COSTING GOVERNMENT GOODS AND SERVICES

1. COSTING GOVERNMENT GOODS AND SERVICES A Seminar by Dr. Clifford McCue Associate Professor School of Public Administration Florida Atlantic university

2. 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.

3. COSTING GOVERNMENT GOODS AND SERVICES • We will cover in this course • The difference between financial, managerial, and cost accounting;

4. 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

5. Comparison of cost, management and financial accounting

6. Meanings • Financial accounting • Cost accounting • Management accounting

7. 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)

8. 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

9. 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

10. Cost and management accountingVs.Financial accounting

15. Cost accountingvs.Management accounting

19. 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)

20. 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.

21. 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?.

22. 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.

23. 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.

24. Costing Techniques The basic types of cost estimates

25. Outline • Introduction • Costing Techniques • Using Costing Techniques • Comparison of Techniques • ABC • Summary

26. 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

27. Costing Techniques • Analogy • Parametric • Build-Up • Other Topics

28. 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”

29. 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

30. 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

31. 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

32. 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?

33. 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

34. 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

35. 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

36. 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

37. 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

38. 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

39. 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

40. 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

41. Other Topics • Expert Opinion • Extrapolation from Actuals

42. Expert Opinion - Method • Uses an expert or a group of experts to estimatethe 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

43. 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.

44. 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

45. Extrapolation from Actuals • 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 could also be called Averages, Learning Curves, Cost Improvement Curves, Cost/Quantity Curve, Estimate at Completion (EAC), and Earned Value (EV)

46. 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

47. 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

48. Using Costing Techniques • Estimate Requirements • Top Down vs. Bottom Up • Cost Element Structure (CES) • Technique Selection • Checking Results • Documentation

49. 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

50. 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