COSTING GOVERNMENT
GOODS AND SERVICES
A Seminar by
Dr. Clifford McCue
Associate Professor
School of Public Administration
Florida Atlantic university
Introductory Disclaimer



This presentation is meant to convey general and explicit ideas
consistent with the manner in which they would be discussed in a
traditional classroom setting
Some ideas and slides were lifted without change or attribution
from other presentations and material from the web
Since it is not meant to be disseminated or used outside of the
intended purposes for this Webinar, ideas and actual slides used
in this presentation are not cited as to their original sources or
presentations and should not be used for any other purpose than
relaying information within this setting.
COSTING GOVERNMENT GOODS
AND SERVICES

We will cover in this course

The difference between financial, managerial, and cost
accounting;
Basic Costing Principles

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
Comparison of cost, management
and financial accounting
5
Meanings
Financial accounting
 Cost accounting
 Management accounting

6
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)

7
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

8
Management accounting
Comprises all cost accounting functions
 The accounting for product and service costs,
management accounting extends to use various
internal accounting reports for planning, control
and decision making

Cost and management accounting
Vs.
Financial accounting
Management
(cost)accounting
Nature
Accounting
system
Financial accounting
Records material, labor Records government
and overhead costs in
transaction events
product or job
External financial
Reports produced are
statements are produced
for internal management
and control

Not based on the
double entry system

Follows the double entry
system

11
Management
(cost)accounting
Accounting
principles
Users of
information
Financial accounting
No need to use
Use Generally Accepted
accounting principles
Accounting Principles for
recording transactions
Adopt any accounting
techniques that generates
useful accounting
information

Used by different levels
of management or
departments responsible
for respective activities

Used by external parties:
bond rating companies,
citizens, elected officials,
etc.

12
Management
(cost)accounting
Operation
guidelines or
standards
Time span
Based on management
instructions and
requirements

Reports are prepared
whenever needed
They may be prepared
on a weekly or daily
basis

Financial accounting
Conforms to local
ordinances, state law, and
GAAP

Reports are prepared for a
definite period, usually
yearly

13
Management
(cost)accounting
Time focus

Perspective

Financial accounting
Future orientation:
Past orientation: use of
forecasts, estimates and historic data for reporting
historic data for
and evaluation
management actions
Detailed analysis of
programs/activities of
the government
Financial summary of the
whole organization,
including all funds

14
Cost accounting
vs.
Management accounting
Management accounting Cost accounting
Objective
Basic of
recording
To provide information
for planning and
decision making by the
management

Concerned with
transactions related to
the future

To ascertain and control
cost

Based on both present and
future transactions for cost
ascertainment

16
Management accounting Cost accounting
Coverage

Covers a wider area:
financial accounts, cost
accounts, etc.
Utility

Only the needs of
internal management
Covers matters relating to
ascertainment and control of
cost of programs, services,
or activities

The needs of both internal
and external interested
groups

17
Management accounting Cost accounting
Types of
transactions
Deals with both
monetary any nonmonetary transactions,
covering both
quantitative and
qualitative aspects

Deals only with monetary
transactions, covering only
quantitative aspect

18
Costing Government Activities

Not surprising, we actually know what it costs to
run a government, both what we anticipated to
spend and what we actually spent.


What we anticipate to spend: Budgeting
What we actually spend: Financial reporting (CAFR)
So what is the Costing Issue

The issue is assigning costs to programmatic
levels within departments.


Typically we can isolate costs for specific items within
a department, normally identified on the accounting
ledger (object of expenditure code).
But that does not really help us identify costs
associated with a specific program, activity or function.
So what do we need to do?

The fundamental issue in cost accounting (notice
how we did not mention management account –
that can only be done once the cost accounting
system is in place) is determining at what level of
the organization do you want to relate costs to
goods and services provided?

For example, the budget assigns costs to the
departmental level, and some budgets, such as a
program budget, can assign costs to specific programs
– but what about overhead costs?.
How to choose a cost center




A cost center is often a department/agency but for costing purposes it
should drill down to the activity level. The manager and employees of a
cost center are responsible for its costs but are not typically responsible for
revenues or other financing decisions, like investment decisions.
Cost centers include each governmental department/agency that generates a
good or a service to its customers. Other examples of cost centers include
the human resource department, the IT department, the accounting
department, and so on.
Cost centers are not limited to departments/agencies. There might be
several cost centers within a department. For example, each program within
a department could be a cost center. Even a special machine in Public
Works could be a cost center.
Cost centers are usually associated with the topic of decentralization,
responsibility accounting, and planning and control.
Cost Centers




Cost centers are used for two reasons: planning and
controlling costs in government.
Cost centers help identify ways for
departments/agencies to improve performance
(financial) by staying within their budgets.
Cost centers provide a vehicle to analyze all expenses
for a particular ACTIVITY and finding ways to
decrease the costs in the future.
The job of a cost center is to control costs and
increase performance.
Costing Techniques
The basic types of cost estimates
Outline
Introduction
 Costing Techniques
 Using Costing Techniques
 Comparison of Techniques
 ABC
 Summary

Introduction

The three essential cost estimating techniques (or
methodologies) are:




Analogy
Parametric
Build-Up
Other topics we will discussed in relation to the
three essential techniques are:


Expert Opinion
Extrapolation from Actuals
Costing Techniques
Analogy
 Parametric
 Build-Up
 Other Topics

Costing Techniques Overview

Costing Techniques provide the structure of your
cost estimate



They’re what enable you to predict future costs based
on historical data
Techniques rely on statistical properties, logical
relationships, and emotional appeal
Three essential types



Analogy: “It’s like one of these”
Parametric: “This pattern holds”
Build-Up: “It’s made up of these”
Analogy - Method



Comparative analysis of similar systems
Adjust costs of an analogous system to estimate the
new system
Adjustments could be based on:




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Programmatic information
Physical characteristics
Performance
Government vs. Commercial practices
Contract specifics
Economic trends
Analogy - Application

Used early in the program life cycle

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The best results are achieved when
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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
Similarities between old and new systems are high
Adjustments can be quantified
Subjective adjustments are minimized
Can be used as a cross check for other methods
Analogy – Advantages /Disadvantages

Advantage



Can be used early in programs before detailed requirements
are known
Difficult to refute if there is strong resemblance
Disadvantage



Introduces subjectivity in the adjustment
Difficult to obtain cost/technical data on old/new systems
for comparison
No objective test of validity
Analogy – Fighter Example
Attribute
Old System
New System
Engine:
Thrust:
Cost:
F-100
12,000 lbs
$5.2M
F-200
16,000 lbs
?
Q: What is the unit cost of the F-200?
A: $5.2M * (16,000/12,000) = $6.9M
Tip: The mischief in
analogy most often
arises in the
adjustment. Why do
we so readily believe
a linear relationship
which passes through
the origin?
Parametric Estimating - Method

A mathematical relationship between a parameter and
cost



Parameter may be physical, performance, operational,
programmatic, or cost
Uses multiple systems to develop relationship
Allows statistical inferences to be made
Parametric could also be called Cost
Estimating Relationships (CERs),
Rates, Factors, Ratios
200
150
100
50
0
0
200
400
600
800
1000
Parametric Estimating - Application

Use of Parametrics


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
Requires a good database which is relevant to the system
being estimated
Excellent for use early in program life cycle before a
detailed design exists
Used as the design progresses to capture changes
Good as a cross-check for other methods
Parametric Estimating –
Advantages/Disadvantages

Advantages





Can be easily adjusted for changes by modifying input
parameters
Sensitivity Analysis - Can show how changes to certain
parameters impact the cost
Objective measures of validity
Statistical measures for risk
Disadvantages



Difficult to ensure consistency and validity of data
Must constantly review relationships to ensure that
relationships reflect current status of relevant programs,
technology, and other factors
“Black box syndrome” with pre-existing CERs, commercial
models
Parametric Estimating - Example

CER for Site Activation as a function of Number
of Workstations:


Site Act ($K) = 82.8 + 26.5 * Num Wkstn
Estimated based on 11 data points for installations
ranging from 7 to 47 workstations
Build-Up - Method

Estimating is done at lower levels and results rolled
up to produce higher-level estimates


Often the lowest definable level at which data exist
Elements of this method could include

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

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
Standards
Time and Motion Studies
Build-Up could also be called
Well defined work flow
Engineering Build-Up, Industrial
Variance Factors
Engineering (IE), Catalog/Handbook
Parts List
Lot Size and Program Schedule Considerations
Program Stage
Support Labor
Build-Up - Application
Used when you know detailed product/service
information at the lowest level (i.e., hours,
material, etc.)
 Used in a environment where labor can be
accurately estimated

Build-Up – Advantages/Disadvantages

Advantages

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
Easy to see exactly what the estimate includes
Can include Time and Motion Study of actual process
Variance Factors based on historical data for a given
program or a specific manufacturer
Disadvantages




Expensive and requires detailed data to be collected,
maintained, and analyzed
Detailed specifications required and changes must be
reflected
Small errors can be magnified
Omissions are likely
Build-Up - Example

Problem: Estimate hours for the sheet metal element
of the signage for traffic division



Similar to other sign manufacturing which has a 20%
variance factor (actual to standards) and a support labor
factor of 48% of the labor hours
The standard to produce the sheet metal element of the new
signage is 2000 touch labor hours
Solution: Apply factors to the standard touch labor
hours


2000 hrs x 1.2 = 2400 labor hours
Add the support factor of 48% to get the total hours
estimate of 2,400 x 1.48 = 3,552 hours
Other Topics
 Expert
Opinion
 Extrapolation
from Actuals
Expert Opinion - Method

Uses an expert or a group of experts to estimate
the cost of a system



One-on-one interviews
Round-table discussions
Delphi Technique
Expert Opinion could also be called
Engineering Judgment, Round
Table, or Delphi Technique
Expert Opinion - Application
Only used when more objective techniques are
not applicable
 Used to corroborate or adjust objective data


Cross check historical based estimate
Use for high level, low fidelity estimating
 Last resort

Tip: Expert opinion is the least regarded
and most dangerous method, but it is
seductively easy. Most lexicons do not
even admit it as a technique, but it is
included here for completeness.
Expert Opinion –
Advantages/Disadvantages

Advantages



Good cross check of other estimate from Subject
Matter Expert (SME) point of view
Allows perspective to an estimate that may be
overlooked without SME
Disadvantages


Completely subjective without use of other techniques
Low-to-nil credibility
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:
100
95



Averages
Learning Curves
Estimate at Completion
90
Cost

85
80
75
70
1
2
3
4
5
6
Quantity
Extrapolation from Actuals could also be called Averages,
Learning Curves, Cost Improvement Curves, Cost/Quantity
Curve, Estimate at Completion (EAC), and Earned Value (EV)
7
8
Extrapolation from
Actuals - Application
Best application is for follow-on production
units/lots
 Requires accurate cost database



At an appropriate level of cost detail
Validate and normalize data
Extrapolation from
Actuals – Advantages/Disadvantages

Advantages





Possible complications:





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
Unknown events affecting bookkeeping of actuals
Changes in cost accounting methods
Contract changes affecting actuals
Configuration changes, process changes all have impacts
Disadvantages:

Extrapolating beyond a reasonable range
Using Costing Techniques






Estimate Requirements
Top Down vs. Bottom Up
Cost Element Structure
(CES)
Technique Selection
Checking Results
Documentation
Estimate Requirements

Why are we developing this estimate? What will
it be used for?





Milestone A, B, or C decision
Developing a budget
Developing a “ball park” or rough order of magnitude
(ROM) estimate
Comparing alternatives
Evaluating proposals
Top Down vs. Bottom Up

There are two general ways to structure an estimate




Top Down
Bottom Up
Top Down is generally associated with the Parametric
or Analogy techniques
Bottom Up frequently uses more than one method at
the lowest level but is generally associated with the
Build-Up technique
Cost Element Structure

Determine what needs to be estimated and develop an
appropriate Cost Element Structure (CES)


CES Dictionary defines what is included in each element
Characteristics associated with cost elements that are
routinely used to classify costs
•
•
•
•
•
Program Phase: Development, Production, O&S
“Color of Money”: RDT&E, Procurement, O&M
Funding Source
Non-Recurring or Recurring
Direct or Indirect
Technique Selection
Review available techniques
 Compare alternatives
 Select or develop appropriate technique
 Identify primary and secondary techniques

Each costing technique has strengths and
weaknesses and can be applied at different
times in the life cycle of a cost estimate
Checking Results

Cross Checking your results greatly increases credibility



Example: A parametric-based estimate can also show an analogy as a
“reasonableness test”
Doesn’t necessarily result in the exact same number, but should be a
similar number (same order of magnitude)
An independent* estimate is more detailed than a cross check
and attempts to get the same result using a different technique

Example: Use the results from one commercial software estimating
package to validate the results of another
*Note: “Independent” has many meanings. The most stringent meaning is in Title 10 USC Section 2434 and involves
an organization out of the chain of command of the acquiring agency. A looser meaning is an estimate done by an
organization unbeholden to the program manager in funding or accountability. The loosest meaning is a separate
estimate.
Documentation
Within reason, more information is better than
less
 Any information that is used in the analysis must
be included in the documentation
 Documentation should be adequate for another
cost analyst to replicate your technique
 Like they used to tell you in math class….

If You Don’t Show Your Work,
You Don’t Get Any Credit!
Comparison of Techniques
Comparison – Advocacy

Advocates of Build-Up drink beer and say:




Hey, it’s a joke,
lighten up!
Advocates of Analogy drink bourbon and say:




More detailed = more accurate
Analogy is prey to invalid comparisons
Parametric is too “theoretical”
Like things cost like amounts
Build-Up is prey to omission and duplication
Parametric is “diluted” by less applicable systems
Advocates of Parametric drink wine and say:



Most thoroughly based on historical data
Analogy is just a one-point CER through the origin!
Build-Up is prey to omission and duplication
Refining a Costing System
More Direct-cost tracing
Indirect-cost pools
(More homogeneous)
Better cost-allocation bases
Activity-Based Costing System
Activity
Indirect Cost
Pool
Design
Setup
Shipping
Cost
Allocation
Base
PartsSquare
feet
No. of
Setup
Hours
No. of
Shipments
Product
Cost
Objects
Lenses
NL
Lenses
CL
Lenses
Other
Activity-Based Management
ABM describes management decisions that use
activity-based costing information to satisfy
customers and improve profits.
Product pricing and mix decisions
Cost reduction and process improvement decisions
Design decisions