(g) Use the output costing information.

Step 1 Determine the outputs to be costed and budgeted

The first step in any costing exercise is to identify the relevant Cost Objects. ACost Object is anything for which a separate measurement of cost is required.Under output budgeting, the Cost Objects can be a cost centre, an output class,an output, a sub-output or an activity that an agency is expected to deliver under the Strategic Business Plan endorsed by the government. These outputs will be



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funded by the Government and the Agencies are required to cost these outputsas a basis for their budget allocation.

Step 2 Define the Required Costing Structure

Agencies have to define the appropriate type of costing structure for their needs.The structure depends on the following factors: The purpose of the system The costs to be assigned through the system The existing cost structure.

The Purpose of the Costing System and Framework

The level and purpose of the costing system should be pre-determined and welldocumented. If the purpose is simply to cost outputs or a group of outputs at thehighest level, then a simple method of costing is sufficient. If, on the other hand,

the purpose is to provide management with detailed information about costs at allactivity levels required to deliver the output for improved decision-making, then amore complex structure of costing is required. This is called Activity BasedCosting (ABC). Then, a clear and detailed output costing framework needs to beprepared as the basis for the design of output budgeting. Before proceeding tothe next stage, senior management should approve this statement.

The Costs to be assigned through the Costing System

In order to arrive at the fully costed outputs, the total costs of the agency must berelevant, accrual based and fully attributed.

The Existing Cost Structure

The existing cost structure should be examined to ensure that the cost elementsmeet these criteria.

Step 3 Review the Existing Costing System

Next step is to carry out a review of the existing costing systems and capabilitieswithin the agency with a view to utilize the existing system where appropriate,and to make improvements and corrections where necessary. The basic purpose

is to keep the implementation cost of output costing as minimum as possible; andto avoid frequent and unnecessary changes. The review should also take intoaccount systems changes so as to take benefits of improved cost managementand to make the output budgeting consistent with systems development.



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Step 4 Select Costing Methods and Techniques

By this stage, agencies have a good understanding of their existing costcollection and assignment systems and they know how they would meetrequirements for output budgeting. It is now necessary to devise ways to bridge

the gaps between the existing systems and the output budgeting needs by theMinistry of Finance. The Governments requirement is that an agencys costingmethods must provide an accurate estimate of the total cost of delivering eachoutput. When upgrading the system and determining accuracy andreasonableness a cost/benefit tests should be carried out by an agency. In larger agencies, it may be appropriate to use a variety of costing methods includingActivity Based Costing (ABC). An ABC system assigns costs among theunderlying cost-drivers on the basis of cause-and-effect rather than on anarbitrary pro-rata basis.

Step 5 Design Costing System Changes

Necessary changes in the existing costing system may be designed for collectionand assignment of the costs according to the costing methods selected. Thechoice of data collection and assignment tools depend upon:

the existing system; the results of a cost-benefits analysis of introducing new costing systems;

and The availability of financial resources and technical manpower to

implement and operate new costing systems.

Step 6 Cost Outputs and Prepare Reports

Agencies cost their budgeted outputs on the basis of selected costing structure,system and methods. Agencies should also prepare an annual report thatincludes the total cost incurred in delivering each of their outputs.

Step 7 Use the Output Costing Information

Output costing can deliver vital information to management for effective decisionmaking. It can provide information on:

cost of outputs for budget submissions; required changes to the funding of outputs; actors responsible for variances between budgeted and actual costs; value-adding activities; how processes can be changed to make the agency more effective and

efficient; How the agency can improve service delivery within given resources.



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4.3 Upgrading Infrastructure

The implementation of output costing becomes successful in an agency only if senior management is committed to its introduction and key personnel are

actively involved in the process. However, the following steps need to be takenfor its successful implementation:

Changes associated with output costing in an agency should beintroduced in a phased, progressive, and manageable way.

Staff should be trained and briefed on the basic concepts andmethodology for output costing and output budgeting.

Detailed guidelines with explanations and examples need to be preparedand given to the staff indicating how to identify activities and outputs andto link these to inputs and costs.

The benefits of the system should be explained to staff in addition togiving them opportunities to raise questions and concerns and to indicateconstraints.

Skills need to be developed to interpret the information produced by thecosting system.

Variances between actual and budget output costs need to be accountedfor.

5. Costing Framework- Basic Concepts and Principles

5.1What is output budgeting?

The concept and scope of output budgeting have been described in detail in thereport on strategic business plans 3. In brief, under output budgeting the cost andbudget estimates are provided for each output (and the costs of separate inputslike man, materials, machines etc. are not shown separately in the budget). Thebasic purpose of output budgeting is that given the budgeted cost, one should beinterested in the achievement of output and outcome (and not in costs for labor,goods and other services). Once one monitors output costs, the input costs areautomatically monitored. But if one simply monitors input costs, one would notknow what happened to the output levels. Thus, under output budgeting, thereare output heads for both accounting and auditing.

Under output costing and output budgeting, an identified output becomes a costcentre as well as a budget centre, so that the cost of that output can beestimated, budgeted, monitored, and evaluated. If single output cannot be

3 Preparation of Strategic Business Plans- General Guidelines, Some Suggestions for Improvement, and Summary of Recommendations by Tarun Das and E. Sandagdorj, Ministry of Finance, August 2007.



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budgeted, then related outputs can form an output group and the cost andbudget centre. The Departments and Agencies who are responsible for deliveringthe output are identified and specified in the Budget.

For operational purpose, it is more convenient to realign outputs with

departments/ divisions or to make a one-to-one correspondence between outputsand departments/ divisions. In other words, at the first phase, each department/division can become a cost and budget centre. At a later stage, when the systemis developed properly, the specific outputs can also become cost centres.

5.2 What is output costing?

Costing is the way by which an agency financially measures the resourcesconsumed in transforming inputs into outputs. Costing is completed through twobroad phases:

1. Cost collection - gathering of costs in an organised way using an accountingsystem.

2. Cost assignment - the assignment of a cost or group of costs to one or moreoutputs.

A good costing system enables an agency to answer the following questions: What is the cost of particular products/services? What is the cost of various activities? What are the drivers of costs? What opportunities exist for an agency to rationalize costs and to improve

efficiency?

Whilst there are many different costing methods, all are designed to describe thetwo primary functions of cost collection and cost assignment. In its simplest form,the diagram below illustrates the basic process, or generic method, of costing.

Output costing is aprocess of determining thetotal cost of each productor service (output)produced by an agency for the purpose of negotiatingfunding under the Budgetallocations. Agencies may



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also use output costing for fixing the prices of goods and services sold by them tothe third parties.

A key step in costing outputs is the identification of the relevant costs incurred;i.e. the cost of the resources consumed in producing the outputs. The total cost

includes all direct and overhead cash costs and accrued costs for the period.Direct costs are the cost of resources consumed that can be traced directly to theCost Object. Direct costs are generally made up of direct materials and directlabour. All costs that are not direct costs are overhead/indirect costs.

Initially, an output costing system may be focused only at an output level, whichrequires only broad cost assignment and therefore minimizes the complexity of the costing system. However, it is likely that none of the activities or processescarried out to produce the outputs is costed. This may not be very beneficial for internal budgeting and management control. So, when the system of outputcosting develops over a few years, a more detailed costing system on the basis

of Activity Based Costing (ABS) may be developed. Finally, an agencys costingsystem must be well documented to ensure that it can be audited and is robustenough to generate public debate.

A key component of the output costing is that agency outputs will be costed onan accrual basis. Major requirements of output costing include the following:

1. Output costs must be calculated on the basis of the accrued costs of allresources (direct and overhead) consumed in the production of the outputs.

2. The total cost must include all the relevant costs. This does not includecompetitive neutrality adjustments.

3. Total cost must include an appropriate share of the agencys total overheadcosts including executive management and corporate services.

4. All resources consumed directly by an output must be assigned to that output.All resources consumed that cannot be traced directly to an output should beassigned to the output using an allocation technique.

5. Agencies must make a cost/benefit trade-off when determining the particular costing systems. In other words, the expected additional benefits of the costingsystem must exceed the additional costs of implementing and maintaining thesystem.

5.3Objectives, purpose and benefits of output budgeting



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The output costing produces a number of benefits to both the agency and theGovernment. Better costing information enables agencies to improve outputplanning, budgeting and operational efficiency. Most benefits result from theimproved reliability and availability of cost information for decision-making. Theinformation of the total cost of each output by agencies helps the Government to

determine an appropriate mix of outputs that can be achieved within availablefiscal limits. The following benefits accrue to the agencies:

More information is available for optimal allocation of resources; A broader range of information is available for better decision-making, for

example: comparison and benchmarking of the total cost of outputs withalternative suppliers; identification of inefficiencies which allows to takeappropriate steps for cost reduction; a better understanding of the costdrivers

Agencies have a more appropriate basis for preparation of internalbudgets.

Access to more accurate information assists agencies to determine theselling prices of goods and services provided to the third parties on a cost-plus principle.

Cross-subsidies become more transparent. Accurate costing identifiescases where some outputs are being over-funded at the expense of other outputs.

5.4 Cost accumulation and General Ledger (GL) Costing

Prior to the output costing, agencies collect their costs under cost centre codeswithin the general ledger. In the Government sector, this is commonly termed asgeneral ledger costing . This technique requires cost data to be collected fromsource documents and processed through the accounting system into thegeneral ledger. All costs incurred during a period are recoded and accumulatedagainst relevant general ledger accounts according to a cost centre structuredefined by the chart of accounts. Depending on the nature of the item, certaincosts may not be able to be posted to a single account. Accordingly, the cost maybe distributed across a number of general ledger accounts.

Output costing recognizes that inputs are transformed into outputs through aseries of events. These events generally require separate identification andcosting. In most cases, this would be too cumbersome to be handled in thegeneral ledger. Internal charging is a variation on the general ledger costingmethod. Costs are accumulated and charged to cost centres on a user-paysbasis at specific rates.

The complexity of cost modules in government departments and public agenciesvaries from simple stand-alone spread sheet to an integrated system that linksthe cost schedules to the general ledger and various output groups.



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Chart of the accounts should be consistent with cost classifications and shouldinclude departmental heads. The budgetary bodies can add 2 digits after last 2digits of expense accounts in the chart of accounts to identify cost centresexpenses. For instance, salaries account has 6 digits. First 2 digits are code of expense account, next 2 digits illustrate salaries account and last 2 digits can

illustrate the department of divisions code. When calculating the cost of outputs,it will be easy to know the departmental salaries and to assign them to specificoutput heads.

5.5 Cost objects

Cost objects are the elements which need to be costed by the agencies for thepurpose of output budgeting. Cost objects could be outputs, group of outputs or activities. The choice of cost objects determines the degree of complexity of thecosting system and methodology and the operating cost of the system. Whilemaking trade-off between complexity and operational cost, agencies need to

emphasize accuracy and timeliness of information and the risk of cross-subsidizing some outputs.

For external reporting, agencies report cost information at the output level. For internal purposes, agencies may like to report costs at sub-output and activitylevels, basic cost centres and major geographic regions.

5.6Cost classification

Costs may be classified in various ways. For example, costs can be classifies asfixed and variable costs. Fixed costs remain unchanged with variations of outputvolumes in the short run, while variable costs change when quantity of outputchanges.

Costs can be classified according to the production function as either outputcosts or non-output costs. For decision making, costs may be classified ascontrollable or uncontrollable by management. For example, employerscontributions to the social insurance funds for the employees are decided byexisting laws and are unavoidable.

Costs can also be classified as incremental costs, sunk costs and opportunitycosts. Incremental costs could be avoided if production plan is dropped. But,sunk costs are those costs, which have been either made or committed, cannotbe avoided and are irrelevant for future financial decisions.

For the purpose of output budgeting, costs are classified into direct and indirectcosts depending on the manner in which costs are consumed by outputs,activities or cost centres. Identifying as many as resources as direct costs helpsin improving the accuracy and relevance of output costing and output budgeting:



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Direct costs

Direct costs are those costs which can be directly attributed to an output. Theyare mostly variable costs and vary in direct proportion to changes in the volumeof output or the level of activity.

In the public sector, where labor is the dominant factor, direct costs are dividedinto direct staffing cost and other direct costs (e.g. direct material costs). Directstaffing costs include not only wages and salaries but also other compensation tolabor such as superannuation, workers compensation insurance, leave travel,uniforms, and payment of payroll tax, if any.

Direct staffing cost is easily identified when the whole or part of theorganisational unit engaged in producing an output is considered as a costcentre. Other direct costs, such as other material costs, are those which can beeasily identified as being directly related to an output.

As regards staffing cost, the following factors should be included if applicable andmaterial:

1 base wage or salary2 overtime3 shift loading4 leave loading5 superannuation6 severance benefits7 other allowance (e.g. on-call allowance) travel expenses1 uniforms2 training3 protective clothing4 payroll tax (see discussion on taxes)5 workers compensation insurance premium6 fringe benefits tax7 housing8 office accommodation9 power 10 equipment (including computer equipment)11 stationary12 other office consumables

Some of these factors require additional explanation as given in Table-1 :

Table-1: Different Components of Staff Expenditure



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Overtime: Only include the employees overtime associatedwith the activity being costed (if the employee(s)works on more than one activity).

Shift Loading: Ensure that the shift penalties reflect the staffingroster which is being proposed for the activity.

Leave Loading: Include accrued as well as cash costs.

Superannuation: Government employees may be members of theRetirement Benefits Fund Scheme, or they may electto contribute to some other complyingsuperannuation funds such as Provident Funds,Pension Funds and Insurance Funds. Thesuperannuation expense should include the

employer amount paid; including any additionalGratuity and Pension contributions to Treasury, butthis will not include any payments of pensions to thepensioners (who have already retired) as this wouldnot constitute part of the cost of services of thecurrent staff.

Travel Expenses: Include all relevant expenses, especially allowancepayable under award provisions.

Training: Training information may be available from data

collected for other purposes. However, the costsincluded would need to exclude the costs attributedto the wages and salaries paid to staff while they areattending training courses.

Housing: If housing is provided through the Government, thenthe cost included in the analysis should be anestimation of the net cost to government of providingthe housing (i.e. net of rent paid by the staff butinclusive of the annualized cost to government,based on full market rent analysis, of having theGovernment provide the house).

Source: Costing Fees and Charges: Guidelines for Use by Agencies, Australian Treasury,December 2006



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Indirect costs

For some costs, it may not be possible to establish direct relationships with thecost objects, because they are common to more than one output. These arecalled indirect costs, and sometimes referred as overheads. For example,

indirect costs can include the salary of the Head of the Agency, corporate officeand general administration costs, the cost of personnel and finance services andthe cost of office accommodation. These costs are assigned to different outputson the basis of their contributions to the output cost.

Other expenses or non-output costs

An agency may incur costs that are unrelated to outputs. For example, therecould be costs due to abnormal restructuring, abnormal write-off of assets, andextra-ordinary costs. These costs are regarded as non-output costs and excludedfrom the output costing exercise.

Direct Costs Mostly variable Little fixed

Indirect Costs Some variable More fixed

Capital Costs Little variable Mostly fixed

Capital Costs

There are two aspects relating to the use of assets which must be considered inany analysis of cost:

1 the determination of an appropriate depreciation charge; and2 Recognition that the funds invested in the assets have alternative uses andtherefore some allowance should be made for a rate of return on those assets(also known as the opportunity cost of capital).

Asset Depreciation

Two common methods of determining the depreciation charge are:

1 the prime cost or straight line method which allocates the cost of the assetover the number of years of useful life; and

2 The diminishing value method which allocates a higher proportion of the costof the asset to the earlier years of its life.A depreciation charge is not relevant in all circumstances. For example, whereagencies purchase equipment, receive an input tax credit, hold the equipment for a relatively short period of time and sell it at a price close to the original purchaseprice, there is no need for a depreciation charge.



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Source: Costing Fees and Charges: Guidelines for Use by Agencies, Australian Treasury,December 2006

5.8Cost drivers

Cost drivers are those activities, events or factors that trigger or have a strongcorrelation to the total cost being allocated. Identification of cost drivers makesthe allocation of costs to outputs easier and more accurate. A simple example isthe allocation of rental and clearing costs to a range of outputs. A cost driver for this will be the ratio of floor space occupied by each work group to the total floor area. Table-1 illustrates the relation between cost items, cost groupings and costdrivers.


BOX-1:

TYPES OF COSTS

Direct CostsStaffing costs (including on-costs such as training and travel)Base wage or salary OvertimeShift loading Leave loadingSuperannuation Retirement/severance benefitsOther allowances (e.g. on-call allowance) Travel expensesUniforms TrainingProtective clothing Payroll tax (see discussions on taxes)Workers compensation insurance premium Fringe benefits taxHousing Power Office accommodation Stationary

Equipment (including computer equipment) Other office consumablesConsumable supplies MaintenanceOffice Equipment

Indirect CostsIncludes corporate services costsCapital CostsDepreciationOpportunity cost of capitalTaxationCommonwealthState

Local GovernmentServices and Resources provided free of chargeProperty management servicesLegal servicesTelephone and communication services


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Table-1: Relation between cost items, cost groups and cost drivers

General Ledger (GL)Cost Items

Cost Grouping Allocation Methodand Cost Driver

Office accommodation

rentals

Employees/ staff Resource usage analysis

(Floor area used)Salaries and wages Employees/ staff Activity analysis (Personhours)

Medical expenses Employees/ staff Activity analysis (Timeconsumption)

Travel Employees/ staff Activity analysis (Timeconsumption)

Telephones, and

communications lines

Communications Resource usage analysis

(Transfer pricing system)

Stationary Consumables Resource usage analysis

Equipment maintenance Equipment Resource usage analysis

Software licenses Softwares Resource usage analysis

Depreciation Depreciation Resource usage analysis

Motor vehicles expenses Overhead Allocation to overhead

Equipment rental Equipment Resource usage analysis

5.9 Costing Methods

A costing method defines the process that is used to trace all relevant costs andattribute them to outputs. In order to determine the cost of its outputs, an agencywill establish a costing system that may use a variety of costing methods,techniques and tools. There are two main types of costing methods:

Job Costing; Process Costing.

These main methods are often used in conjunction with refinements and other techniques such as Activity Based Costing (ABC) or Standard Costing.



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Job Costing : Job Costing is usually used by organisations that produce uniqueproducts or special order products, where each unique product or serviceconsumes a different amount of direct material, direct labour and overhead costs.Job Costing may also be used on jobs that are significant in size and havedistinct start and finish times. Examples of non-manufacturing entities that

regularly use the Job Costing method are: Appliance repairers Main Roads engineering jobs School repair orders Auto repairers Doctors and dentists Accountants Universities.

.Process Costing: Process Costing is the method of assigning costs to the

products/ services resulting from the mass production of like units through asequence of several processes. Under this method it is the production processthat is costed, not the specific jobs or units produced. Under Process Costing,costs are accumulated for a period of time. Individual units are not separatelycosted. In order to obtain an average unit cost, the total cost for the period isdivided by the number of units produced during that period. Process Costing canbe used in both a manufacturing or non-manufacturing environment.

Job Costing and Process Costing

The main distinction between process and Job Costing is the number of unitsbeing produced. Job Costing is generally appropriate when the number of units issmall, the units are not homogeneous and the cost per unit is high. ProcessCosting is generally undertaken when the number of units is large, the units arehomogeneous and the cost per unit is low.

Which method should be used?

The most important aspect of costing is the understanding of cost behavior patterns and influences. Consequently, the decision as to which method or methods an agency might use is influenced by the following factors:

Size, structure and type of the agencys operation; Agencys outputs required to be costed; Existing costing or accounting systems currently in use; Availability of technology and other resources to support a costing system; Cost/benefit analysis of alternative methods.



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5.10Activity Based Costing (ABC)

ABC is a Process Costing technique that aims to attribute overheads (or jointcosts) to the Cost Centres based on some norms rather than on some arbitrary

allocation basis. ABC assigns the costs to activities on the basis of resourcesconsumed by the activities. The activity costs are reassigned to outputs usingcost-drivers based on the amount of the activity used by the outputs. In manycircumstances, ABC provides meaningful costing data and information.Accordingly, its use by agencies should be encouraged.

ABC has the following potential benefits:

more meaningful costing of outputs as overheads are included in totalcosts;

more effective cost management through improved information about the cost of activities undertaken to produce an agencys outputs; process improvement through benchmarking the cost of activities against

other providers and industry Best Practices; and increased public accountability for resource consumption; improved cost management due to regular analysis and monitoring of the

cost of activities; improved customer service by providing activity information that can

contribute to improved service levels or improved service quality; improved cost modeling by allowing changes in activities;

Better ability to align activities to organisational units and therefore assistin internal budget allocation.

The ABC Process

The implementation of an ABC system can be best described by the following sixsteps:1. Identify the agencys activities. Activities are the works performed toproduce outputs;2. Identify the cost of input that will be consumed by the direct and indirect activities . Direct activities are those activities that can be traced directly to a

Cost Centre. Indirect activities cannot be traced directly to a Cost Centre, and thecost of these activities is collected into activity cost pools. If the costs in anactivity cost pool can be attributed to a Cost Centre on a cause-and-effect basis,these activities are known as primary activities. Where the costs in an activitycost pool cannot be attributed directly to a Cost Centre, they must be attributed tosecondary activities.



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3. Assign cost elements to supporting activities (tertiary and secondary)using resource-drivers. Resource-drivers reflect the quantity of each resourceconsumed by the activity.4. Reassign the cost of supporting activities to primary activities using resource-drivers.

5. Assign costs from primary activities to Cost Key Points using activity cost-drivers. Activity cost-drivers reflect the quantity of the primary activity usedby the Cost Centre and activity cost-drivers should have a close cause-and-effectrelationship.6. Assign to outputs the cost of relevant sub-outputs consumed.

Activity based costing (ABC)

Activity Based Costing (ABC) is useful for both Job Costing and Process Costing.It examines the way activities consume resources and how they relate to outputs.The unit cost of products and services determined using ABC can be further

utilized by a costing system to cost jobs which consume these products or services. These jobs can then be grouped according to the output which theyhelped to produce.

Standard Costing

Standard costing is not a costing method; rather it is a technique to calculate abenchmark against which the actual cost can be compared.



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6 Output Costing Methodology

Various steps involved in output costing include the following:(a) Specify the outputs to be delivered by agencies

(b) Gather accurate and reliable information on costs(c) Assign costs to outputs(d) Estimate total output costs for output budgeting

6.1Step-1: Specification of outputs

There are three basic questions in government budgeting:

i. What does government want to achieve?(Outcomes)

ii. How does it achieve this?(Outputs and administered items)iii. What does it cost to the government?

(Output budgeting)

In other words, government of Mongolia delivers benefits to its people primarilythrough administered items (often but not always labeled as programs) andagencies' goods and services (outputs), which are delivered at a given budgetaryallocation (output budgeting).

All agencies who receive appropriations from Parliament are required to report

on the basis of an outcomes and outputs framework as indicated in their strategicbusiness plans (SBPs) endorsed by the government. Outputs are deliverablesand the immediate or end results of activities, whereas outcomes are the mediumterm result or impact of public programs and policies on the economy and onuser groups.

Agencies apply inputs (e.g., finances, human resources, capital equipment) tothe activities and processes that generate the products and services thatconstitute their outputs. These inputs include the funds appropriated to them fromthe budget or received through purchaser/ provider arrangements, and revenueraised through other means, such as sales, user charges and contributions bytrade and industry.



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The output and outcome framework & how it works

The outcomes and outputs framework is intended to be dynamic and flexible. Itworks as a decision hierarchy:

government (through its ministers and relevant agencies) specifies theoutcomes it is seeking to achieve in a given area; These outcomes are specified in terms of the impact government is aiming

to have on some aspect of society (e.g., education and health), and theeconomy (high growth, moderate inflation and low interest regime etc.)

Parliament appropriates funds to allow the agencies to achieve theseoutcomes through delivery of specified goods and services.

6.2 Step-2: Identification and Information on costs

The cost information is collected from the source documents; for example,purchase invoices and employee time sheets. Cost element information must be

on an accrual basis, because the objective is to include the cost of resourcesconsumed and not the cost of resources paid for. Accrual accounting leads tocosts being identified for which no cash payment is required by the budgetarybody during the period (for example, depreciation). Another cost which must beidentified and allocated is the cost of the governments investment in thebudgetary body- this is called the governments financial charge.

6.3Step-3: Assignment of direct costs

Cost assignment is the assignment of a cost or group of costs to one or moreoutputs. Where a resource is used by only one output, the cost of this resource

consumption can be traced directly to the output. These are called direct cost.Depending on the nature of outputs, direct costs can include salaries and wages,travel, materials, consultancy costs and motor vehicle expenses. There arevarious ways to assign direct costs to the outputs. Table-2 lists the methods,which are most commonly used for assigning direct costs to outputs.

6.4Step-4: Allocation of indirect costs

In many cases, resources are consumed by support activities which cannot betraced directly to outputs. These overhead costs must be attributed to the outputsusing an allocation method, (for example, the salary of a corporate services staff

member in the head office would be attributed across departmental outputs).When apportioning overhead costs between outputs, an agency may choosealternative techniques depending on availability of data. These can be classifiedinto two categories:

Logical cause-and-effect or cost-driver Arbitrary pro-rata.



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Table-2: Methods to assign direct costs to outputs

Method(When used)

Description Advantages Disadvantages

1. Cost centreattribution i.e.

Activity Review(When businessunits areresponsible for delivery of oneoutput only)

Direct costs are allocated to the costcentres as they are incurred.

Estimates are compiled of a costcenters or individual time requiredfor completion of specific activitiesand costs assigned on the basis of these estimates.

Flexibility andsensitivity tochange.

Costly in theshort run.

Requireddisciplinedimplementation.

2. Time recordingsystems (Usefulfor assigningdirect labor andstaff cost.

Employees record the time theyspend for the delivery of each output.The time may be recorded on hourly,daily, weekly, monthly or annualbasis. Time recording systems aregenerally used for charging andother staff related costs.

Flexibility andsensitivity tochange.

Costly in theshort run.

Requireddisciplinedimplementation.

3.Resourceconsumptionaccounting(when the use of these resourcesis significanteasily recorded,)

Measure each outputs use of resources such as photocopies,computers, telephones and printers.The costs are directly charged to theoutputs for the use of theseresources on a transaction basis. For example, the cost of use of photocopies might be allocated onthe basis of the cost per page andnumber of pages copied.

Flexibility andsensitivity tochange

Tailored for organisedcharging.

Results inequitablecharging.

Providesinformation for value-addedbusiness

decisions.

Costly toimplement.

Requiresresource for ongoingmaintenanceand control.

4. OutputAccounting(Suitable onlywhen there is arelationshipbetween outputsand cost centres.Judgments needto be applied if abudgetary bodyhas manyoutputs.)

Direct costs are allocated to specificoutput codes in the budgeting bodysaccounting records (i.e. generalledger) as they are incurred. Theoutput code can then be used toproduce a report showing the totaloutput cost. This method requires allcosts to be coded to outputs.

Flexibility andsensitivity tochange

Requireddisciplinedimplementation

5. Experienced judgments (Not agenerallyacceptedmethod).

Management and staff often usetheir own experience to estimateeach outputs use of resources andattribute costs on the basis of theseestimates.

Quick andeasy toimplement.

Low cost.

May beinaccurate. May be

arbitrary. No formal

documentation.

Logical Cause-and-Effect



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With the cause-and-effect technique, costs that cannot be traced directly tospecific outputs are attributed to cost pools/centres. The total cost in a costpool/centre is then attributed to outputs based on the cost-driver that causes theactivity to be undertaken. The technique is based on the assumption that there

exists a cause-and-effect relationship between the output and the cost pools.Some commonly used cost-drivers are: Floor space Number of staff Number of hours worked Number of transactions processed Number of documents received.

Arbitrary Pro-Rata

This technique attributes costs without determining a clear cause-and-effectrelationship. Usually all overhead costs are firstly aggregated and then attributedto outputs using some arbitrary pro-rata basis (for example, corporate overheadsare attributed using the number of direct labour hours consumed in producing theoutput). As for example, the total cost of computer maintenance can be firstlyattributed on a pro-rata basis of Full Time Equivalents (FTEs), and secondlyusing the cause-and-effect relationship of the number of computer work-stationsused by each output. In other words, the more computer work-stations that anoutput uses, the greater will be their computer maintenance costs.

6.5 Appropriate costing methodology

Agencies should make an assessment of the most appropriate methodology for costing and pricing their goods and services. There are three basic methods for costing individual items viz. Marginal Cost (MC), Fully Distributed Cost (FDC)and Avoidable Cost approaches.

Marginal cost

Marginal cost is the cost of producing an additional unit of a good or service. Itgenerally includes direct costs that vary with output and some indirect costs.Marginal cost can be measured in the short run or the long run. Conceptually, short

run marginal cost (SRMC) gives the best cost estimate of producing an additionalunit of output at any point in time. It excludes capital costs because these are fixedin the short run. SRMC also excludes many indirect costs such as genericadvertising or management time of the chief executive officer, since they do notvary with output in the short run. In practice, however, SRMC is difficult to defineand to measure. There are also problems in specifying the short run or long run

periods, and how to treat joint costs. In addition, prices for some products or



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services using capital which is lumpy could display excessive variability in theshort run.

An alternative measure is the long run marginal cost (LRMC). LRMC is the costof supplying an additional unit of a good or service when capacity can be varied. Itcomprises not only operating costs, but also the capital costs associated withincreasing productive capacity. Conceptually, LRMC is the correct cost base for making investment decisions. In contrast to FDC, it excludes indirect costs that arefixed in the longer run, such as corporate overheads and their associated capitalcosts. In summary, marginal cost is, in principle, an appropriate measure of thecost of additional output.

Fully Distributed Cost (FDC)

Under this method, the total costs of an agency or business are fully allocated to

all commercial and non-commercial outputs. Direct costs are allocated to their respective outputs, while indirect and joint costs are averaged across all outputs.The cost base for each output includes the share in direct capital costs (such asdepreciation) and overhead costs (such as corporate services). In the simplestform of FDC, indirect costs are allocated to activities on a pro-rata basis (for example, business activity staff as a percentage of total agency staff).

Avoidable/ Incremental Cost

Avoidable Cost includes all direct costs relating to an output, but includes onlythose indirect costs that can be avoided if the output was not provided by the

agency. For example, direct costs such as labour and materials and someindirect costs (such as payroll administration) can be avoided if the output is notproduced. But, other costs, such as some corporate overhead expenses (e.g.salary of the portfolio Chief Executive) and depreciation on jointly used assetsare incurred regardless of whether the outputs are produced or not. Under avoidable costing these costs would not be included in the output cost.

Avoidable Cost is usually a long run concept. The longer the time frame, themore costs become avoidable. To ensure that capital and other long term costsare considered for inclusion in the calculation of output cost, a medium to longterm time frame should be taken (generally at least three years).

The most important factor for determining the appropriate cost allocation methodis the objective of competitive neutrality. If the cost allocation method leads to acost base that is too low in relation to market price, a business unit may beencouraged to supply a product when it is not efficient to do so. Conversely, if thecost base is too high, the business may neglect efficient supply opportunities.



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FDC is a conceptually simpler costing methodology than Avoidable Costing. If anagency is already using a FDC approach it may be useful to examine anAvoidable Cost base, but only when it is expected to have an impact on thebusiness units decision making.

Table 1 - Treatment of costs under different allocation methods

Diagram-1 outlines the steps involved to fully cost the outputs of a significantbusiness activity. When using Avoidable Costing, this approach is modified byselecting only those costs considered to be avoidable.

FDC should take account of:

all direct costs such as labour, materials and premises;indirect costs (overheads) such as personnel services, IT support,administration; anddepreciation of physical assets utilised.

The following components of financial management system should be in place,

and will be used to calculate the cost base:

accrual accounting;output costing; andasset valuation.



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of the service; Cost of materials and services directly consumed in the production process; An appropriate share of indirect labour costs; Accommodation costs; A share of indirect materials and services;

Capital costs including depreciation of fixed assets and capital charges;6.6 Accrual Output Budgeting

As a part of a broader public management reform program , Australia budgetingin recent years are being framed on the basis of a new budgeting system knownas accrual output budgeting (AOB), whereby government purchases outputs 6 from its departments, under circumstances similar to private business andcompetitive market structures. The system was derived from the New Zealandcontract budgeting system ( NZT 1996; Robinson 2000), which was adaptedfrom the British National Health System (NHS) internal market model introduced

in the early 1990s ( Culyer, Maynard and Posnett 1992; Bartlett and Harrison1993). The UK NHS internal market model, based on earlier US prospectivepayment systems of health finance, was an attempt to place the public fundedNHS on a market footing. Since the early 1990s, Governments in many other countries introduced a variety of other service-specific internal market models.

In Australia, AOB first came into full operation in 1998, in the states of Victoriaand Western Australia. The Commonwealth (i.e. national) government and mostof the other state governments achieved this position in 1999. The models differ across the states, although there is a lot of commonality as regards methodologyand basic concepts.

Prior to AOB, Australian Parliaments appropriated funds to departments in twocategories: current and capital expenditure. No distinction was made between,on the one hand, expenditure on goods and services for which departments wereresponsible and accountable and, on the other hand, expenditure which wasbeyond departmental control (examples of which include interest on governmentdebt, and welfare entitlement expenditure relating to legal social insurance).Under AOB, however, this distinction becomes crucial. As a consequence,Australian Parliaments now appropriate funds to each department in threecategories: payments for departmental outputs (controlled outputs); paymentsfor items not under departmental control (administered items); and

appropriations to fund new capital funds.

6 In Australia, as in New Zealand, outputs have been defined to include not only services provided to the community, but also services (such as policy advice) which is provided by departments to ministers or to other elements of the political leadership (Cabinet, Parliament etc).There is some debate about whether interagency intermediate services might sometimes beconsidered to be outputs.



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As a reflection of the business model, the payment for departmental outputsappropriation is now an accrual appropriation. This means that departments arerequired to cover non-cash costs (e.g. depreciation, accumulating liabilities toemployees) as well as the cash costs of their outputs from this appropriation.AOB also reflects a system of performance budgeting, which explicitly link

budgetary resource allocations with the results (outputs and outcomes). Thestarting point for most forms of performance budgeting, including AOB, isprogram budgeting, which was the standard public budgeting practicethroughout Australia in the 1980s prior to the adoption of AOB. AOB incorporatesmost of the former program budgeting framework. The annual governmentbudget documents under AOB report the breakdown of funds allocated to broadoutput groups within each Department, very much like the former programs 7.These output groups are groups of related outputs designed to deliver the sameoutcome 8. Each broad output group comprise a number of sub-output groups,like the former sub-programs.

Budgetary allocations for the separate output groups are not binding. Instead,parliamentary appropriations for departmental outputs are global, just as theywere under the former program budgeting regime 9. In other words, parliamentapproves for each department one aggregate sum to cover all the outputs for which the department is responsible, but has the flexibility to reallocate fundsbetween outputs during the year in response to unanticipated events.

Although AOB has its roots in program budgeting, it differs from programbudgeting in many respects. First of all, it incorporates private business andcompetitive market environment in government activities to ensure efficiency.Essentially, it builds a market-type superstructure upon program budgetingfoundations (

WAT 1996a). In this respect, it differs considerably from the forms of

performance budgeting which operate in other countries and do not generallyregard agency profit results as a key performance measure. To take an example,in the USA under the system of performance based program budgeting theannual budget for each agency passed by the legislature includes only outputand outcome targets, but no prices. The United Kingdom has developed since1998 a system of Public Service Agreements and Service Delivery Agreementsbetween the Government and agencies linked to the budget. In Australia, NewSouth Wales is the only state not to have adopted accrual output budgeting.

7

Output groups are defined in such a way that they more truly reflect the concept of an output than that under the program budgeting practice. For example, departments are not permitted touse corporate services as an output group, although corporate services programs were commonunder program budgeting.

8 The Commonwealth refers to Outcomes rather than output groups, meaning the same thing.

9 The Commonwealth submits appropriations to Parliament in a form grouped into outcomes.However, this allocation is not binding, and is purely for information (DOFA, 1998; 1999c).



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Another important aspect of the Australian AOB is that the capital appropriationsto departments have now been re-labeled as equity injections 10. Financeministries assert that, in addition to equity injections, departments may, likeprivate corporations, have access to two main alternative capital funding sources.The first is the so-called depreciation-based capital funding, which is a draw-

down of the accumulated depreciation reserves. The other is the rearrangementof the asset structure, an accounting jargon for funds derived from departmentalasset sales ( Robinson, 2002a) . Consequently, Australian agencies, like privateenterprises, enjoy considerable degree of freedom for new investments.

So-called capital charging has also been introduced by most of the states in theAustralian AOB system. Capital charging is a private-sector idea to include it as apart of the output cost to reflect return on capital. Its first application to the publicsector appears to have been by the British National Health Service (NHS). NewZealand subsequently extended capital charging to the whole budget sector. Theidea is that, in addition to depreciation, a type of interest charge is levied upon

departments for the use of the capital, particularly in physical assets. The rate of the capital charge is supposed to reflect the opportunity cost of capital providedto Departments, and it is expected that that the Agencies to which thegovernment provides capital should earn at least a normal rate of return.Proponents of capital charging argue that it would reduce wasteful capitalexpenditure and encourage the identification and sale of idle and surplus assets.

Clearly, in a budgeting system based upon output prices, it is logical to treat theopportunity cost of capital as a component of cost in price-setting. Accordingly,the State governments which impose capital charges treat it as an above theline expense in operating statements. However, the Commonwealth Governmenttakes a different approach, treating the capital charge as a below the line entry,treating the capital charge equivalent of a profit dividend paid to shareholders.

Benefits of Accrual Output Budgeting

The above analysis suggests that the market principle of funding based onoutput prices can only be selectively applied in the public sector. In addition tothe distinctive market aspects of AOB, the system has led to a renewed effort toimprove and extend performance measures and indicators. Considerable work isbeing undertaken in the Australia, Canada, New Zealand, UK and USA toarticulate the linkages between outputs and outcomes, and strategy. Moreover, ithas been associated with a major drive to shift public sector accounting inAustralia onto an accrual basis: a step which arguably has many benefits in other areas, including fiscal policy (Robinson, 2002).

6.7 Cost Allocation: An Example

10 The Commonwealth differs from the states in that it provides loans to the departments as well as equity injections (DOFA 1998; 1999c).



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Table-2: Cost structure at Departmental level

Costing results

The following allocation principles have been applied for cost allocation inTable-3:

(a) Cost of capital (computer) - Full cost charged directly to the division, thenpro-rated to the contractbased on capacity usage (i.e., 50 000 x 30%).(b) Computing labor (systems) - Pro-rated to the contact based on capacityusage (i.e., 150 000 x 30%).(c) Computing labor (processing- The cost (80 000) of the additional staff required to service the commercial activity is charged directly to the contract.Processing labour used for non-commercial functions (350 000) is not charged tothe contract.(d) Policy and program labor - Not allocated to the division as functions areunrelated.(e) Executive labor - Pro rated on the percentage of commercial staff to totalstaff (2% x 400 000).(f) Other corporate labor - 350 000 x 2%(g) Training - Training for the contact staff is charged directly (2500).(h) Furniture & fittings - 100 000 x 2%(i) Other equipment- The cost increase (3000) is charged directly.



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6.8 A Case study 12 for Output Costing

The University of Australias Economics Department has decided to undertakeOutput Costing, and to consider the following subjects as cost objects :

(A) Accounting;(B) Economics;(C) Econometrics; and(D)Applied mathematics.

The Departments Cost Pools have been identified as:

(a) Library;(b) Lecturers;(c) IT;(d) Enrolments

Activity Based Costing Example

The General Ledger provides the following information:

Cost pools (Cost) General Ledger Expenses Expense (A$)Library ($40,000) Library staff wages 20,000

Book purchases 15,000Library consumables 5,000

Lecturers ($112,000) Accounting lecturers wages 15,000Economics lecturers wages 15,000

Econometrics lecturers wages 16,000Applied Maths lecturers wages 16,000Other lecturers wages 35,000Lecturers travel 12,000Lecturers subscriptions 3,000

IT ($125,000) Help Desk costs (including wages) 75,000Software subscriptions 50,000

Enrolments ($18,000) Enrolment staff wages 10,000Enrolment office consumables 8,000

Based on surveys, questionnaires, timesheets and other statistics, the followingdata has been collected:

12 Source: Output Costing Methods Module: A Costing Framework, Queensland Treasury, November 1998.



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Cost drivers Accounting Economics Econometrics AppliedMath

Total

No. of libraryborrowings 250 500 50 200 1000Lecturers timespent (%) 25 30 10 35 100Help deskrequests (No.) 45 15 25 25 110StudentEnrolments(No.) 50 75 25 100 250

Distribution of Cost Drivers in proportion to totalCost drivers Accounting Economics Econometrics Applied

MathTotal

No. of libraryborrowings

0.25 0.50 0.05 0.20 1

Lecturers timespent (%)

0.25 0.30 0.10 0.35 1

Help deskrequests (No.)

0.41 0.14 0.23 0.23 1

StudentEnrolments(No.)

0.20 0.30 0.10 0.40 1

On the basis of these information and data, the allocated costs for differentsub outputs are indicated in the following diagram.



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The costs shown above exclude a number of important components of full cost:

Depreciation

The inclusion of depreciation as a capital-related cost will ensure that someallowance is made for the use of capital equipment. The following depreciationexpenses should be included in the measurement of full cost:

Opportunity cost of capital

For the purposes of this worked example, a rate of 6 per cent is used torepresent the foregone opportunity to invest assets in the Public Bank Account.The rate is applied to the net assets of the organization, as illustrated below:Assets

Head office overheads

The Computer West Division has to bear its share of the department'sadministrative costs for items such as the chief executive's salary. Its share of these costs is estimated to be $96,000.



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Services received free of charge

For the purposes of this exercise, the parent departments accounts are assumedto be audited at no charge by the Office of the Auditor General. The value of thisservice is estimated to be in the order of $30,000 of which the Divisions

allocated share is $10,000.Total cost

The full cost of Computer Wests operations is therefore:



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Mercer, John: See Website on GPRA and Performance Management:www.governmentperformance.info

NZT (New Zealand Treasury) (1996) Putting It Together: An Explanatory Guideto the New Zealand Financial Management System , The Treasury (Wellington).

Queensland Treasury (1998) Output Costing Methods Module: A CostingFramework, Government of Australia, November 1998.

Robinson, Marc (2000) Contract Budgeting, Public Administration , Vol. 78, No.1, pp.75-90.

Robinson, Marc (2002) Accrual Accounting and Australian Fiscal Policy, Fiscal Studies .

Robinson, Marc (2007) edited. Performance Budgeting- Linking Funding andResults, Palgrave McMillan.

South Australian Department of Treasury and Finance (2000) A Guide toImplementation of Cost Reflective Pricing- A Part of Neutrality Competitive Policy,October 2000.

USA (1993) Government Performance and Results Act (GPRA) of 1993, Office of Management and Budget (OMB).

United States of America, Office of Management and Budget (OMB)Homepage: http://www.whitehouse.gov/omb/gils/gil-home.html

VDTF (Department of Treasury and Finance, Victoria) (1998a) Accrual Accounting Manual , Melbourne: The Department.

VDTF (Department of Treasury and Finance, Victoria) (1998b) The Capital Assets Charge in 1998-99 , The Department (Melbourne).

WAT (Treasury, Western Australia) (1998) Output Based Management Output Measures - Guidelines To Assist Agencies , The Treasury (Perth).

http://www.governmentperformance.info/http://www.whitehouse.gov/omb/gils/gil-home.htmlhttp://www.governmentperformance.info/http://www.whitehouse.gov/omb/gils/gil-home.html


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Output Budgeting Tarun Das ________________________________________________________________

APPENDIX - GLOSSARY

Accrual Accounting Accounting method in which revenue andcosts are recognized for the period in whichthey are incurred, irrespective of whethercash has been received or paid.

Activity BasedCosting (ABC)

A costing approach which focuses onidentifying activities required to produceoutputs. Direct and indirect costs areallocated to the activities performed in orderto produce a product. This contrasts withtraditional costing techniques that focus onthe elements of cost. For example, ABCwould assign a cost for providing policyadvice and administering a grant programrather than labour or property operatingexpenses.

Avoidable Cost

.

Those costs that would be avoided if anoperation were suspended or closed down(such as raw materials and labor cost). Manycomponents of avoidable costs are similar tothose of marginal costing. However, marginalcosting focuses on the change in costsarising from an additional unit of outputwhile avoidable cost takes a more macroapproach by focusing on the costs of addingor deleting an entire function or operation.

Cost Allocation Base The basis for allocating costs to an output,activity, process, project, or cost centre, etc.

That basis may be the cost driver or adifferent basis altogether. For example, staff

numbers, office floor space.Cost Driver A factor or variable that triggers the

occurrence of a cost or has the greatesteffect on the activity level. When it isimpossible or impractical to measure thetriggers, a surrogate should be used instead(something which has strong correlation with

Glocoms Inc. (USA) MOF, Govt. of Mongolia48


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the activity being measured).

Cost of Capital The costs associated with working capitaland capital goods (i.e. depreciation andopportunity cost). The required rate of return

on the investment of funds in capital goods(e.g. plant, equipment etc), land andfinancial assets.



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Cost ReflectivePricing (CRP)

Cost of outputs adjusted for any competitiveadvantages and disadvantages due togovernment ownership and setting an outputprice on the basis of principle of

competitively neutral cost. It is one of three measures to implement competitiveneutrality, and used where the other two,viz. corporatization and commercialization,are not appropriate. It can be used inconjunction with structural reform (resultingin greater private sector equivalence) orwithout any organisational restructuring.

Current Asset An asset that, within the normal course of events, is expected to be converted into

cash within the next 12 months.

Current Cost A cost stated in terms of current marketprices rather than historical cost.

Debt Guarantee Fees A fee which is intended to eliminate thecompetitive advantage of a governmentactivity over private sector competitorsthrough receiving cheaper finance as a resultof a government guarantee. The fee appliesto the face value of debt outstanding, butmay vary according to the level of debt andan assessment of risk.

Depreciation An expense that measures the consumptionof an asset over time and according to theintensiveness of its use.

Differential (orincremental) Costs

Future costs that differ between one courseof action and another whether fixed orvariable.

Direct Allocations Allocates costs directly to the final user of the service and ignores intermediate usersand support services.

Direct Costs Those costs which can be directly andunequivocally attributed to the production of an output.



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Fixed Costs Those costs that remain unchanged in totalfor a given time period and level of operation, despite fluctuations in outputlevel. This is only relevant in the short term,

as in the longer term all costs becomevariable.

Full Cost The total cost of all resources used in theproduction of an output. The total of directand indirect costs.



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Full Costing The process of accumulating and allocatingthe total costs of a business unit to all of theactivities undertaken by the unit. Under fullcosting, indirect costs and overheads are

fully absorbed into the costs of activities. Fullcost may be defined per unit of output(average full cost) for the complete businessunit . The measurement of full cost provides akey benchmark in the sense that itrepresents the minimum level of revenuethat has to be generated by firms in theprivate sector to remain commercially viablein the long term.

Government BusinessActivities (or

CommercialActivities)

Activities which produce goods and servicesfor sale in the market with the intention of

earning profits and financial returns to theirowners, or at least of recovering all or asignificant proportion of their operatingcosts.

GovernmentGuarantee

An undertaking by the government to coverthe liability of an entity in the event that it isunable to meet its debt servicing obligations.It is regarded as a contingent liability of thegovernment.

Indirect Costs Costs that are not exclusively or directlyattributable to an output, but necessary forthe functioning of an organization (such ascost for chief executive officer).

Inputs Labour, materials and other resources usedto produce outputs.

Long Run A period of time in which capacity can beconsidered to be variable.

Long Run MarginalCost

The cost of the last unit of production whenproductive capacity can be altered.

Marginal costing A system of costing that examines thechange in total costs resulting from anincrease in one unit of production. Marginalcosting is based on the distinction betweenfixed and variable costs. Marginal costs will



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assets (or equity) which reflects the cost of capital from the owners perspective.

Transition cost The once-off costs incurred in changing an activity from public to private operation and vice versa.

Variable costs Costs that fluctuate in direct proportion tochanges in the level or volume of output.

Weighted AverageCost of Capital

An approach under which the cost of equityis calculated in accordance with the Capital

Asset Pricing Model using the followinginputs: A risk free rate of return (normallyequivalent to the 10-year Treasury bondrate);

A market risk premium for additional riskattached to equity investments versus debt; A factor to represent the volatility of investment compared to the total equitymarket.

mongolia output costing and budgeting-tarun das

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