Output Costing and Output

Budgeting
Session-4A: Output Costing
Methodology
Professor Tarun Das

Output Budgeting Session-4A by Tarun Das 1

 Contents of this
presentation
Output Costing Methodology
Step-1: Specification of outputs
Step-2: Identification of costs
Step-3: Assignment of direct costs
Step-4: Allocation of indirect costs
Step-5: Appropriate costing
methodology
Step-6: Accrual output budgeting (AOB)

Output Budgeting Session-4A by Tarun Das 2

 1.1 Step-1 Specification of Output
• There are three basic questions in
government 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 its
programs and agencies' goods and
services (outputs), which are delivered at
a given output budgeting.

Output Budgeting Session-4A by Tarun Das 3

 1.2 Step-1 Specification of
Output
• All Line Ministries/ Agencies who
receive appropriations from
Parliament are required to report
outcomes and outputs as indicated in
their strategic business plans (SBPs)
endorsed by the government.
• Outputs are deliverables and the
immediate or end results of activities.
• Outcomes are the medium term result
or impact of public programs and
policies on the economy and on user
groups.

Output Budgeting Session-4A by Tarun Das 4

 1.3 Step-1 Specification of
Output
• Agencies apply inputs (e.g., man,
materials, money, machines) to the
activities and processes that generate
the products and services that
constitute their outputs.
• These inputs include the funds
appropriated to them from the budget
or received through purchaser/
provider arrangements, and revenue
raised through other means, such as
sales, user charges and taxes or
contributions by trade and industry.
Output Budgeting Session-4A by Tarun Das 5
 1.4 Output and Outcome framework
• The outcomes and outputs framework is
intended 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 the
economy (high growth, moderate inflation
and low interest rate etc.)
3. Parliament appropriates funds to allow
agencies to achieve these outcomes
through delivery of goods and services.

Output Budgeting Session-4A by Tarun Das 6

 2.1 Step-2: Identification of costs
• Cost information is collected from the source
documents; for example, purchase invoices and
employee time sheets.
• Cost element information must be on an accrual
basis, because the objective is to include the cost
of resources consumed and not the cost of
resources paid for.
• Accrual accounting leads to costs being identified
for which even no cash is paid by an agency (for
example, depreciation).
• Another cost which must be allocated is the cost
of the government’s investment in the agency -
this is called capital charge.

Output Budgeting Session-4A by Tarun Das 7

 3.1 Step-3: Assignment of direct
costs
• Cost assignment is the assignment of a cost
or group of costs to one or more outputs.
• Where a resource is used by only one output,
the cost of this resource consumption can be
traced directly to the output. These are called
direct cost.
• Depending on the nature of outputs, direct
costs can include salaries and wages, travel,
materials, consultancy costs and motor
vehicle expenses.
• There are various ways to assign direct costs
to the outputs.

Output Budgeting Session-4A by Tarun Das 8

3.2 Assignment of costs to
outputs
G/L Items Cost centers Outputs
•Salaries •Economic •Policy
•Goods Policy advice
•Telecom •Fiscal Policy •Budget
•Fuel •Treasury preparation
•Power •Loan and Aid •Revenue
•Water •Procurement collection
•Stationary •Financial sector •Treasury
•Software •Administration functions
•Rental • Accounting •Public debt
•Depreciatio • State management
n Secretary •External
•Equipment •Finance assistance
Minister •Advice on
Output Budgeting Session-4A by Tarun Das
A/C and audit9
 3.3 Assignment of costs to
outputs
Cost Output-1
Drivers Cost
Centre-1 Output-2
Cost Output-3
Drivers
G/L Cost Output-4
Items
Centre-2
Output-5
Cost Output-6
Centre-3
Output-7
Output Budgeting Session-4A by Tarun Das 10
 3.4 Methods to assign direct
costs
Method (When used) Description

1. Cost centre Direct costs are

attribution (When allocated to the cost
business units are centres as they are
responsible for incurred.
delivery of one
output only)
2. Time recording Employees record
systems (Useful for the time they spend
assigning direct labor for the delivery of
and staff cost). output. Time may be
recorded on hourly,
Output Budgeting daily,
Session-4A by Tarun Das weekly, 11
 3.5 Methods to assign direct
costs
Method (When used) Description

3.Resource Measure each

consumption output’s use of
accounting resources such as
(when use of photocopies,
resources is computers,
significant) telephones and
printers.
4. Output Accounting Direct costs are
(Suitable only when allocated to specific
there is a relationshipoutput codes in the
between outputs and budgeting body’s
cost centres.
Output Budgeting General
Session-4A by Tarun Das Ledger as 12
 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 staff
members in the head office are attributed across all
departmental outputs.
• When apportioning overhead costs between
outputs, an agency may choose alternative
techniques depending on availability of data.
• These are two basic methods:
1. Logical cause-and-effect or cost-driver
2. Arbitrary pro-rata.

Output Budgeting Session-4A by Tarun Das 13

 4.2 Logical Cause and Effect
• Costs that cannot be traced directly to specific
outputs are attributed to cost pools/centres.
• The total cost in a cost pool/centre is then
attributed to outputs based on the cost-driver that
causes 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

Output Budgeting Session-4A by Tarun Das 14

 4.3 Arbitrary Pro-Rata
• This technique attributes costs without
determining a clear cause-and-effect
relationship.
• Usually all overhead costs are firstly aggregated
and then attributed to outputs using some
arbitrary pro-rata basis:
• For example, corporate overheads are
attributed using the number of direct labour
hours consumed in producing the output.
• Another example, the total cost of computer
maintenance can be attributed equally to all
output/ cost centres.

Output Budgeting Session-4A by Tarun Das 15

 5.1 Appropriate Costing
Methodology
• There are three basic methods for costing
individual items viz.
1. Marginal Cost (MC),
2. Fully Distributed Cost (FDC) and
3. 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 commercial
and non-commercial outputs.
• Avoidable Cost includes all direct costs
relating to an output, but includes only those
indirect costs that can be avoided if the
output was not provided by the agency.

Output Budgeting Session-4A by Tarun Das 16

 5.2 Marginal Cost
• It generally includes direct costs that vary
with output and some indirect costs.
• Marginal cost can be measured in the short
run or the long run.
• Short run marginal cost (SRMC) gives
the best cost estimate of producing an
additional unit of output at any point in
time.
• It excludes capital costs because these
are fixed in the short run.
• SRMC also excludes many indirect
costs such as generic advertising or
management time of the chief executive
officer, since they do not vary with output
in the short run.
Output Budgeting Session-4A by Tarun Das 17
 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 and
joint costs are averaged for all outputs.
• The cost base for each output includes
the share in direct capital costs (such as
depreciation) and overhead costs (such
as corporate services).
• In the simplest form, indirect costs are
allocated to activities on a pro-rata basis
(for example, business activity staff as a
percentage of total agency staff).
Output Budgeting Session-4A by Tarun Das 18
 5.4 Fully Distributed Cost (FDC)
• FDC takes account of:
1. All direct costs such as labour, materials and
premises;
2. Indirect costs (overheads) such as personnel
services, IT support, administration; and
3. Depreciation and capital charge of physical
assets utilised.
• The following financial management systems
are developed and used to calculate FDC:
1. Accrual accounting;
2. Output costing; and
3. Asset valuation.

Output Budgeting Session-4A by Tarun Das 19

5.5 Fully Distributed Cost (FDC)
Capital Costs
•Depreciation
•Capital Charge
Allocated indirect costs
•HR and IT
•Administration
•Finance
Direct Costs
•Labour
•Materials
•Services

Output Budgeting Session-4A by Tarun Das 20

 5.6 Avoidable/ Incremental Cost
a) Avoidable Cost includes all direct costs
relating to an output, but includes only those
indirect costs that can be avoided if the
output was not provided by the agency.
b) For example, direct costs such as labour and
materials and some indirect costs (such as
payroll 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 portfolio
Chief Executive) and depreciation on jointly
used 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.

Output Budgeting Session-4A by Tarun Das 21

 5.7 Treatment of costs under different
methods

Output Budgeting Session-4A by Tarun Das 22

 5.8 Output Costing for Mongolia

• Public Sector Management and

Finance Act (27 June 2002) of
Mongolia mandates that “Cost of
outputs shall be determined on the
basis of full accrual cost of
production, including management
overheads and capital charges”
(Article 26.3).
• So, total costs must include both
direct and indirect costs, and also
capital cost. Session-4A by Tarun Das
Output Budgeting 23
 5.9 Output Costing for Mongolia
• So, total costs must include the following:
1. Cost of labour directly used for production of the
output 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.

Output Budgeting Session-4A by Tarun Das 24

 6.1 Accrual Output Budgeting (AOB)
• As a part of a ‘public management reform
program’, Australia introduced ‘Accrual
Output Budgeting (AOB)’ in 1998.
• The system is derived from the New
Zealand ‘contract’ budgeting system,
adapted from the British National Health
System (NHS) ‘internal market’ model
introduced in the early 1990s .
• The UK NHS internal market model, based
on earlier US ‘prospective payment’
systems of health finance, was an attempt
to place the public funded NHS on a
market footing.

Output Budgeting Session-4A by Tarun Das 25

 6.2 Australian AOB
• Prior to AOB, Australian Parliaments
appropriated funds to departments in two
categories: current & capital expenditure.
• No distinction was made between
expenditure for which departments are
accountable and expenditure which was
beyond departmental control (such as
interests and legal social insurance).
• Under AOB, this distinction becomes crucial.
• Australian Parliaments now appropriate funds
in three categories: ‘controlled’ outputs;
‘administered’ items; and ‘funds for
new capital’.

Output Budgeting Session-4A by Tarun Das 26

 6.3 Accrual, Performance, and
Program Budgeting
• As a reflection of the private sector business model,
the ‘payment for departmental outputs’ is now on
accrual appropriation.
• Departments are required to cover also non-cash
costs (e.g. depreciation, liabilities to employees) in
addition to the cash costs of their outputs from this
appropriation.
• AOB reflects a system of performance budgeting,
which links budgetary resource allocations with the
outputs and outcomes.
• Starting point is program budgeting, the standard
budgeting practice in Australia in the 1980s prior to
the adoption of AOB.

Output Budgeting Session-4A by Tarun Das 27

 6.4 Accrual and Program Budgeting
• AOB incorporates most of the former
program budgeting framework.
• The annual government budget
documents under AOB report the
breakdown of funds allocated to broad
output groups within each Department,
very much like the former ‘programs’
budgeting.
• These output groups are groups of related
outputs designed to deliver the same
outcome.
• Each broad output group comprises a
number of sub-output groups, like the
former ‘sub-programs’.
Output Budgeting Session-4A by Tarun Das 28
 6.5 Accrual and Program Budgeting
• Budgetary allocations for the separate output groups
are not binding. Appropriations for departmental
outputs are ‘global’, just as under the former
program budgeting regime.
• Parliament approves for each department one
aggregate sum to cover all the outputs for which the
department is responsible, but it has the flexibility to
reallocate funds among outputs in response to
unanticipated 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.

Output Budgeting Session-4A by Tarun Das 29

 6.6 Accrual and Program Budgeting
• Another aspect of AOB is that capital appropriations to
departments are now re-labeled as ‘equity injections’.
• Like private corporations, Departments have access to
two sources of capital funding.
• The first is the so-called ‘depreciation-based’ capital
funding, which is a draw-down of the accumulated
depreciation reserves.
• The other is the ‘rearrangement of the asset structure’,
an accounting jargon for funds derived from
departmental asset sales .
• So-called ‘capital charging’ to reflect return on capital
as also been introduced by most of the states in the
Australian AOB system.

Output Budgeting Session-4A by Tarun Das 30

 6.7 Benefits of Accrual Output
Budgeting
• 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 articulate
the linkages between outputs and outcomes, and
performance management.
• Moreover, it has led to a major drive to shift
public sector accounting in Australia onto an
accrual basis: a step which arguably has many
benefits in other areas, including fiscal policy
(Robinson, 2002).

Output Budgeting Session-4A by Tarun Das 31

 Thank you
Have a Good Day

Output Budgeting Session-4A by Tarun Das 32