ACTIVITY-BASED COSTING

The City of Indianapolis has held the line on taxes and general efficiencies strengthen its competitive position regionally, nationally and in the global marketplace. Unlike other municipalities, Indianapolis has embarked on an aggressive performance management program. Several components of the program, initiated in a short time frame, are being deployed to all employees through a comprehensive training effort. The combination of all facets of this performance management discipline is commonly referred to as the "strategic tools initiative." These innovative tools, described in more detail below, are as follows:

* Activity-Based Costing Management

* Performance Measures

* Activity-Based/ Performance Budgeting

* Performance Reporting Performance-Based

* Compensation

Also combined with these tools is the effective use of citizen surveys to gauge the public's perception about the amount and quality of service delivery. Opportunities for citizen input are offered several times each year. The results are distributed throughout all departments for use in developing new-or revamping ongoing--projects or processes that address the public needs: The city encourages citizen input about individual projects, which support the overall division. An example would be neighborhood meeting at various stages of road improvement project.

Activity-Based Costing (ABC), which is more common to private industry, has recently crossed over into the government sector, at the federal state and local levels; The city historically knew what direct costs were at the organizational level, but not how much it cost to perform a particular activity, Full cost estimates were determined by the typical hod of including indirect or overhead expenses by using a multiplier on direct labor costs. This method of guessestimating the cost of city programs and services made it difficult to believe in them, The city realized the following needs:

* Accurate information about the cost to provide city services

* Measuring productivity

* Measuring the quality of service delivery

* Measuring the efficiency of service delivery

Activity-Based Costing is a tool that helps break down a business into core activities, Each activity becomes the cost focal point, Each activity becomes a discrete operating unit with processes subject to analysis and potential for redesign, This analysis can be done at each phase of the process as well as the process in total.

Activity-Based Costing provides a technique for cost control that assigns costs -- both direct and indirect -- of products or services (activities), based on if the consumption of resources, In other words, it gathers all associated cost of generating a unit of output and it helps you understand the details or circumstances that drive the cost. When the ABC project was engaged, we anticipated the following benefits:

* Improved management

* Significantly improved service and cost savings

* Delivered a dollar's worth of service for each dollar of investment

The Activity based management tools give support data for analysis of contracting verses in-house scenarios. Public forces within the City have successfully competed for street maintenance, sewer maintenance, solid waste collection and mowing service contracts. These are but a few of the examples of where competition was deployed.

Another benefit derived from these tools, is the ability to benchmark and make adjustments towards efficiency. The city has used information from other agencies, cities, and to a large extent, the private

sector, to benchmark performance. To truly wring out the inefficiencies in the organization, benchmarking, analyzing and reporting become continual activities for all managers, as well as those individuals and work teams closest to the product/project development.

For those agencies that generate revenue for services rendered, there is an attempt to establish the true internal cost of performing a service and recoup as close to 100% through properly priced user fees. One such area in the City of Indianapolis, and perhaps in other governmental units at all levels, is the permitting function. The current permits sections' operating budget is subsidized by the general fund. This subsidy detracts from critical infrastructure improvements. By knowing the true cost of the permitting process, fees are adjusted accordingly and either reduce or eliminate the need for a subsidy.

ABC provides a more in-depth and analytical understanding of the inter-relationship of process components. ABC computes the total cost of activities (products) as well as the unit cost of activity components, sub-activities, tasks and phases.

Activity-Based Costing forms the basis for the development of other components of the overall Performance Management discipline. Along with unit cost information generated by ABC, welldefined performance measures are the logical next step.

With the establishment of the core activities, defining the performance measurement criteria must follow. Measures of quantity, efficiency, productivity and quality must be developed. These indicators, which support the vision of the organization, must be meaningful, challenging, and perhaps most importantly, able to be tracked and reported. The data collected and reported through these indicators is the catalyst for process redesign required to promote continuous improvements in service delivery.

The basis of quantitative assessments is output measures, which identify the quality of a unit produced or performed (e.g., 50 lineal feet of sidewalk).

Efficiency is measured by the cost per unit of activity performed (e.g., $20/lineal foot sidewalk). This rate could be compared across other similar sections, with industry standards, etc. It also serves as a benchmark to evaluate the performance of the same group over time, thus facilitating and supporting appropriate process redesign.

Another measure of performance is productivity measures, which indicate the quantity of a unit produced or performed relative to a unit of time. A productivity measure for street maintenance crews may be the number of potholes filled per week or the lineal feet of sidewalk repaired per month.

The basis for ascertaining quality is the outcome measure. This assessment covers the overall effectiveness of the service provided. Feedback from the public is the key ingredient for this measurement. There must be ample opportunity given for the public to have input and to gauge the performance of the service provider. The service provider must, in return, use the information to base future improvements of the agencies processes.

It is important to note that the public perceptions developed over time are sometimes difficult to influence. The use of citizen surveys, or other such mechanisms, to collect information about public sentiment has been integrated and used on a regular and continuous basis.

* Output measure = Quality of work accomplished

* Efficiency = Unit cost measure

* Productivity measure = Work accomplished vs. time

* Quality measure = Effectiveness, how good the outcome

Crucial to the success of an Activity-Based Costing model or any of the Activity-Based Management tools is careful planning and communication. As with other managerial change efforts, there must be substantial support throughout the organization, particularly from the agency head or in the case of the City of Indianapolis, the Mayor.

"If government does not provide its customers with a dollars worth of service for every dollar it takes in taxes, then it isn't helping them out--it's ripping them off. Activity-Based Costing is a fundamental component of our City's comprehensive effort to link costs and outcomes and create a budget that our customers can easily review."

Mayor Stephen Goldsmith Indianapolis, Indiana

A common understanding of the organization's vision must permeate all levels. The philosophy clearly communicated allows each employee to know how he/she can assist in the achievement of the stated goals and objectives. The City of Indianapolis's vision is: A competitive city, with safe streets, strong neighborhoods and a thriving economy.

Every city employee is to critically review his/her activities to assure that work is moving the city towards reaching its vision.

After communicating the vision, the core activities of the organization should be established. Historic information on cost, performance and public perception, if available, should be used in determining strengths and weaknesses in service provision. This, in turn, assists in steering resource allocation decisions.

* Establish the core activities of the business. (Includes services produced for both internal and external customers.)

* Establish the active measure of productivity (output measure). Must directly relate to performance measurement.

* Establish the activities measure of quality (Activity-Based Management--Total Quality Management). Many of the core activities have quality implications and can be tied to Total Quality Management efforts.

* Collect needed support data.

* Generate the cost data.

* Analyze the results.

Management must use Activity Based Costing to support the "Culture of Change." The primary function of this management tool is to provide support data for redesign, restructuring and reengineering. Management must emphasize creativity and be willing to accept changes, rethink their whole way of doing business and learn from mistakes that can and will occur. Operational management must believe in the process and treat this as a long-term management tool. The cost data dues not have much use if management does not act on it.

A good costing system takes General Ledger and related financial information and assigns the expenses to an activity based on the consumption of those expenses. This financial data must be entered into the cost system and may be available from existing systems. A quick summary follows:

* General ledger provides expense information such as labor, material, utilities, supplies and contractual services.

* Work order or Labor Project Tracking system. This provides "consumption" data per activity on usage of resources such as labor hours, machine/equipment hours, vehicle hours, material and supplies used.

* The cost system will match the general ledger dollars to the usage quantity to give component cost such as cost for labor hour, cost per ton of material used and cost per vehicle hour.

Also useful is Fleet Management Data, which takes the general ledger payment and sorts the payments (costs of fuel & maintenance) per vehicle. This facilitates matching with the consumption data. Depreciation of vehicles should be sorted in this matter and included. A Fixed Asset report will give depreciation information of machines equipment for entry into the cost system.

Last, ABC allocates internal overhead costs and costs from other support agencies (such as Human Resources, Controllers Office, Purchasing, Legal, etc.). The allocation to the core activities is on a basis that reflects the best correlation of expenses to output. By way of illustration, man hours for human resource expenses, equipment hours for storage expenses, quantities, of material for warehousing expenses; etc. These fully loaded costs give true indication of the cost of doing business at the activity level.

Activity-Based Costing/Management

is flexible and applied to various disciplines of government. Examples are:

* Infrastructure maintenance activities

* Infrastructure construction activities

* Revenue generating operation for pricing strategies

* Fleet management operations

* Public safety programs

* Environmental activities

* Waste control operations

* Recreation facility activities

ACTIVITY-BASED MANAGEMENT--ABM

ABM forces a department to analyze what drives costs. Referring to the street maintenance process of crack sealing, the initial application of ABC produced a unit cost per lane mile of $1,200.00. In order to be competitive with private sector, the maintenance division mapped out the crack sealing process, made major changes and developed a new process that reduced costs to $850.00 per lane mile. This analysis and change is called Activity-Based Management. The ABM process can have division-wide results. The city's fleet services division budget decreased 11% since 1991. This was accomplished even with an expansion of the fleet by 61 vehicles. Customer complaints decreased from 30 to five during the same time period, which is a good example of a "quality" indicator.

Activity-Based Management is a

* Identifying business focus

* Increasing production of valued activities

* Outsourcing activities of low proficiency

* Reducing non-value-added activities

* Decreasing waste

* Increasing quality of products/services

* Eliminating unneeded activities

Also, excellent for comparing output cost for same services in different locations (e.g., comparison between Districts, Sections, Quads, etc.). Activities are classified as follows:

Value-added activities -- contribute to the organizational objectives and/or contribute to the direct benefit of the customer. Below is a list and the related output or productivity measures.

Support (Secondary) Activities -- assist the organizational and value-added activities, These activities are important and have an indirect effect output, but should be kept to a minimum to free-up more resources to value-added activities. For example, safety meetings can reduce accidents, downtime and workman's compensation expense, thereby reducing extra costs and maximizing productivity time.

Non-value-added activities -- do not contribute to the organizational objectives nor do they support the value added activities. Non value activities are the equivalent of waste.

ACTIVITY-BASED BUDGETING--ABB

Once the Activity-Based Costing System is in effect, it can also produce budget projections at the activity level. This would include costs incurred for next year's fiscal period plus the amount of "output" produced. For example, the "ABB" for the activity of crack sealing would be $510,000 and the budget output would be 600 lane miles for a cost per lane mile of $850. This is instrumental in developing a "Performance Measures Budget" The budget activity rolls up into major "outcomes," which relate to the citizens concerns. The performance measures budget shows these outcomes with the related costs and anticipated production. For example, the crack sealing activity would roll up into the outcome "Smooth Roads or Safe Roads."

The statutory line-item budget is still prepared, but the performance measures budget has its own unique uses (e.g., information for citizens' groups and department's goals/objectives). The ActivityBased Costing reports actual expenses and compares it to the Activity-Based Budget. The variances must be explained, in a management report. The Performance (ABB) Budget can also be translated to the statutory format.

In conclusion, the Activity-Based Cost/Management process makes government more accountable by helping employees and citizens to understand its services and costs.