Cost Allocation
Challenges for
Governments
FGFOA Annual Conference
June 3, 2014
Presented by
Lynda M. Dennis; CPA, CGFO, PhD
Overview




Why cost allocation?
Internal uses of cost allocation
Cost allocation basics
Cost allocation – grant reporting
Why Worry about Cost
Allocation?



Systematic allocation produces better
decision making information
Documented allocation process provides
basis for reliable financial reports for external
parties
Ratios & indicators from these reports provide


Data to assess financial sustainability
Basis to deal with scrutiny by grantors/donors
& oversight agencies
Today’s Concerns for
SLGs

Budget cuts in administrative positions


Previous allocation models may require
revision
Allocation of indirect costs to
Stimulus programs
 Other grants


Consideration of indirect costs to fees &
charges
SLG Characteristics
Affecting Cost Allocation




Services difficult to measure
Provision of public goods often required
Labor-intensive operations
Limited staff




Expertise
Available time
Regulatory oversight
Governments are different
Users & Uses of Cost
Allocation Information

External users
Financial statement users
 Oversight organizations
 Federal, state, and local agencies

• Compliance

Internal users
Financial information
 Operating information
 Grant administration

Governmental Oversight
Organizations


Federal
 OMB
 GAO
 Specific departments/agencies providing funding
State
 Auditor general
 Department of revenue
 Secretary of state
 Department of law enforcement
 Specific departments/agencies providing funding
 Citizen groups
External Financial
Reporting of Costs

Expense/expenditure


Cost during period from
delivering/producing goods, rendering
services, carrying out other
major/central activities
Functional expense

Cost reported by function/activity
Financial Statement
Analysis - SLGs

Regulatory or statutory requirements


Building function
User expectations

Governmental vs. business-type activities
Financial Statement
Analysis - SLGs

Government-wide statement of activities


Expenses net of program revenues
Difficulties in allocating indirect costs
To functions
 GAAP

• interest expense
• Depreciation
Financial Statement Analysis

Allocation of indirect costs affects
Ratio of functional expenditures to total
expenditures
 Ratio of intergovernmental revenues to
total revenues
 Interfund transfers
 ISF reimbursements
 Operating results

Comparisons

Benchmarks


Internal
External
• Similar in scope & objectives
• Use to identify potential improvement areas
• Issues to using
• Occupancy
• Geographic location
• Services provided & area competition
Internal Uses of Cost
Allocation
Uses of Internal Cost Data




Capture cost data for decision making
purposes
Program administration
Budget compliance
Grant administration
Internal Cost Basics

Types of internal costs

Variable


Fixed


Costs changing with level of activity
Costs not changing with level of activity in a
specified time period
Differential


Costs changing in response to particular
course of action
Similar to “incremental” costs
Internal Cost Basics

Types of internal costs

Discretionary fixed

Costs that can be avoided in short run


Sunk


R&D, R&M, travel, training
Costs resulting from expenditure made in
past that present or future decisions can not
change
Encumbrance

Earmarking of available financial resources

Usually via purchase order
Internal Cost-Based Decisions

Programs

Start


Terminate


Decreases allocation base/allocable costs
Expand


Increases allocation base/allocable costs
Increases allocation base/allocable costs
Reduce

Decreases allocation base/allocable costs
Internal Cost-Based Decisions

Locations

Add


Expand


Increases allocation base/allocable costs
Relocate


Increases allocation base/allocable costs
May increase or decrease allocation base or
allocable costs
Close

Decreases allocation base/allocable costs
Internal Cost-Based Decisions

Other



Level of service
Program pricing
Cost recovery



Internal service funds
Inter-agency billings
Grant reimbursement
Internal Costs & Grant
Administration

May affect

Amount & timing of purchasing decisions




Grant specific & in total
Amount of costs allocable to other grants
&/or for other purposes
Decisions to apply for other grants
Allocation of indirect expenses to
grants discussed in depth later
Cost Allocation Basics
Cost and Cost Concepts

Cost object


Any item/purpose for which costs need to be
measured
Direct cost

Can be clearly identified with/directly related
to a single cost object


Economically feasible manner
Indirect cost

Cannot be clearly identified with/directly
related to a single cost object
Cost Accounting Terms

Cost recording


Cost accumulation


Collecting all costs of a specific activity
Cost assignment


Entering costs in accounts
Tracing direct costs to a cost object/purpose
Cost allocation

Relating indirect costs to cost objects or
purposes
Cost Assignment
and Allocation Purposes
• Need to determine based on various
demands
– Assigned costs = direct
– Allocated costs = indirect
Cost Allocation
• NOT cost assignment
– Direct costs
• Allocation criteria for indirect costs
– Cause and effect
• Most preferred
– Benefits received
– Equity
– Ability to bear
• Least preferred
Cause & Effect
• AKA causal criterion
• Identification of activity causing costs to
be incurred
• Difficult for indirect costs
• Statistical relationships vs. assumed
relationship
• Best to use
Benefits Received
• AKA beneficial relationship
• Identification of users of outputs
from activity
• Costs allocated among users
proportional to benefit
• Direct costs – proxy for benefits
Equity
• Use when cost allocation used for
reimbursement
– Grants
• Reasonable/fair means of
establishing reimbursement basis
– Fairness not an operational criterion
Ability to Bear
• Cost allocation in proportion to
some user attribute
– Attribute presumed to support
charging costs to user
Allocation Guidance
• Objective methods preferable to
subjective methods
• Base may be financial or nonfinancial data
• Allocation methods should be reviewed
periodically & revised as needed to reflect
significant changes
– Nature or level of current activities
– Jurisdictional limits
Allocation Methods
Allocation Methods
• Stand-alone
• Relative sales value (direct cost)
• Physical units
Stand Alone Allocation Method
• Closest to “ability to bear”
• Allocates indirect costs to each final
cost objective
– Proportional to SAC to independently
accomplish one objective
Stand Alone Allocation Method
• Disadvantages
– Allocation can change - SAC does not
– SAC changes, total basis changes
– SAC may not exist
– Assumes indirect costs functionally
related to SAC
Stand-Alone Method
Activity A: 1,000 X 1,500,000 = $750,000
2,000
Activity B:
800 X 1,500,000 = $600,000
2,000
Activity C:
200 X 1,500,000 = $150,000
2,000
Problems:
• An allocation of indirect costs can change
• Stand-alone costs may not exist
Relative Sales Value Method
(Direct Cost Method)
• Close to “ability to bear” & “cause &
effect”
– Improvement over stand alone
• Sales value/direct cost as allocation
basis
Relative Sales Value Method
(Direct Cost Method)
• Assumes indirect costs incurred in
same proportion & for same reason
as direct costs (OMB “simplified
method”)
– No change to expense for each objective
compared to total direct costs
– Increases total reported for each
objective
Direct Cost Method
Cost
Objective
Total
Direct
Costs
Relative
Share
Indirect
Costs
Total
Costs
$375,000
1,875,000
Activity A: 1,500,000
1,500
2,000
x 500,000
Activity B:
200,000
200
2,000
x 500,000
=
50,000
250,000
Activity C:
300,000
300
2,000
x 500,000
=
75,000
375,000
$2,000,000
=
Allocated
Costs
$500,000 $2,500,000
Physical Units Allocation Method
• Consistent with “cause & effect”
• Allocate costs to objectives proportional
to units of activity/output for each
objective
• May not reflect total effort needed to
produce output
• Assumes indirect costs incurred
proportional to some unit measure of
activity/purpose
Cost Determination
Allocation Steps
1.
2.
3.
4.
5.
6.
7.
Reason(s) for cost information
Cost objects or purposes
Types of relevant costs
Assign direct costs to cost objects
Select allocation base(s) or cost drivers
Allocate indirect costs
Ensure appropriateness
Step 1 - Cost Determination
• Reason(s) for cost information
– Process depends on info needed
• Internal
– Accumulation only
– Accumulation/assignment/allocation
• External
– Assignment
– Allocation
Step 2 - Cost Determination
• Cost objects or purposes
– Reason may require 1+ cost objects
• Activities – departments, programs, etc.
• Objects highly likely to be different
Step 2 - Cost Determination
• GAAP cost objects
• GWS
– Statement of net position
– Statement of activities
• Fund level
– Governmental vs. proprietary & fiduciary funds
» Position statements
» Activity statements
Step 3 - Cost Determination
• Types of relevant costs
– Requires judgment & estimates
– Use cause & effect criterion
– Direct
• Readily traced to/identified with cost object or
purpose
– Indirect
• NOT readily traced to/identified with cost
object or purpose
Step 4 - Cost Determination
• Assign direct costs to cost objects
– Cost driver = assignment process
• Relates cost incurred to purpose for which
incurred
• Example
– Cost object includes labor
» (time used * rate) = cost driver
Step 5 - Cost Determination
• Select allocation base(s) or cost
drivers
– Use cause & effect criterion
– Most common in SLGs
• Direct labor
• Square footage for occupancy
Step 6 - Cost Determination
• Allocate indirect costs
– Single stage
• Straight forward situations
• Single or multiple drivers
– Multiple stage
• More complex situations
– Multiple assignments & allocations
• Single or multiple drivers
Single Stage Allocation
Single Driver
Natural Expense
Purpose
Labor
Labor Hours Cost
Driver
A
Rent
Labor Hours Cost
Driver
B
C
Cost Assignment
Cost Allocation
(Based on Labor
Hours)
Two Stage Allocation
Two Drivers
Natural Expense
Purpose
Labor Hours
Labor
Labor Hours
Space Rent
A
Cost Driver
(1)
Cost Driver
B
Equipment Rental
C
Data
(2)
Processing
Cost Assignment
Stage 1 Allocation
(Based on Labor Hours)
Stage 2 Allocation
(Based on Computer Time)
Computer
Time Cost
Driver
Step 7 - Cost Determination
• Ensure appropriateness
– Approach should fully relate all costs to
cost objects
– Care needed to ensure all appropriate
costs assigned
• UBIT & allowable lobbying
• Unallowable costs
– Bad debts, alcohol, etc.
Activity Based Costing
Really Think This One Through
Resources
Labor
$1,600k
Facilitator
$1,000k
EquipRent
$400k
Contracting
$200k
Material
$600k
Storage
$400k
.25
Stage 1
Cost Drivers
.2
Activity Cost
Pools
Deliver
$1,800k
Stage 2
Cost Drivers
Cost
Objectives
.3
.25
Setup
$700k
.25
.6
.3
Contract
$450k
Process
$1,250k
.7
.75
.167
.4
Basic
$1,973k
Enhanced
$2,227k
.833
Cost Allocation for Grant
Reporting
OMB Cost Principles
Provides cost principles – government
contracts & awards
Allowable
Allocable
Direct & indirect
Indirect cost proposals
OMB Cost Principles
 Uniform administrative requirements
 Cost principles
 New changes from OMB
New guidance for indirect costs
 De minimus 10%
Supplies increased to $5,000
Budgeting for contingencies for certain awards
Documentation of cost accounting practices
Salaries & benefits charged to awards
 Must be based on records that accurately reflect work
performed
• Supported by IC system
• Incorporated into entity records
• Reasonably reflect total activity performed
 Allocation based on budget estimates only not acceptable
 Time records for exempt employees
Allowable Costs
General Guidelines

MUST BE
Reasonable & allocable
 Allocable
 Conform to any limitations or
exclusions
 Consistent with policies & procedures

Allowable Costs
General Guidance
Accorded consistent treatment
 Determined in accordance with GAAP
 Not included as a cost or used to meet
cost sharing or matching requirements
 Adequately documented

Allocable Costs
General Guidance

MUST BE

Treated consistently with other costs incurred
for same purpose in like circumstances AND
• Is incurred specifically for the award
• Benefits both the award and other work
• Is necessary to the overall operation of the
organization

Applicable credits
• Offset/reduce expenditures
• Purchase discounts, rebates, etc.
Cost Determination

Direct costs



Specifically identified
Unallowable activities subject to indirect cost allocation
even though not direct
Member services may/may not be allowable
• Services to members typically direct costs to which
indirect costs are allocated

Indirect costs


Common/joint objectives
Not readily identifiable with specific objective
Indirect Cost Rates

Methods considered by OMB
Simplified allocation
 Multiple allocation base
 Direct allocation

Indirect Cost Rates
Simplified Allocation Method



One major function OR
All major functions benefit same from indirect
costs
Steps

Segregate all activities & costs
• Direct & indirect


Deduct capital expenditures & unallowable
costs
Compute indirect cost rate
Indirect Cost Rates
Multiple Allocation Method


Indirect costs benefit major functions differently
Cost groupings – permit allocation on benefits
provided



Facilities
Administration
Indirect cost pools & order of allocation




Depreciation & use allowance
Interest
Operation & maintenance – physical plant
General administration & general expenses
Indirect Cost Rates
Multiple Allocation Method

Special indirect cost rates
Single rate not appropriate
 Separate applicable indirect cost
pool(s) first

Indirect Cost Rates
Direct Allocation Method

All costs considered direct except G&A




General administration & general expenses
Fund raising
Other direct functions
Joint costs allocated directly to functions
using indirect cost rates



Reasonable & consistent
Supported by current organizational data
Based on benefits received
Indirect Cost Rates
Direct Allocation Method

Indirect cost rates
Eliminate capital & unallowable costs
 Calculate rate

• Rate base = program services & fund
raising costs

G&A allocated to federal award activity
eligible for reimbursement