Output Costing Methodology- A Case Study for Mongolia by Tarun Das

8/14/2019 Output Costing Methodology- A Case Study for Mongolia by Tarun Das

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Output Budgeting Session-4A by Tarun Das 1

Output Costing and OutputBudgeting

Session-4A: Output Costing

MethodologyProfessor Tarun Das


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Contents of thispresentation

Output Costing Methodology

Step-1: Specification of outputs

Step-2: Identification of costs

Step-3: Assignment of direct costs

Step-4: Allocation of indirect costsStep-5: Appropriate costing

methodology

Step-6: Accrual output budgeting (AOB)


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1.1 Step-1 Specification of Output

There are three basic questions ingovernment budgeting:

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

2. How does it achieve this?(Outputs and Activities)

3. What does it cost to the government?(Output budgeting) In other words, govt of Mongolia delivers

benefits to its people primarily through itsprograms and agencies' goods and

services (outputs), which are delivered ata given output budgeting.


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1.2 Step-1 Specification ofOutput

All Line Ministries/ Agencies who

receive appropriations fromParliament are required to reportoutcomes and outputs as indicated intheir strategic business plans (SBPs)endorsed by the government.

Outputs are deliverables and theimmediate or end results of activities.

Outcomes are the medium term resultor impact of public programs and

policies on the economy and on usergroups.


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1.3 Step-1 Specification ofOutput

Agencies apply inputs (e.g., man,

materials, money, machines) to theactivities and processes that generatethe products and services thatconstitute their outputs.

These inputs include the fundsappropriated to them from the budgetor received through purchaser/provider arrangements, and revenueraised through other means, such assales, user charges and taxes orcontributions by trade and industry.


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1.4 Output and Outcome framework

The outcomes and outputs framework isintended to be dynamic and flexible.

It works as a decision hierarchy:1. Government (through ministers/ agencies)

specifies outcomes;2. These outcomes are specified in terms of

their impact on some aspect of society(e.g., education and health), and theeconomy (high growth, moderate inflationand low interest rate etc.)

3. Parliament appropriates funds to allow

agencies to achieve these outcomesthrough delivery of goods and services.


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2.1 Step-2: Identification of costs

Cost information is collected from the sourcedocuments; for example, purchase invoices and

employee time sheets. Cost element information must be on an accrual

basis, because the objective is to include the costof resources consumed and not the cost ofresources paid for.

Accrual accounting leads to costs being identifiedfor which even no cash is paid by an agency (forexample, depreciation).

Another cost which must be allocated is the costof the governments investment in the agency -

this is called capital charge.


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3.1 Step-3: Assignment of directcosts

Cost assignment is the assignment of a costor group of costs to one or more outputs.

Where a resource is used by only one output,the cost of this resource consumption can betraced directly to the output. These are calleddirect cost.

Depending on the nature of outputs, directcosts can include salaries and wages, travel,materials, consultancy costs and motorvehicle expenses.

There are various ways to assign direct coststo the outputs.


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3.2 Assignment of costs tooutputs

G/L Items Cost centers Outputs

SalariesGoodsTelecomFuel

PowerWaterStationarySoftwareRentalDepreciationEquipment

EconomicPolicyFiscal PolicyTreasury

Loan and AidProcurementFinancial sectorAdministration Accounting StateSecretaryFinanceMinister

PolicyadviceBudgetpreparation

RevenuecollectionTreasuryfunctionsPublic debtmanagementExternalassistanceAdvice on

A/C and audit


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3.3 Assignment of costs tooutputs

G/LItems

CostCentre-1

Cost

Centre-2

Cost

Centre-3

Output-2

Output-3Output-4

Output-1

Output-5

Output-6

Output-7

CostDrivers

CostDrivers


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3.4 Methods to assign directcosts

Method (When used) Description

1. Cost centreattribution (Whenbusiness units are

responsible fordelivery of oneoutput only)

Direct costs areallocated to the costcentres as they are

incurred.

2. Time recording

systems (Useful forassigning direct laborand staff cost).

Employees record

the time they spendfor the delivery ofoutput. Time may berecorded on hourly,

daily, weekly,


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3.5 Methods to assign directcosts

Method (When used) Description

3.Resourceconsumptionaccounting

(when use ofresources issignificant)

Measure eachoutputs use ofresources such as

photocopies,computers,telephones andprinters.

4. Output Accounting(Suitable only whenthere is a relationshipbetween outputs and

cost centres.

Direct costs areallocated to specificoutput codes in thebudgeting bodys

General Ledger as


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4.1 Allocation of Indirect Costs In many cases, resources are consumed by support

activities which cannot be traced directly to

outputs. These overhead costs must be attributed to the

outputs using an allocation method.

For example, salaries of corporate services staffmembers in the head office are attributed across all

departmental outputs. When apportioning overhead costs between

outputs, an agency may choose alternativetechniques depending on availability of data.

These are two basic methods:

1. Logical cause-and-effect or cost-driver2. Arbitrary pro-rata.


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4.2 Logical Cause and Effect

Costs that cannot be traced directly to specific

outputs are attributed to cost pools/centres. The total costin a cost pool/centre is then

attributed to outputs based on the cost-driver thatcauses the activity to be undertaken.

Some commonly used cost-drivers are:

1. Floor space

2. Number of staff

3. Number of hours worked

4. Number of transactions processed

5. Number of documents received & dispatched


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4.3 Arbitrary Pro-Rata

This technique attributes costs without

determining a clear cause-and-effectrelationship.

Usually all overhead costs are firstly aggregatedand then attributed to outputs using some

arbitrary pro-rata basis: For example, corporate overheads are

attributed using the number of direct labourhours consumed in producing the output.

Another example, the total cost of computermaintenance can be attributed equally to alloutput/ cost centres.


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5.1 Appropriate CostingMethodology

There are three basic methods for costing

individual items viz.1. Marginal Cost (MC),2. Fully Distributed Cost (FDC) and3. Avoidable Cost approaches. Marginal cost is the cost of producing an

additional unit of a good or service. Under FDC, the total costs of an agency or

business are fully allocated to all commercialand non-commercial outputs.

Avoidable Cost includes all direct costsrelating to an output, but includes only thoseindirect costs that can be avoided if theoutput was not provided by the agency.


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5.2 Marginal Cost

It generally includes direct costs that vary

with output and some indirect costs. Marginal cost can be measured in the shortrun or the long run.

Short run marginal cost (SRMC) givesthe best cost estimate of producing an

additional unit of output at any point intime. It excludes capital costs because these

are fixed in the short run. SRMC also excludes many indirect

costs such as generic advertising ormanagement time of the chief executiveofficer, since they do not vary with outputin the short run.


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5.3 Fully Distributed Cost (FDC) Under FDC, total costs of an agency are

fully allocated to all commercial and non-commercial outputs. Direct costs are allocated to their

respective outputs, while indirect andjoint costs are averaged for all outputs.

The cost base for each output includesthe share in direct capital costs (such asdepreciation) and overhead costs (suchas corporate services).

In the simplest form, indirect costs areallocated to activities on a pro-rata basis(for example, business activity staff as apercentage of total agency staff).


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5.4 Fully Distributed Cost (FDC)

FDC takes account of:

1. All direct costs such as labour, materials andpremises;

2. Indirect costs (overheads) such as personnelservices, IT support, administration; and

3. Depreciation and capital charge of physicalassets utilised.

The following financial management systemsare developed and used to calculate FDC:

1. Accrual accounting;2. Output costing; and

3. Asset valuation.


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5.5 Fully Distributed Cost (FDC)

Capital Costs

DepreciationCapital Charge

Allocated indirect costsHR and IT

AdministrationFinance

Direct Costs

LabourMaterialsServices


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5.6 Avoidable/ Incremental Costa) Avoidable Cost includes all direct costs

relating to an output, but includes only thoseindirect costs that can be avoided if theoutput was not provided by the agency.

b) For example, direct costs such as labour andmaterials and some indirect costs (such aspayroll administration) can be avoided if the

output is not produced.c) But, other costs, such as some corporate

overhead expenses (e.g. salary of the portfolioChief Executive) and depreciation on jointlyused assets are incurred regardless of

whether the outputs are produced or not.d) Under avoidable costing, costs under (c)would not be included in the output cost.


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5.7 Treatment of costs under differentmethods


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5.8 Output Costing for Mongolia

Public Sector Management andFinance Act (27 June 2002) ofMongolia mandates that Cost ofoutputs shall be determined on the

basis of full accrual cost ofproduction, including managementoverheads and capital charges

(Article 26.3). So, total costs must include both

direct and indirect costs, and alsocapital cost.


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5.9 Output Costing for Mongolia

So, total costs must include the following:

1. Cost of labour directly used for production of theoutput or provision of services;

2. Cost of materials and services directly consumed

in the production process;

3. An appropriate share of indirect labour costs; and

other overheads.4. Accommodation costs & maintenance.5. A share of indirect materials and services;

6. Capital costs including depreciation of fixed assets

and capital charges.


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6.1 Accrual Output Budgeting (AOB)

As a part of a public management reformprogram, Australia introduced AccrualOutput Budgeting (AOB) in 1998.

The system is derived from the NewZealand contract budgeting system,adapted from the British National Health

System (NHS) internal market modelintroduced in the early 1990s . The UK NHS internal market model, based

on earlier US prospective paymentsystems of health finance, was an attempt

to place the public funded NHS on amarket footing.


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6.2 Australian AOB

Prior to AOB, Australian Parliamentsappropriated funds to departments in two

categories: current & capital expenditure. No distinction was made between

expenditure for which departments areaccountable and expenditure which was

beyond departmental control (such asinterests and legal social insurance). Under AOB, this distinction becomes crucial. Australian Parliaments now appropriate funds

in three categories: controlled outputs;

administered items; and funds fornew capital.

6 3 Accrual Performance and


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6.3 Accrual, Performance, andProgram Budgeting

As a reflection of the private sector business model,the payment for departmental outputs is now onaccrual appropriation.

Departments are required to cover also non-cashcosts (e.g. depreciation, liabilities to employees) inaddition to the cash costs of their outputs from thisappropriation.

AOB reflects a system ofperformance budgeting,which links budgetary resource allocations with theoutputs and outcomes.

Starting point is program budgeting, the standardbudgeting practice in Australia in the 1980s prior tothe adoption of AOB.


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6.4 Accrual and Program Budgeting

AOB incorporates most of the formerprogram budgeting framework.

The annual government budgetdocuments under AOB report thebreakdown of funds allocated to broadoutput groups within each Department,

very much like the former programsbudgeting.

These output groups are groups of relatedoutputs designed to deliver the same

outcome. Each broad output group comprises anumber of sub-output groups, like theformer sub-programs.


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6.5 Accrual and Program Budgeting

Budgetary allocations for the separate output groupsare not binding. Appropriations for departmental

outputs are global, just as under the formerprogram budgeting regime.

Parliament approves for each department oneaggregate sum to cover all the outputs for which thedepartment is responsible, but it has the flexibility to

reallocate funds among outputs in response tounanticipated events. However, AOB differs from program budgeting in

many respects. First of all, it incorporates private business and

competitive market environment in government

activities to ensure efficiency.


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ene s o ccrua u pu


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. ene s o ccrua u puBudgeting

In addition to the distinctive market aspects,AOB has led to renewed effort to improve and

extend performance measures and indicators. Considerable work is being done in the Australia,

Canada, New Zealand, UK and USA to articulatethe linkages between outputs and outcomes, and

performance management. Moreover, it has led to a major drive to shiftpublic sector accounting in Australia onto anaccrual basis: a step which arguably has manybenefits in other areas, including fiscal policy

(Robinson, 2002).


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Thank you

Have a Good Day

Output Costing Methodology- A Case Study for Mongolia by Tarun Das

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