Cost estimation in public sector entities:a methodological proposal*
* This article is a synthesis of a paper written by the authors for the Government of Nicaragua for the Effectiveness Program for Development (PRODEV in Spanish) of the Inter-American Development Bank.
** Marcos Makón is the President of the Argentine Association of Budget and Public Financial Administration (ASAP); Raúl Calle, a Bolivian citizen, is an international advisor on budget and fiscal statistics.
The new performance management administrative model being implemented by most of Latin American countries proposes, as one of its priorities, to pass from a traditional administration model, where control and the performance of formal procedures are prioritized, to a management that privileges the production of goods and the rendering of services demanded by society, and that enables us to obtain the results that improve life quality.
This concept, quite related to the criteria of public management efficacy and effectiveness, requires, as its base for certain decision-making, true, faithful and reliable information, not only about the real and financial resources required by the State to deal with the demand of goods and services, but also about their cost. The resources are always limited, and consequently, certain methodologies and processes must be used to optimize their use and enable higher levels of efficiency in public productive processes.
This paper has the aim of introducing a proposal to improve the sustainability of the allocation processes and use of public resources, adding to the traditional criteria of analysis of public spending, elements oriented to improving its efficiency through the use of methodologies for public management cost determination. This implies supplementing and enriching the efficiency analysis in public spending provided by the per program budgeting technique, through the use of budget programmatic categories, with the concepts used in the cost systems.
Therefore, it will previously be necessary to make a clear definition and distinction of the concepts of expenditures and costs and to establish a link with the programmatic categories and cost centers, respectively. This requires the use of the concept of supply- product – a basic expression element of the public productive processes – both from the point of view of the expenditures as well as the point of view of the costs.
In the first part, this paper highlights the concepts of the basic elements which characterize budgeting per program technique, cost accounting and the cost determination systems. It is concluded that it is better to develop a cost determination system for the environment of the General Government of the public sector, which must be interrelated with the per program budgeting technique applicable to said sector. To be considered, in the case of public companies, the most suitable methodology implies the utilization of cost accounting, a basic element for fixing prices and rates, and definition of profitability policies.
Based on said conceptualization, in the second part, a simple methodological proposal is developed which enables us to allocate expenditures per programmatic categories and costs per cost centers, with the final objective of determining costs per each of the products originated in the public institutions forming the General Government.
II. Basic definitions
1. Importance of conceptual aspects
In this first part, the basic concept aspects which characterize the methodology are developed. Under this premise, definitions of costs and expenditures are introduced, the subjects related to the cost estimation systems and the classification of types of costs are summarized, a conceptual approach to cost accounting in the public sector is developed and it ends with the relations that must exist between the budgetary system and said accounting. Finally, we tackle subjects related to definitions about cost center types, programmatic categories and the relation between both.
2. Efficacy, efficiency and economy
The terms efficacy, efficiency and economy are many times wrongly used within the setting of the public sector. Therefore, it is necessary to clear up these concepts in order to determine their contribution to the methodology of cost estimation in the public sector entities.
Efficacy means the performance of the planned objective in a determined period of time. The degree of efficacy is usually measured by estimating the degree of achievement of an objective without considering the cost to perform the objective. When the objectives are quantitative, such as a growth rate, it is not so difficult to measure the efficacy. Whereas in the case of qualitative objectives, (service quality, customer service, etc.), it is necessary to try to identify these objectives with a susceptible measured variable to solve this inconvenience.
Efficiency is an indicator that relates the cost of the resources used with the objectives achieved, that is, to what extent the scheduled objective has been achieved with the minimum cost used. For example, the cost of the supplies used may be related to in terms of the time consumed to teach, the books used or any other type of material with the number of students who graduated.
Economy shows whether the costs of the supplies used in the development of a certain activity have been minimized. It refers to the rational consumption of the production factors necessary for the generation of a certain product or service.
Cost accounting is essential to measure the efficiency and the economy because in these cases the data about costs of the resources used is fundamental. Cost accounting and the cost estimation method– described below – upon producing the necessary information to measure mainly the degrees of efficiency and economy of public management, are important at the time of decision-making in the allocation of resources in the budget.
3. Costs and expenditures
The term “costs”, as an expression of value, is used to denominate how much a good or service costs or is alternatively used to measure the consumptions of production factors who serve to manufacture a good or service.
The word “cost” is a complex term used in a variety of concepts.
In the case of industrial production, costs are the expenditures directly related to the product and the expenditures are the necessary expenditures to enable the manufacturing and commercialization of the products. According to this approach, the production cost is formed by three basic elements: the raw materials, labor, and other manufacturing costs. Similarly, the expenditure is related with the commercialization expenditure, administration expenditure and the financing expenditure.
In accounting, cost is defined as the set of the consumptions necessary to perform the process of transformation of productive factors into concrete productions. On the other hand, expenditures is defined as the goods and services that a company (industrial, commercial or service) purchases and that means the achievement of a real consideration of goods or service.
According to the above definition, the costs are incorporated to the inventories of in-process products and finished products and are reflected as assets in the General Balance sheet. Afterwards, and as the finished products are sold, they are added to the state of results affecting the cost account of products sold. Expenditures, however, do not form part of the inventories and are recorded in the state of results negatively affecting the patrimony.
For example, in a furniture factory, the salary a worker is paid in the assembly section is a cost of the products made in said section and which later on will form the cost of the end product (piece of furniture) and will be accounted as inventory of the finished products (assets). Instead, the salary of an accounting assistant of the accounting department is usually considered as spending and not as a cost, because the contribution of his/her work cannot be identified with the product obtained. This spending is imputed to the State of Results and, therefore, constitutes a negative expression in the patrimony.
In the case of the non-entrepreneurial public sector, as there is no need to set up profit margins or profits for the sale of the institutional production, the concept of costs is associated to the attainment of information to support strategic decisions in the fiscal framework. In this sense, to define the concepts of costs and expenditures, from the point of view of the non-entrepreneurial public sector, the definitions to be used are “cost supply” and “budgetary supply”.
4. Cost estimation systems
A summary of the cost estimation systems most commonly used will help to interpret the cost estimation model proposed in the present methodology.
a) Costs of absorption
This cost modality separates the costs of the production process itself from those that do not constitute costs. According to this approach, in production costs, only three cost elements are incorporated: raw materials, labor and manufacturing costs. The other types of costs are left aside as they are considered as fiscal year expenditures and directly imputable to results, not to the product cost.
b) Costs per work orders
In this modality, costs are allocated and accumulated for each work and are used by considering the type of product and the organization of the production process. In general, work orders are made for products or product lots which are considerably different or in cases of production of sophisticated goods with high value that are not mass produced. Each work is tailor-made and the necessary time to carry out the manufacturing of a product unit is relatively long. Examples of this type of costs are the manufacturing of aircrafts and ships. In these cases, cost elements accumulate in the work orders, thus obtaining the unitary cost by the division between the total cost of production in the work order and the number of units of the same order.
c) Costs per processes
In the model of accumulation of costs per processes, costs are accumulated during a period of time in cost centers represented by a unit, department or production process. In general, it is used when the production occurs in a continuous and routine manner and when standardized products are mass produced to meet the uniform demands or to accumulate stock in warehouses.
The accumulation of costs is made in the accounts of each of the cost centers through which mass production passes, successively passing to those of the next center with the purpose of accumulating in the last center, the total costs of a series or periods and divide them by the number of units produced – as far as that cutting point – to obtain the unitary cost. Examples of this system are the production of cars, as well as steel and its derivatives.
d) Complete cost
In the complete cost model the products absorb all the costs related to the manufacturing in each phase of the production process. In this case, direct cost, whether it is variable or marginal, incorporates the three cost elements (raw materials, labor and manufacturing direct costs) plus the expenditures considered as administration, commercialization and even financing expenditures. Then, the entire amount of these costs is classified in variable and fixed.
e) ABC Costs
This method establishes costs based on activities which are used to measure costs and performance of an institution. The ABC cost method is based on the activities that are developed to produce a certain product or service where all the fixed and direct costs are dealt with as if they were variables and does not perform distributions based on the production volumes, percentage of costing and another distribution criterion.
f) Historical costs
They are determined once the production process is fulfilled or the cost period has ended.
g) Standard costs
The increasingly competitive nature of the markets obliges companies to know the costs beforehand in order to schedule the production and obtain advantages in the market. This system is fundamentally designed for control purposes and is very useful when working with budgets because it enables the cost projection and its later control against actual performance.
5. Basic classification of costs
a) Costs by nature
Classification of costs according to their nature is called in the cost estimation methodology for public sector entities as “objects of cost” and they refer to those goods and services consumed by the institution and grouped in significant categories according to their nature. The level of disaggregation depends on the information required by its users. Regarding this methodology, the disaggregation must be shown in such a level which enables the allocation of said costs to cost centers and to programmatic categories, being able to group those elements of the same nature for which the same distribution criteria are going to be used. Cost classification by their nature is carried out from the budgetary classifier of the object of spending, whose account structure already has a spending group according to their nature.
b) Direct and indirect costs
The costs of the products used in the production process developed by the institutions and which are originally classified according to their nature (staff costs, service costs, material costs, etc.), can also be classified as direct costs and indirect costs, the objective of the cost being the reference point on which said classification is based, depending on the level of existing relation between said costs and the cost objective proposed.
In this regard, cost objective must be understood as everything for which a measurement of its cost is required; for example, a product, a cost center or any other dimension for which costs need to be measured.
When the objective of the cost is an end product, the costs will be direct as far as they can be allocated in a concrete manner to said product. But indirect costs will be those which, in spite of contributing to the formation of the product, cannot be allocated in a direct manner to these products. For example, for the hospital care service product, costs will be direct for the surgeons’ salaries, whereas the expenditures for electricity, water, maintenance, etc., will be indirect costs as they cannot be imputed directly to the cost of the hospital care service product because they require a distribution criterion.
Consequently, direct costs are consumptions that may be unmistakably measured and allocated to a certain product and the indirect costs are those which are consumed affecting a group of products or activities, and thus a direct measurement of the quantity consumed by each unit of the product is not feasible. Thus, it is necessary to use previously defined distribution criteria for the imputation to the product.
In this regard, it is necessary to make a comment about indirect costs relative to the product of those general indirect costs. The first ones are costs of indirect nature related to the production process, such as, electricity, water, maintenance, etc. On the other hand, the general indirect costs refer to the cost of the functional areas of higher management, accounting, human resources, treasury, warehouses, etc. The inclusion of these general indirect costs in the estimation of the costs of the end product will depend on the cost system used.
In other words, direct costs may be allocated to a determined product or cost center, whereas indirect costs do not possess that characteristic, and therefore, it becomes necessary to apply some distribution criteria for their imputation to the product or to the cost center.
6. Costs in the public sector
The public sector encompasses all the institutions that are responsible for the provision of public goods and services and income redistribution, as well as the public companies that belong or are controlled by the government and which perform a production function.
The general government sector is formed by the central government and the decentralized institutions, as well as by the local or regional governments. The central government applies taxes on the resident and non-resident institutional units and dedicates said resources to services of a collective nature. It also incurs, amongst others, expenditures for education, health and social assistance, security, defense, foreign relations, justice and makes transfers to fund activities in other public entities, as well as in the private sector. Decentralized institutions provide different services of non-entrepreneurial character funded with its own resources and funding granted by the central government.
Beyond the general government are the public companies which develop production or commercial businesses under conditions that may be very similar to those of the private companies. The spending of these companies matches the purchase of production supplies, whereas their incomes are the product of their sales. In order to get funding, public companies must sell their products and cover their costs so that they obtain the maximum profitability possible.
Once the public sector setting is delimited, we can distinguish between institutions whose income is generated through the sale of goods or services, from those in which their income is provided directly or indirectly from compulsory taxes.
The institutions of the first case will have an activity similar to that of the private sector, obtaining margins or results from an economic-financial perspective with criteria utilized by private companies. In these cases, cost determination has an essential role as it provides all the information necessary to establish prices from the estimated costs and other decisions of tactical and strategic nature in order to achieve better results in the market.
On the other hand, the institutions funded mainly by taxes and whose activity consists of providing indivisible goods or services or which is of collective use, cost information must provide information, mainly to schedule and evaluate the result of management.
In the case of institutions that form part of the non-entrepreneurial public sector, fees or public prices are often charged for service provision, so that the information about the cost of the services is very useful to establish the amount of those fees or public prices, although this doesn’t mean that said information forces the institution to have to totally recover all the costs incurred in the production of said services. In this case, cost information will enable a better determination of the amounts per transfers with which the central government usually supports.
But the central benefit derived from the information supplied about costs is to count on elements to measure the efficiency in programming and executing public production processes and supplementing the analysis that are performed to evaluate budgetary execution. The information about the costs incurred enables us to determine the deviations with relation to the costs scheduled in the budgetary programs. Also, comparisons can be made between similar service costs provided by other public institutions and even by the private sector. Specific examples of this are the cases of education and health.
In any case, the information of costs is supplementary information to which patrimonial accounting contributes through the traditional financial statements and is addressed to support the rational process of decision-making in a management where the resources are normally scarce and it is necessary to control the levels of efficacy, efficiency and economy.
The methodological proposal refers, as already pointed out, to the activities developed by the Central Government and non-entrepreneurial public institutions with their peculiar characteristics of organization and financing. With relation to the object of analysis, it refers to the costs of budgetary programs expressed in the institutional budgets.
The proposal for cost estimation in the public sector entities is necessarily conceptually supported on cost management techniques developed in the private sector.
7. Public accounting and cost accounting
Public accounting, as a branch of general accounting, is the determination of accounting standards, principles and techniques used for the elaboration and supply of economic-financial information of public institutions.
Public accounting has the purpose of reflecting all kinds of operations and results of the activities carried out by public institutions. Thus, it is defined as an information system about the economic-financial facts developed by the institutions and that is formed by systems related to patrimonial accounting and cost accounting.
In this sense, public cost accounting is defined by the sub system which provides information about the process of cost formation in the production of public goods and services and supplies information for management analysis and control, with indicators of the efficiency with which the available resources have been used.
From the point of view of the information systems, cost accounting may be integrated to the public accounting system by three ways:
•Single data input and differentiated treatment according to the accounting sub system considering them.
•Obtaining data previously processed by the other accounting sub systems for their later treatment in the cost accounting.
•Design of differentiated sources for obtaining data.
In order to reach the maximum operation in the information system, it is preferable that there is a single data input for the different accounting sub systems. With the appropriate treatment for each of them, and regardless of obtaining a sufficient degree of coherence, we can establish the timely conciliation of the resulting information processes and thus obtain an important effect of crossed-referenced control.
8. Cost accounting and cost estimation
With the purpose of delimiting the field of cost accounting, it is necessary to make a difference between cost estimation and cost accounting.
Cost estimation is a useful function in almost all the industrial or social activity practiced at an informational level mainly with the purpose of comparability, as well as to know its composition or to achieve further efficiency in resource allocation.
On the other hand, cost accounting implies the methodical record of the costs and report issue and, therefore, requires a systematic order to achieve data collection, measurement, record, and processing and report issue. A cost accounting system always has implicit multiple estimation formulas.
In this document, we develop a methodological proposal referring to cost estimation as an instrument which potentiates the possibilities of a better budgetary analysis and, therefore, improves the criteria for resource allocation in the public budget for the organizations forming part of the general government.1 In the document, general theoretical conceptual approaches of cost accounting are taken as reference to derivate the methodological proposal later.
Although cost accounting is oriented to the determination of profitability margins in the private sector, its use does not lose value in the public setting where it is necessary to increase rationality in decision-making and responsible management of public resources. This type of accounting is essential in the case of the public financial and non-financial companies.
9. Cost center
The cost centers may be defined as the “places” where costs are used or consumed (staff, materials, services, etc.) necessary for the development of the production process carried out in an institution.
The categories included in the present rating of cost centers are structured from the conceptual setting of the budgeting by programs technique and are defined with enough amplitude so that they can apply them to multiple institutions.
10. Types of cost centers
a) Main cost centers.
These centers are the ones that exclusively perform activities oriented to the production of intermediate, direct and end goods and services.2
Thus, for example, in the case of health, the group of consulting rooms for outpatient medical assistance or the hospitals for hospital care constitute main cost centers. In the case of education, the rooms for primary school, and in the case of the tax administration, the regional revenue offices are main centers.
b) Auxiliary cost centers.
Auxiliary cost centers represent units that give support to the main centers which are not involved directly with the end production. Therefore, they are characterized for having an indirect intermediate production and may be classified in regular cost centers and central cost centers.
The regular cost centers or those cost centers that give support to more than one main cost center but not to all, have indirect intermediate production and include the centers which perform a support activity and which, without affecting in an immediate manner the costs of the main centers, are essential for the latter’s development of the production process; that is, their conditioning relations with those of the cost centers are indirect.
For example, in the health sector, laboratories and x-ray centers are auxiliary cost centers. In the agricultural sector, research laboratories about agricultural technology may also be auxiliary cost centers and in the education sector, libraries and information technology laboratories are auxiliary cost centers.
Central cost centers are configured as those centers that impute their cost to activities that generally condition the production, both of the main cost centers and that of those centers which have support production, that is, perform direction and administration activities in general terms.
For example, accounting, treasury, budgeting, warehouses and purchase offices, information technology centers and the communication and access to information offices constitute central cost centers.
In this case, the costs of these centers are not distributable among the main cost centers and form part of the general expenditures of the institution.3
The use of cost centers constitute a supplementary mechanism to the one of the expenditures allocated to the programmatic categories, providing important information supplies for a more accurate estimation of end production cost.
For example, for some types of cost, there may be immediate chances of identification of costs in relation to a physical room (office, laboratory, sports center, cultural center, building, etc.) than to a programmatic category. In those cases, the use of cost centers facilitates the imputation of the cost objects to a physical site and its later allocation to budgetary categories.
11. The budget and cost estimation
The budget is a basic instrument of short and medium term planning. In the case of the public sector, it is also the legal and financial framework to which all public institutions must adapt.
Among the techniques that have been implemented in the public sector to achieve a more rational allocation of public resources, there is the budgeting by program technique, which has the central objective of reflecting public production processes and therefore, enabling that the allocation of resources is done based on programmable production.
In the context of performance-oriented management, the budgeting by program technique demands an important volume of information. The financial information provided by the traditional accounting systems is not enough and therefore the information facilitated by cost estimation is extremely useful.
In this context, cost estimation gives or provides information which contributes to a rational adoption of decisions in the management of public resources and helps in planning, budgeting and control.
12. Concept and types of programmatic categories4
A basic requirement for the design and instrumentation of cost estimation is to have a budgetary programmatic structure which reflects expenditures-products relations allocated to executing units since the definition of this type of relations is a prior requirement for the determination of costs per products.
The basic criterion that orients the use of the budgeting by program technique is that it should express throughout all the stages of the budgetary system, the public production processes and therefore, the corresponding relations between public production and the expenditures it implies.
From there, the basic concept of budgetary action is derived, as a special type, aggregated or combined of supply-product relation that has the following characteristics:
•Its productions are end or intermediate goods or services
•It requires actual and financial resources allocated to said production
•It has one or several executing units responsible for combining the actual resources with the purpose of producing the respective goods or services
From the aforementioned, it is inferred that budgetary action is a unit of resource programming and, therefore, it constitutes a programmatic category of the budget that has a responsible executing unit; in the case there is more than one executing unit involved in the production, it should have a coordinating unit.
The end or intermediate nature of a product is determined by the setting which encompasses the budget and the role that each budgetary action plays in the production technology. Thus, they are end goods or services for an institution and they justify their existence and constitute end nodes of the production network in that setting. Therefore, a product is the end of a production network when it does not suffer any other transformation process in the institution originating it and it directly conditions a policy, and sometimes, another end product of the same institution. Intermediate goods and services are all those which are needed to make end products and, consequently, constitute intermediate nodes of the production network made by an institution.
The programmatic categories used according to the type of product they originate are as follows:
13. Cost supply and budgetary supply
a) Cost supply5
The concept of cost supply refers, as already pointed out, to the use of resources required by the production of the budget period, either in actual or financial terms. Therefore, cost supply is formed by a set of goods and services consumed in the production process.
Thus, for example, the depreciation of the computing equipment for children’s teaching is a cost imputable to production as it expresses the use of the computer in a production process. That loss of value of the equipment is the part that transforms into a supply cost, in this case due to the use of the equipment during the budgetary fiscal year.
Another aspect related to the concept of cost supply refers to the purchase and use of materials. In this case, the concept of cost supply refers to the total or partial use of said material in the production and not to the amount required for the purchase of materials.
Therefore, the definition of cost in the budgetary setting is the necessary consumptions (supply-cost) that are incorporated to the production process of public institutions and that should be expressed through a measurement and value.
b) Budgetary supply6
The concept of budgetary supply refers to the financial appreciation of the goods and services necessary in a budgetary fiscal year to provide the public institutions with the necessary production capability for supplying public goods and services. According to this definition, the budgetary supplies are human resources, services, materials and equipment required to obtain a certain product and that don’t necessarily mean the cost of said product.
Consequently, the expenditures, from the budgetary point of view, come from obligations legally necessary for the supply of a good or service, or those in which, by virtue of an agreement, the institution commits to performing an activity without expecting a monetary compensation.
From the above mentioned, it is concluded that not all expenditures are costs, nor are all costs, expenditures. Therefore, it is necessary to reclassify expenditures making a distinction between those that are incorporated to cost estimation from those that, in view of their own nature, don’t form part of said estimation. For example, the value of the chattel and real estate purchases (budgetary supply) is not incorporated, but, instead, their depreciation which is a cost supply is incorporated. The transfers granted to fund expenditures of public institutions, the debt interests originated in disbursements for budgetary support and the expenditures corresponding to prior fiscal years do not form part of the costs of a public institution either.
14. Spending allocation to programmatic categories
Based on the definitions indicated in the two items above, it can be concluded that the allocation of expenditures to the budget programmatic categories is subject to the following basic rules:
a)The expenditures are allocated to executing units responsible for programmatic categories
b)The programming of the expenditures and the record of their execution is made under the concept of budgetary supply.
c)The record of the expenditure accrued in each programmatic category is the “bridge” which enables to relate the expenditures with the costs.
d)The expenditures allocated to the central and regular activities (whose productions are indirect intermediate) are indirect expenditures to the end production and, therefore, they are budgetary distributable because they are expenditures allocated to existing executing units.
e)When a supply is used in more than one programmatic category, the spending is imputed to the programmatic category where its highest volume is recorded. For example, an agricultural technician in a region supplies services in research and technical assistance to rural habitants.
f)When a supply is used exclusively in a programmatic category, it cannot be allocated to a central or regular activity; for example, the purchase of medicine for hospitals.
On the other hand, it is worthwhile mentioning that the expenditure-product relations within a programmatic category may present the following variants which create different ways to determine costs:
a)Originates a single product and all the supplies are assigned to it. In this case, the spending per product unit directly comes from the budgetary allocation.
b)Originates a single product and does not contain the entire quantity of supplies required by said product. It is the case where there are human resources that work for several programmatic categories and/or the purchases and services are allocated to other programmatic categories.
c)Originates more than one product and all the supplies are allocated to the corresponding programmatic category.
d)Originates more than one product and does not contain all the supplies required by said product. It is the case where there are human resources working for several programmatic categories and/or the expenditures in goods and services are centralized in other programmatic categories.
For the determination of expenditures per products and consequent determination of costs per products in cases b), c) and d), it is necessary to apply the cost distribution criteria mentioned in item 6 of the second part of this paper.
15. Relations between cost centers and programmatic categories
As a final synthesis of this first part, it is worthwhile highlighting that the relations between cost centers and programmatic categories may present the following situations:
•A cost center matches a programmatic category
•A cost center matches more than one programmatic category
•A programmatic category may contain more than one cost center
The identification of cost centers offers important possibilities of analysis in relation to the cost of the end production of the institutional budgets, specifically in the case when there are two products in a same programmatic category or when the provision of a public service is performed by means of a network of organizational units spread across a certain territory. For example, health services usually are provided in outpatient consulting centers and hospitals distributed at local and national level; the same happens with the education services whose production processes are developed in multiple educational units spread all over the territory. Something similar happens with research services in agricultural technologies.
Consequently, the “cost centers” associated to the programmatic categories facilitate the cost estimation of the latter from the information coming from the corresponding centers.
Likewise, to know the cost of a center may, in some cases, be more relevant than the own estimation of the production costs in said center. It is basically about the cases in which the end production of the institution or certain programs of an institution is not quantifiable. Thus, for example, the determination of the cost estimation of a criminal court, of an embassy of a country abroad, of a commission of the legislative power may be very useful for the allocation and evaluation of the resources they are assigned.
III. Methodological setting
1. Importance of methodology
As pointed out above, the cost objective estimation in non-entrepreneurial public institutions is to provide useful information to the different users for decision-making in order to improve the efficiency of public management. The various users are, first of all, the public institutions themselves which carry out the production processes; secondly, the authorities in charge of the regulation and supervision of budgetary processes and administrative management and thirdly, senior government authorities. On the other hand, it enables that the people, the final receptor of public production, know the cost of said production and the measures that have been taken to decrease these costs without affecting the quality of goods and services production.
In summary, the methodology for cost estimation of public management:
•Provides solid judgment elements for the negotiations of the institutional budgets with the ruling organization of the budgetary system during the budgeting.
•Counts on information about the evolution of the production costs of goods and services, and therefore, of the levels of improvement or deterioration in the efficiency of the management of public institutions, in order to adopt the corresponding measures.
•Supplements and enriches the analysis performed on the physical-financial execution of the budget through the measurement of the evolution of the costs incurred for the production of goods or provision of services.
•Improves and extends the control of public management by the ruling organizations of the budgetary system and external control.
2. Main characteristics
The methodology for cost estimation is considered as a process in which the transformation of data inputs is carried out to obtain information outputs in order to determine the cost of public production of goods and services.
For the methodology to be operative, it requires information of the financial execution of expenditure budget and the human resource systems, purchases and hiring, inventories and property administration.
The methodology proposed poses, as a fundamental principle, the obtaining of costs identifying the “cost centers” and their relation to the programmatic categories used in the budgeting process. Therefore, it supplements and enriches the criteria to analyze expenditure allocation to the programmatic categories performed at the time of budgeting.
The methodology has the following basic features:
Adaptability. Understanding this concept as the possibility of its application to the highest number of institutions of the non-entrepreneurial public sector.
Flexibility. The methodology must be flexible enough so that, while respecting the characteristics of the production processes of public institutions, it may be applied to any public institution and may generate information for the different users and in different time spaces.
The practical application of the methodology requires the elaboration of tables of equivalence where the correspondence between the objects of expenditures and the costs is shown as well as between the cost centers and the programmatic categories.
3. Basic principles
There are some principles of cost determination that must be taken as reference when the procedures for estimation are established.
First of all, no costs should be charged before they have occurred. For example, the cost of office materials is determined once there is information about the use of said materials in the generation of the end or intermediate product and not with the information of the budget financial execution.
Second, consumptions must be true although their quantity is not perfectly determined. Thus, for example, when costs are calculated in periods of accounting closure, it must be considered as costs those that, although not having been invoiced, consumption has taken place, has been true, although its quantity will be approximate for not having received the document certifying the exact amount.
Third, the cost must refer to the period of estimation. If, for example, a cost has been charged in a certain period for 10 pesos and when the corresponding invoice is received, the amount is 15, the shortfall of 5 which was not considered in the original estimation shall not be included in the costs of the following period either.
4. Information systems required
The basic input information originates in the record of budget financial execution of expenditures. However, this information in itself is not sufficient to carry out a suitable process of cost estimation. This insufficiency usually derives from the level of aggregation with which the budget execution is recorded.
The methodology proposed starts from the assumption that in every organization there are a series of administrative systems, such as staff management, purchase management, and hiring, management of fixed assets and warehouse management that produce useful information for cost estimation.
The information that is considered useful for a practical application of the methodology and that must be obtained from the management systems are as follows:
The spending financial execution system must provide information about the spending accrued originated by the purchase of goods and services so that it facilitates the identification of expenditures at the cost centers and programmatic categories level.
As mentioned above, the information coming from this system is not enough; therefore, it will be necessary to have further information addressed, mainly, to the establishment of the relations between the categories of the methodology (objects of cost, cost centers, programmatic categories). For example, further information about cost centers shall refer to surface, number of telephone lines, electricity points, center installed power, etc. This information enables, when there is no direct correspondence between cost and center line, to derive a relation between consumptions and the centers where they are consumed and between the latter and programmatic categories.
The staff management system must supply the information referring to staff costs and the effective work times of the persons to the different cost centers and programmatic categories with the followings characteristics: i) allow individual follow up of the staff and ii) determine the staff cost in relation to the centers and programmatic categories.
The purchase and hiring system must provide information about the purchase administrative processes starting with the request of purchases and hiring of goods, works and services, continue with the selection and award and end with the reception in compliance with the material resources required by cost centers and programmatic categories.
The fixed assets management system must provide the data referring to depreciation cost per center and programmatic category.
The warehouse management system provides data related to the consumption by the cost centers and the programmatic categories about the different uses of goods which are considered storable and that were incorporated to the production process.
Additionally, it is advisable to count on contract data in order to receive information about the following types of contracts: i) rent contracts, insurances and other services with a fixed amount, but that have a periodical expiration date, generally monthly, ii) contracts for services of electricity, water, gas, telephone, etc., with a variable amount and that have a periodical expiration date, generally monthly; and iii) contracts for the supply of fuel, stationery, magazines, etc., that do not have a periodical expiration date and whose amounts may be fixed or variable.
5. Sources for the determination of costs
The methodology has been constructed from the application of the principle of “universality”, which is to say, it includes all the costs which are consumed by the centers and by the programmatic categories, regardless of their origin. In this sense, we state below the possible sources for cost determination.
Costs whose origin is the financial execution of the expenditure budget of the institution. The source of information for this case is the records of the financial execution of the expenditure budget of the institution itself. Thus, for example, data about the expenditures of staff, materials and supplies, basic services, equipment, etc. are included.
Costs whose origin is the financial execution of the expenditure budget of other institutions. This title comprises the costs derived from the application of the expenditures which originate or come from the records of the budget financial execution of other institutions, but which are destined to perform activities in the institution that is carrying out cost estimation. For example, staff assigned to an institution whose funding is covered by the budget of another institution.
Costs that result from internal estimation processes in the institution. In this item, there are the costs that do not result from a spending originated in a relation with third parties, but that are a manifestation of costs that should be calculated internally in the institution. For example, depreciation costs.
Regardless the origin of the costs, it is necessary to define which type of expenditures will be part of the methodology for cost determination and which ones should remain apart. This discrimination in the treatment of the information referring to the expenditures gives way to the terms “incorporable expenditures” and “non-incorporable expenditures”.
The “non-incorporable expenditures” are the following cases:
•Expenditures of other fiscal years and that are not included in the methodology as they constitute variables which do not correspond to the period subject to estimation.
•Expenditures that are imputed to the financial execution of the institution’s budget and whose cost corresponds to another institution.
•Expenditures for the purchase of fixed assets. In this case, the cost is expressed through the estimation of the depreciation of said fixed assets.
•Expenditures of materials that have admission in warehouses and that are not directly consumed by one or several cost centers and programmatic categories. These materials will be considered costs at the time they have left the warehouse in order to be consumed.
Opposite to the above mentioned definition, “incorporable expenditures” are those originating in the budget financial execution (of the institution itself or from another institution) or corresponding to an internal estimation that can be attributed as a direct or indirect cost to a center or programmatic category of an institution where cost estimation is being developed.
6. General distribution criterion of indirect costs
Direct costs of a production are allocated to the latter, whereas the indirect costs should pass through a series of stages called indirect cost distribution process.
The indirect costs are the consumptions made in cost centers and programmatic categories which do not have, in an immediate manner, a way for discriminating their amount in relation to the centers and programmatic categories which initiate end production. Distribution methods of those amounts are needed to relate the global amounts in disaggregated or individualized amounts.
Once the indirect costs incurred in a certain period are included and once the structure of cost centers is known (main centers and auxiliary centers), the next step is to proceed with the distribution of indirect costs based on certain distribution criteria. This occurs when one same cost item may affect several centers. For example, office rent, insurance premium, electricity and water services, etc., are costs that may affect several cost centers and programmatic categories. The distribution of said costs is made by means of distribution criteria through which it is allocated to each center and programmatic category, the part from the cost that corresponds to it.
The distribution criteria are instruments used to distribute the object of cost among the cost centers. The institutions should have minimum information, both technical and accounting, with the purpose of establishing the distribution criteria. Thus, for example, it will be necessary to have information about the staff distribution per cost centers, the land and building size, occupation of each office in the building, the location of the computing technology per office, etc.
The distribution criteria are related, therefore, with surface areas, time of staff dedication, installed power, number of telephone connection points, etc. In any event, the criterion that best measures the cost behavior must be chosen.
These criteria must be understood as an orientation of institutional production processes and their organization will be the characteristics of the determining factors to choose in each case, one or the other criterion, within the subjectivity which any distribution implies.
These problems appear in both the formulation and financial execution of the budget, being precisely the need to generate information for a more detailed analysis of costs that produces the disaggregation problem of indirect costs.
At the time of defining the distribution criteria, at least the following aspects should be taken into account:
•The objective of the methodology is the achievement of total costs per cost centers and programmatic categories and, consequently, the determination of the costs of end production; therefore, the definition of distribution criteria should be aligned with said purpose.
•The choice of a distribution criterion must be according to the reasonable balance between the cost and the benefit it provides. This means that it will always be possible to identify the criteria that meet the theoretical requirements, but if its practical application ends up being complex and not very useful, it is preferable to choose simple criteria and avoid multiple distribution criteria.
•Practical experience indicates that public institutions are characterized for an intensive use of human resources (staff cost); consequently, an important part of the costs would be distributed according to this characteristic. On the other hand, staff costs are characterized for a relation with costs, such as office material, communications, supplies, etc. and, therefore, it is obvious to suppose that where more people are working, more supplies on average must be used, which in a way, justifies the fact of preferably using the criterion to calculate staff costs. For the latter, it is useful to determine of indicators that define the operation spending per occupied person.
In summary, even though it is not the only one, the distribution criterion “time of dedication of persons to cost centers or programmatic categories” is the most representative in the public institutions that are intensive in labor, such as those integrating the General Government. Consequently, an important dimension of indirect costs may be identified with the effective work time of the persons to centers or programmatic categories.
On the other hand, it is necessary to distribute the center costs of the auxiliary cost centers among the main centers. In this case, the mechanism of distribution consists of estimating or obtaining the costs of the auxiliary centers and later, imputing indirectly to the reception centers which, in this case, are the main centers according to the criteria above mentioned. The mechanism with relation to the programmatic categories that assign their costs to other programmatic categories is similar to that mentioned in the prior case, with the following characteristics. The expenditures of the regular activities must be distributed among the programs which they condition, whereas in the case of central activities, the expenditures themselves of the executing units are not distributed. Only the expenditures allocated to these last activities which correspond to all the institution, such as basic services, centralized purchases, etc., are distributed.
As an example, some particular bases for distribution that the accounting theory has been using may also be mentioned:
•Number of telephone lines
•Number of users
•Number of computers
•Effective time of work per person
7. Criterion to estimate the staff cost
Staff costs are those which reflect the relation of the institution with the persons; therefore, they include the costs derived from a labor relation or which are a consequence of that relation (social security or compensations).
The staff management system must supply all the data related to payrolls where it is included the spending in salaries and other staff expenditures derived from a labor relation in a wide sense, that is, including hired staff, fixed staff, substitute staff, etc.
In addition, it will be necessary that the financial execution information system of the expenditures budget provides related data, for example, to the expenditures in training courses, expenditures in staff transport, expenditures for clothes provision, items that usually form part of the staff cost, but are not included in the staff expenditure allowances or in the payroll process systems.
With relation to the information coming from the staff management system, the following considerations should be made. At the closure of the period subject to estimation, the information about staff costs should include the remunerations that are owed to the staff at the moment of ending said period. Although the criterion of record of the expenditures in financial execution of the budget is the one accrued, in general there are delays of administrative nature which prevent us from knowing the actual datum on the month the staff spending is accrued. On the other hand, reimbursements should be eliminated, that is, the amount paid to the staff for mistakes in the payroll process and which having to be reimbursed, were not made at the moment the information about staff costs is processed.
Data requirements about staff for the operation of the methodology introduced should refer to the following aspects: a) assignment of persons per cost center, b) assignment of persons per programmatic category, c) determination of the cost per cost center; and d) determination of the staff cost per programmatic category.
a) Assignation of persons per cost center
To estimate the staff cost per cost center, the persons must be associated or assigned to one or several cost centers. For example, if an institution defines the budget office as a cost center, the staff management system must provide information about the persons assigned to said center.
Further information should be obtained about the persons who move to another cost center, as well as variations caused by discharges and incorporations.
When a person in a period of time has been enrolled in more than one cost center, it is necessary to define the cost assigned to each cost center.
When people are hired or laid off, those changes implying a variation in the time effectively worked by one person in relation to another who has had continuous work will be controlled.
With this purpose, we propose using an index that makes the person-time relation homogeneous. This index is called Effective Work Time and is calculated from the relation between the numbers of days worked by one person in a cost center by the total number of days of a period. This index will be used to assign persons to the cost centers according to the time and to obtain the total effective work time for each cost center.
If a person has worked in a single center, Effective Work Time will be the same for the center and, consequently, its cost will be related to said center. On the contrary, if he/she has been assigned to more than one center, the cost of each of them would be subdivided between them in proportion to the Effective Work Time in each center. In this case, the total Effective Work Time per person per cost center is the reference information useful for the distribution of the staff cost per programmatic category, as discussed in the next item.
b) Assignation of persons per programmatic category
Just like the cost centers, people must be allocated to programmatic categories from the point of view of costs. In this case, the person-programmatic category relation must be understood as the work time the person dedicates for the performance of a product, either intermediate or end. Thus, for example, it is customary in the universities that the university deans dedicate some time for the direction of the university and other time to university teaching. The same happens with hospital directors and outpatient consultation medical centers where time is shared between direction tasks and medical consultation.
The procedure used for the estimation of effective work time of a person in a programmatic category is the following:
•Obtain the time that each person dedicates to each programmatic category. To obtain this information, each institution should apply the criteria that have been defined, such as, number of class hours per subject; number of hours worked, parts of work, estimated dedication, etc. This time of dedication of persons per programmatic category will be expressed by means of a percentage to each programmatic category.
•Calculate the index of Effective Work Time per programmatic category by means of the application of the parameter of effective work time per person estimated in the stage of allocation of persons to the cost centers to the values of dedication of persons to the programmatic categories. The estimation procedure consists of multiplying the total value of effective time per person by the time of dedication to the programmatic categories per person divided by 100.
c) Determining the staff cost per cost center
The determination of the staff cost of a cost center will be the sum of remunerations of each person assigned to that center plus the part corresponding to the staff costs which is not possible to relate to a concrete person (training, transport, clothes, etc.) and that must be distributed, preferably, in relation to the effective work time per cost center. In the event one person has been recorded in several centers, the cost will be imputed in proportion to the parameter of effective work time per center.
d) Determining the staff cost per programmatic category
The cost of staff per programmatic category will be the sum of the cost of dedication of each person to his/her programmatic category, adjusted in relation to the index of effective time of work per cost center, plus the part corresponding to the staff costs which are not possible to relate to a concrete person (training, transport, clothing, etc.) and that should be distributed in relation to the effective time of work per person.
From the point of view of the allocation and record of the budgetary execution, if the staff works in more than one programmatic category, the expenditure in staff must be allocated to the programmatic category where the person dedicates most of their time.
Allocation and information of staff cost execution per programmatic category is extra budgetary.
8. Criterion to distribute the spending of goods and services and non-storable services
For the estimation of the costs of purchase of non-storable goods and services, the basic information must be the record system of the financial execution of the expenditure budget.
Said system provides the information of the goods and services purchased which will be used in cost estimation at the cost centers and programmatic categories level. For that, it is based on the record of the expenditures accrued, produced by the same.
Further information required by cost centers, shall refer, for instance, to surface, number of telephone lines, electricity points, installed power, etc. This information enables, when there is no direct correspondence between cost and center line, to derivate a relation between consumptions and the centers where they are consumed and between the latter and the programmatic categories.
The information quoted enables to identify the different types of distribution which are formed upon combining the cost centers, the programmatic categories, the direct costs and indirect costs. Among the possible combinations, the following cases may appear:
•Direct costs to centers and programmatic categories
•Direct costs to center and indirect to programmatic categories
•Indirect costs to centers and direct to programmatic categories
•Indirect costs to centers and to programmatic categories
A fundamental aspect in cost treatment consists of the possibility of working with the data from the invoices and contracts to adequate them to the distribution requirements. In the case of the invoices, it is necessary to disaggregate this information in more detailed concepts. For example, several expenditures could be included in the same invoice, and each of them may correspond to different centers and programmatic categories.
On the other hand, there is a series of budgetary practices such as cash advance payments (rotary funds and small cash) that may delay the identification of the spending in the execution system due to the fact that the spending acknowledgement and its record is subject to accountability after the delivery of funds. In the cases in which the accountabilities are incorporated timely to the spending execution system, it will be identical to the cases in which the expenditures are justified with invoices or contracts.
9. Criterion to estimate the cost of warehouses
In this section, the aspects related to the determination of the costs of materials and products stored are described. With this purpose, the following points are made:
•When a storable product is purchased to be incorporated to the cost of the product, this is not immediate or simultaneous, but done at the time of use or consumption of said product in the production process.
•The determination of the storable category of a product must be determined by the general accounting standards.
•The information about the movements of storable products in warehouses must be provided by the inventory system.
Consequently, to determine the cost of products related to the use of products and materials stored, it is necessary to have information about the following aspects: i) consumed goods and ii) recipients, that is, the cost center and the programmatic category.
The information about consumptions shall be provided by the warehouse management system. The choice of the type of distribution to which consumption belongs is based on the fact that the person responsible for the warehouse management systems must know the recipients of those consumptions well enough, which enables us to know for sure their consumption at the cost center and programmatic category levels.
In the case of general warehouses for the institution, budgetary loans will be allocated to the programmatic category responsible for their administration. In case there are also specific warehouses for cost centers and programmatic categories, budgetary loans will be allocated to each of them.
Cost allocation for the consumption of this type of goods to each cost center and programmatic category shall be made by using the FIFO or LIFO methods or any other deemed suitable and its support will be the warehouse exit document used.
10. Criterion to estimate the cost per depreciation
In reference to obtaining costs per depreciation, the existence of a fixed asset system is essential, in order to provide data for the cost estimation.
The fixed assets management system will provide data about the depreciation according to the specifications of physical distribution of said assets and their use in cost centers and programmatic categories.
This distribution is possible as far as the fixed asset system knows the adscription of said goods to cost centers and programmatic categories as the adjustments that must be given for the variations produced during the assets’ life.
The depreciation of goods starts from the moment the goods starts to be in service in the institution or when this datum is not known, from the time it is registered in the institution.
Therefore, the goods that are object to depreciation, not being object to a leasing agreement, are considered as part of the fixed assets of an institution and consequently, are destined to the performance of the activities of that institution.
The systems of fixed assets management generally provide detailed information about the incorporation, transfer and discharge of the real estate, as well as data relative to the depreciation of the goods located per cost centers. However, in the case of depreciation of the buildings, it is necessary to adopt distribution criteria of their cost in general related to the surface of the offices.
11. Criterion to estimate other costs (execution of spending in other institutions)
In budgetary practice, it is relatively usual to find situations in which the expenditures are scheduled and imputed in a certain institution and the consumption should be charged to the production processes of other institutions.
On the other hand, within one institution, it is observed with a certain degree of regularity, cases in which the expenditures are imputed to a certain department and the consumption corresponds to another department or departments.
In the first case, a typical example is of the officers assigned to other institutions where the salary is imputed in one institution and the officer works in another institution.
In the second case, there are the expenditures for water, electricity and other services which budgetary credits are centralized in the cost center of the Administration Direction and in the Central Activities programmatic category.
In both cases, the expenditures allocated to the respective institution or department must be distributed and allocated as costs of the institutions or departments where they are effectively used, applying some of the criteria provided in this chapter.
For all these casuistries, the aspects that will define which applications of expenditures will and won’t be considered as costs coming from other institutions and departments are the institutions’ setting and their assigned competences.
In the public value chain, solid conceptual aspects have been developed about the connection of public production with the results and impacts obtained from it, in order to obtain improvements in meeting the population’s needs. This has led to the development of the budget based on results and the consequent use of performance indicators. But it is not less true that for the entire instrumentation of a management oriented to results, it is also necessary to have suitable methodologies that enable us to express the supply-product relation present in institutions and value them in terms of expenditures as well as costs.
Conceptual and methodological statements shown in this document have the aim of contributing to the improvement of allocation decision processes and use of public resources which require the goods and services produced, combining the use of the per program budgeting technique with the cost estimation techniques, through the relation of the expenditures allocated to programmatic categories with the costs incurred in the cost centers.
The introduction of cost estimation techniques, necessary to measure efficiency of the production processes, not only oblige us to reanalyze the use of the per program budgeting technique, but it also validates said technique as a skilled tool to express the production processes carried out by public institutions, both in terms of supply-product relations and relation among products.
The methodological proposal presented here refers to the utilization of a cost estimation system to be applied to the non-entrepreneurial public sector or general government and consequently the methodical record and report issue required for the instrumentation of cost accounting is not so strict. The objective is to obtain suitable information to improve the efficiency of public management, establishing the main principles of cost accounting as a reference setting.
Finally, it is worthwhile mentioning that the implementation of this proposal must necessarily rely on solid economic-financial information systems produced by accounting systems, supplemented by those produced by the real resource administration systems (human, material and infrastructure), all in the framework of the operation of a modern and integrated financial administration system.
Carrasco Díaz, Daniel, Navarro Galera, Andrés, Valencia Quintero, María. José, Sánchez Toledano, Joaquín, “Un modelo de cálculo de costes para los servicios públicos municipales: Hacia un sistema integral de información en la administración local”, Revista del Instituto Internacional de Costos, No. 5, July/December, 2009.
Intervención General de la Administración del Estado, Contabilidad Analítica de las Administraciones Públicas.
Matus Carlos, Makón Marcos and Arrieche, Víctor, Bases teórica del presupuesto por programas, Caracas, Venezuela, 1979.
Requena Rodríguez, José María., Vera Ríos, Simón, Contabilidad interna (Contabilidad de costes y de gestión), cálculo, análisis y control de costes y resultados para la toma de decisiones, 1a Edición, Ariel Economía, 2006.
Ripoll, Vicente, Balada, Tomás, Manual de Costes, Edición Gestión 2000, Barcelona 2003.
1 See Central Government conformation in item 6 of this section.
2 See definitions of end and intermediate products in item 12 of this paper.
3 See absorption cost method in item 4.
4 Matus Carlos, Makón Marcos and Arrieche, Víctor, Bases teórica del presupuesto por programas, Caracas, Venezuela, 1979.