Statement #4/Managerial Cost Accounting Concepts and Standards

for the Federal Government

Executive Office of the President

Office of Management and Budget

"Managerial Cost Accounting Concepts and

Standards for the Federal Government"

Statement of Federal Financial Accounting Standards

Number 4

July 31, 1995

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TABLE OF CONTNETS

EXECUTIVE SUMMARY (paragraphs 1-12)

INTRODUCTION (paragraphs 13-30)

Background

Users of Federal Government Cost Information

Objectives

Terminology

Materiality

Effective Date

PURPOSES OF USING COST INFORMATION (paragraphs 31-40)

Budgeting and Cost Control

Performance Measurement

Determining Reimbursements and Setting Fees and Prices

Program Evaluations

Economic Choice Decisions
MANAGERIAL COST ACCOUNTING CONCEPTS (paragraphs 41-66)

MANAGERIAL COST ACCOUNTING STANDARDS (paragraphs 67-162)

Requirement for Cost Accounting (paragraphs 67-76)

Responsibility Segments (paragraphs 77-88)

Full Cost (paragraphs 89-104)

Inter-Entity Costs (paragraphs 105-115)

Costing Methodology (paragraphs 116-162)

APPENDIX A: Basis for Conclusions (paragraphs 163-270)

APPENDIX B: Glossary

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EXECUTIVE SUMMARY

1. The managerial cost accounting concepts and

 standards contained in this statement are aimed at

 providing reliable and timely information on the

 full cost of federal programs, their activities,

 and outputs. The cost information can be used by

 the Congress and federal executives in making

 decisions about allocating federal resources,

 authorizing and modifying programs, and evaluating

 program performance. The cost information can

 also be used by program managers in making

 managerial decisions to improve operating economy

 and efficiency.

2. The concepts of managerial cost accounting

 contained in this statement describe the

 relationship among cost accounting, financial

 reporting, and budgeting. The five standards set

 forth the fundamental elements of managerial cost

 accounting: (1) accumulating and reporting costs

 of activities on a regular basis for management

 information purposes, (2) establishing

 responsibility segments to match costs with

 outputs, (3) determining full costs of government

 goods and services, (4) recognizing the costs of

 goods and services provided among federal
 entities, and (5) using appropriate costing

 methodologies to accumulate and assign costs to

 outputs.

3. These standards are based on sound cost

 accounting concepts and are broad enough to allow

 maximum flexibility for agency managers to develop

 costing methods that are best suited to their

 operational environment. Also, the managerial

 cost accounting standards and practices will

 evolve and improve as agencies gain experience in

 using them. The following is a summary of the

 concepts and standards contained in this

 statement:

Managerial Cost Accounting Concepts

4. Managerial cost accounting should be a

 fundamental part of the financial management

 system and, to the extent practicable, should

 be integrated with other parts of the system.

 Managerial costing should use a basis of

 accounting, recognition, and measurement

 appropriate for the intended purpose. Cost

 information developed for different purposes

 should be drawn from a common data source,

 and output reports should be reconcilable to

 each other.

Managerial Cost Accounting Standards

 Requirement for cost accounting

5. Each reporting entity should accumulate

 and report the costs of its activities on a

 regular basis for management information

 purposes. Costs may be accumulated either

 through the use of cost accounting systems or

 through the use of cost finding techniques.

 Responsibility segments

6. Management of each reporting entity

 should define and establish responsibility

 segments. Managerial cost accounting should
 be performed to measure and report the costs

 of each segment's outputs. Special cost

 studies, if necessary, should be performed to

 determine the costs of outputs.

 Full cost

7. Reporting entities should report the full

 costs of outputs in general purpose financial

 reports. The full cost of an output produced by a

 responsibility segment is the sum of (1) the costs

 of resources consumed by the segment that directly

 or indirectly contribute to the output, and (2)

 the costs of identifiable supporting services

 provided by other responsibility segments within

 the reporting entity, and by other reporting

 entities.

 Inter-entity costs

8. Each entity's full cost should

 incorporate the full cost of goods and

 services that it receives from other

 entities. The entity providing the goods or

 services has the responsibility to provide

 the receiving entity with information on the

 full cost of such goods or services either

 through billing or other advice.

9. Recognition of inter-entity costs that

 are not fully reimbursed is limited to

 material items that (1) are significant to

 the receiving entity, (2) form an integral or

 necessary part of the receiving entity's

 output, and (3) can be identified or matched

 to the receiving entity with reasonable

 precision. Broad and general support

 services provided by an entity to all or most

 other entities generally should not be

 recognized unless such services form a vital

 and integral part of the operations or output

 of the receiving entity.

 Costing methodology

10. Costs of resources consumed by
 responsibility segments should be accumulated

 by type of resource. Outputs produced by

 responsibility segments should be accumulated

 and, if practicable, measured in units. The

 full costs of resources that directly or

 indirectly contribute to the production of

 outputs should be assigned to outputs through

 costing methodologies or cost finding

 techniques that are most appropriate to the

 segment's operating environment and should be

 followed consistently.

11. The cost assignments should be performed

 using the following methods listed in the

 order of preference: (a) directly tracing

 costs wherever feasible and economically

 practicable, (b) assigning costs on a cause-

 and-effect basis, or (c) allocating costs on

 a reasonable and consistent basis.

12. These accounting standards need not be

 applied to items that are qualitatively and

 quantitatively immaterial. The Board

 recommends that the managerial accounting

 standards of this Statement become effective

 for fiscal periods beginning after September

 30, 1996. Earlier implementation is

 encouraged.

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INTRODUCTION

Background

13. Reliable information on the costs of federal

 programs and activities is crucial for effective

 management of government operations. In Statement

 of Federal Financial Accounting Concepts (SFFAC)

 No. 1, Objectives of Federal Financial Reporting,

 issued in 1993, it is stated that the objectives

 of federal financial reporting are to provide

 useful information to assist internal and external

 users in assessing the budget integrity, operating

 performance, stewardship, and systems and control
 of the federal government.[Footnote 1]

[Footnote 1: Statement of Federal Financial Accounting

Concepts No. 1, "Objectives of Federal Financial

Reporting" (September 2, 1993), pars. 110 and 111,

pages 34-35.]

14. Managerial cost accounting is especially

 important for fulfilling the objective of

 assessing operating performance. In relation to

 that objective, it is stated in SFFAC No. 1 that

 federal financial reporting should provide

 information that helps users to determine:

-- Costs of specific programs and activities and

 the composition of, and changes in, those

 costs;

-- Efforts and accomplishments associated with

 federal programs and their changes over time

 and in relation to costs; and

-- Efficiency and effectiveness of the

 government's management of its assets and

 liabilities.[Footnote 2]

[Footnote 2: Ibid., pars. 126-130, pages 39-40.]

15. It is further stated in SFFAC No. 1 that "The

topics of costs and performance measurement are related

because it is by associating cost with

activities or cost objectives that accounting can

make much of its contribution to reporting on

performance."[Footnote 3] "Cost" is the monetary

value of resources used or sacrificed or

liabilities incurred to achieve an objective, such

as to acquire or produce a good or to perform an

activity or service. Costs incurred may benefit

current and future periods. In financial

accounting and reporting, the costs that apply to

an entity's operations for the current accounting

period are recognized as expenses of that period.

[Footnote 3: Ibid., par. 192, page 63.]
16. The Chief Financial Officers Act of 1990

includes among the functions of chief financial

officers "the development and reporting of cost

information" and "the systematic measurement of

performance."[Footnote 4] In July 1993, Congress

passed the Government Performance and Results Act

(GPRA) which mandates performance measurement by

federal agencies.[Footnote 5] In September 1993,

in his report to the President on the National

Performance Review (NPR), Vice President Al Gore

recommended an action which required the Federal

Accounting Standards Advisory Board to issue a set

of cost accounting standards for all federal

activities.[Footnote 6] Those standards will

provide a method for identifying the unit cost of

all government activities.

[Footnote 4: 104 Stat. 2938 (See particularly 31

U.S.C. sec 902).]

[Footnote 5: 107 Stat. 285 (See particularly, 31

U.S.C. sections 1101, 1105, 1115, 1116-1119, 9703,

9704).]

[Footnote 6: Vice President Al Gore, "Creating A

Government That Works Better & Costs Less,"

Accompanying Report of the National Performance Review

(September 1993), p. 59.]

17. In early 1994, the Federal Accounting

Standards Advisory Board (the Board) convened an

advisory group to help develop standards for

managerial cost accounting in the federal

government. The group included members from

government, business, and academe. Their views

and proposals have been considered by the Board,

and their work contributed greatly in developing

this document.

Users of Federal

Cost Information

18. The cost of government is a concern to the

public as well as to the federal government

itself. Most government service efforts and

accomplishments cannot be measured in financial
terms alone. Unlike private business, there is no

"bottom line" or profit index to help measure

public sector performance. However, government

service efforts and accomplishments can be

evaluated using both financial and non-financial

measures, and "cost" is an important financial

measure for government programs. Internal and

external federal information users identified

below will find these standards helpful in

assessing operating performance, stewardship,

systems, and control of the federal government.

19. Government managers are the primary users of

cost information. They are responsible for

carrying out program objectives with resources

entrusted to them. Reliable and timely cost

information helps them ensure that resources are

spent to achieve expected results and outputs, and

alerts them to waste and inefficiency.

20. Congress and federal executives, including

the President, make policy decisions on program

priorities and allocate resources among programs.

These officials need cost information to compare

alternative courses of action and to make program

authorization decisions by assessing costs and

benefits. They also need cost information to

evaluate program performance.

21. Citizens, including news media and interest

groups, are concerned with the costs and results

of federal programs that affect their interests.

They need program cost information to judge

whether resources are allocated to programs

rationally and if the programs operate efficiently

and effectively.

Objectives

22. The managerial cost accounting concepts and

standards presented here are intended for all the

user groups identified above. These standards are

aimed at achieving three general objectives:

-- Provide program managers [Footnote 7] with

 relevant and reliable information relating
 costs to outputs and activities. Based on

 this information, program managers can

 respond to inquiries about the costs of the

 activities they manage. The cost information

 will assist them in improving operational

 economy and efficiency;

[Footnote 7: Statement of Federal Financial Accounting

Concepts No.1, "Objectives of Financial Reporting,"

defined "Program managers" as individuals who manage

federal programs, and stated that "Their concerns

include operating plans, program operations, and budget

execution." SFFAC No. 1, par. 85, page 29. ]

-- Provide relevant and reliable cost

 information to assist the Congress and

 executives in making decisions about

 allocating federal resources, authorizing and

 modifying programs, and evaluating program

 performance; and

-- Ensure consistency between costs reported in

 general purpose financial reports and costs

 reported to program managers. This includes

 standardizing terminology for managerial cost

 accounting to improve communication among

 federal organizations and users of cost

 information.

Scope of Standards

23. This statement contains managerial cost

concepts and five standards for the federal

government. The five standards address the

following topics:

(1) Requirement for cost accounting,

(2) Responsibility segments,

(3) Full cost,

(4) Inter-entity costs, and

(5) Costing methodology.

The essence of each standard is briefly stated in

a box followed by detailed explanations. However,

both the words in the boxes and the entire text of
explanations constitute the requirements of the

standards.

24. These standards are based on sound cost

accounting concepts and allow sufficient

flexibility for agencies to develop managerial

cost accounting practices that are suited to their

specific operating environments. Also, it is

expected that cost accounting standards and

practices will evolve and improve as agencies gain

experience in using them.

25. Other Statements of Federal Financial

Accounting Standards (SFFAS) address recognition

and measurement of assets and liabilities. For

additional guidance, readers should consult: SFFAS

No. 1, Accounting for Selected Assets and

Liabilities; SFFAS No. 2, Accounting for Direct

Loans and Loan Guarantees; and SFFAS No. 3,

Accounting for Inventory and Related Property.

The Board is working on and will soon complete

other recognition and measurement projects related

to revenues, liabilities, property, plant, and

equipment, and other elements of financial

statements.[Footnote 8]

[Footnote 8: See FASAB Exposure Drafts, "Accounting

for Liabilities of the Federal Government" (November 7,

1994); "Accounting for Property, Plant, and Equipment"

(February 28, 1995); and "Revenue and Other Financing

Sources" (Pending).]

Terminology

26. Managerial cost accounting information, to be

useful, must rely on consistent and uniform

terminology for concepts, practices, and

techniques. Consistent and uniform use of

terminology can help avoid confusion and miscommunication among organizations and individuals.

27. As a start toward developing consistent

managerial cost accounting terminology within the

federal government, this statement includes a

glossary of basic cost accounting terms.
Materiality

28. Except as otherwise noted, the accounting and

reporting provisions of these accounting standards

need not be applied to items that are

qualitatively and quantitatively immaterial.

29. The determination of whether an item is

material depends on the degree to which omitting

information about the item makes it probable that

the judgment of a reasonable person relying on the

information would have been changed or influenced

by the omission.

Effective Date

30. The Board recommends that the accounting

standards of this Statement become effective for

fiscal periods beginning after September 30, 1996.

Earlier implementation is encouraged.

Purposes of Using Cost Information

31. There are many different purposes for which

cost information may be used by the federal

government. The focus of this statement is on

cost information needed to improve federal

financial management and managerial decision

making.

32. In managing federal government programs, cost

information is essential in the following five

areas: (1) budgeting and cost control, (2)

performance measurement, (3) determining

reimbursements and setting fees and prices, (4)

program evaluations, and (5) making economic

choice decisions. Each of these uses is discussed

below.

Budgeting and Cost Control

33. Information on the costs of program activities

can be used as a basis to estimate future costs in
preparing and reviewing budgets. Once budgets are

approved and executed, cost information serves as

a feedback to budgets. Using cost information,

federal managers can control and reduce costs, and

find and avoid waste. For example, with

appropriate cost information, federal managers

can:

-- Compare costs with known or assumed benefits

 of activities, identify value-added and non-

 value-added activities, and make decisions to

 reduce resources devoted to activities that

 are not cost-effective;

-- Compare and determine reasons for variances

 between actual and budgeted costs of an

 activity or a product;

-- Compare cost changes over time and identify

 their causes;

-- Identify and reduce excess capacity costs;

 and

-- Compare costs of similar activities and find

 causes for cost differences, if any.

Performance Measurement

34. Measuring performance is a means of improving

program efficiency, effectiveness, and program

results. One of the stated purposes of the GPRA

of 1993 is to ". . .improve the confidence of the

American people in the capability of the federal

government, by systematically holding federal

agencies accountable for achieving program

results."

35. Measuring costs is an integral part of

measuring performance in terms of efficiency and

cost-effectiveness. Efficiency is measured by

relating outputs to inputs. It is often expressed

by the cost per unit of output. While

effectiveness in itself is measured by the outcome

or the degree to which a predetermined objective

is met, it is commonly combined with cost
information to show "cost-effectiveness." Thus,

the service efforts and accomplishments of a

government entity can be evaluated with the

following measures:

(1) Measures of service efforts which include the

 costs of resources used to provide the

 services and non-financial measures;

(2) Measures of accomplishments which are outputs

 (the quantity of services provided) and

 outcomes (the results of those services); and

(3) Measures that relate efforts to

 accomplishments, Such as cost per unit of

 output or cost-effectiveness.

36. Thus, as stated previously, performance

measurement requires both financial and nonfinancial measures. Cost is a necessary element

for performance measurement, but is not the only

element.

Determining Reimbursements

and Setting Fees And Prices

37. Cost information is an important basis in

setting fees and reimbursements. Pricing and

costing, however, are two different concepts.

Setting prices is a policy matter, sometimes

governed by statutory provisions and regulations,

and other times by managerial or public policies.

Thus, the price of a good or service does not

necessarily equal the cost of the good or the

service determined under a particular set of

principles. Nevertheless, cost is an important

consideration in setting government prices. With

certain exceptions, OMB requires: [Footnote 9]

[Footnote 9: OMB Circular A-25, User Charges (Revised

July 8, 1993).]

-- With respect to goods and services that the

 government provides in its sovereign capacity

 to a particular group of individuals as a

 special benefit, user charges should be
 sufficient to recover the full cost of those

 goods and services; and

-- With respect to goods and services that the

 government provides under business-like

 conditions, user charges for those goods and

 services need not be limited to the recovery

 of full cost and may yield a net revenue.

38. Also, cost information is important in

calculating reimbursements for products and

services provided by one government agency to

another. Even if fees or reimbursements do not

recover the full costs due to policy or economic

constraints, management needs to be aware of the

difference between cost and price. With this

information, program managers can properly inform

the public, the Congress, and federal executives

about the costs of providing the goods or

services.

Program Evaluations

39. Costs of federal resources required by

programs are an important factor in making policy

decisions related to program authorization,

modification, and discontinuation. These

decisions are usually subject to policy

constraints, and often require the consideration

of social and economic costs and benefits

affecting different sectors of the economy and

society. Nevertheless, the costs of federal

resources required are an important factor.

Information on program costs can be used as a

basis for cost-benefit considerations.

Economic Choice Decisions

40. Often, agencies and programs face decisions

involving choices among alternative actions, such

as whether to do a project in-house or contract it

out; to accept or reject a proposal; or to

continue or drop a product or service. Making

these decisions requires cost comparisons among

available alternatives.
 Managerial Cost Accounting Concepts

 Managerial cost accounting should be a fundamental

part of the financial management system and, to the

extent practicable, should be integrated with other

parts of the system. Managerial costing should use a

basis of accounting, recognition, and measurement

appropriate for the intended purpose. Cost information

developed for different purposes should be drawn from a

common data source, and output reports should be

reconcilable to each other.

41. Managerial cost accounting should be an

essential element of proper financial planning,

control, and evaluation for any organization or

activity that uses resources having monetary

value. Managerial cost accounting is a basic part

of the financial management system in that it

supports and provides data to the budgetary and

financial accounting functions and, by itself,

provides useful information for both internal and

external users.

Role of Managerial Cost

Accounting in Financial Management

42. Managerial cost accounting is the process of

accumulating, measuring, analyzing, interpreting,

and reporting cost information useful to both

internal and external groups concerned with the

way in which the organization uses, accounts for,

safeguards, and controls its resources to meet its

objectives. Managerial cost accounting,

therefore, is the servant of both budgetary and

financial accounting and reporting because it

assists those systems in providing information.

Also, it provides useful information directly to

management. These relationships are shown in

Figure 1.

Figure 1: Financial Management Information Framework
(Omitted, see hard copy)

Common Data Source

43. The information flow within a financial

management system begins with a basic information

pool or common data source. This data source

consists of all financial and programmatic

information used by the budgetary, cost, and

financial accounting processes. It includes all

financial and much non-financial data, such as

environmental data, that are necessary for

budgeting and financial reporting.[Footnote 10]

The common data source also includes evaluation

and decision information developed as a result of

prior reporting and feedback. Other types of data

may be included based upon perceived needs and

purposes related to the ultimate users of the

information.

[Footnote 10: The makeup of core data and

environmental data is discussed in Statement of Federal

Financial Accounting Concepts No. 1, "Objectives of

Federal Financial Reporting," Chapter 7, and,

therefore, a detailed discussion is not provided here.]

44. The common data source may include many

different kinds of data. It is far more than the

information about financial transactions found in

the standard general ledger, although that is a

significant part of the data source. Few

organizations or entities maintain all these data

in any one system or location. Furthermore, the

use of the term "data source" is not meant to

imply the use of computerized systems for source

information. Instead, the term is used in a broad

way to include many sources of information.

45. Managerial cost accounting, financial

accounting, and budgetary accounting draw

information as needed from the common data source.

The data obtained by each of these is processed to

attain specific objectives by reporting useful
information.

Relationship to Financial Accounting

46. As shown in Figure 1 by their overlap,

managerial cost accounting and financial

accounting are closely related or integrated. To

some degree, this is due to the historical

development of cost accounting as a method for

more detailed scorekeeping with the requirement to

provide inventory values for external financial

reporting purposes.[Footnote 11] In part, it is

because cost information generally originates with

transactions recorded for financial accounting

purposes.

[Footnote 11: Coulthurst, Nigel and John Piper, "The

State of Cost and Management Accounting," "Management

Accounting," April 1986.]

47. While inventory valuation is still part of

the fundamental relationship, managerial cost

accounting serves financial accounting in several

other ways. Fundamentally, managerial cost

accounting should assist financial accounting in

determining the results of operations during a

fiscal period by providing relevant data that are

accumulated to produce operating expenses. These

data include the allocation of capitalized costs

to periods of time or units of usage.

48. Traditionally, managerial cost accounting

information pertaining to financial accounting has

involved costs of past transactions and the

assignment of transaction value to fiscal periods

and outputs. These purposes and uses are closely

aligned with the financial accounting activity and

traditional external financial reporting. This

past cost aspect has been acknowledged in

Objectives of Federal Financial Reporting which

states that "financial accounting is largely

concerned with assigning the value of past

transactions to appropriate time

periods."[Footnote 12]

[Footnote 12: Statement of Federal Financial
Accounting Concepts No.1, "Objectives of Federal

Financial Reporting," par. 168, page 55.]

Relationship to Budgetary Accounting

49. Managerial cost accounting should also

provide budgetary accounting with cost

information. However, the two are not as closely

aligned as is the case with financial accounting

(see Figure 1). Mostly, this is because costs are

usually recorded, accumulated, and allocated by

managerial cost accounting on an accrual basis of

accounting which is different from the obligation

or cash basis generally used in budgetary

accounting.

50. Still, managerial cost accounting does

provide cost information to budgetary accounting

for use in preparing yearly and long-term budgets

for required materials, supplies, equipment, human

resources, and other resources needed to produce

different levels of outputs. Managerial cost

accounting also helps in making many budgetary

decisions such as those concerning future capital

expenditures and purchase/lease alternatives.

51. It is important to note that the Board's

authority does not extend to recommending

budgetary standards or budgetary concepts, and

that is not the purpose of this

statement.[Footnote 13] However, the Board is

committed to providing relevant and reliable cost

accounting information that supports budget

planning, formulation, and execution.

[Footnote 13: Memorandum of Understanding establishing

the FASAB, October 10, 1990.]

Cost Information for Management Purposes

52. Managerial cost accounting produces

information directly for management use, sometimes

employing data produced by the budgetary and

financial accounting processes. Cost information

is used for many different purposes which can be

generally classified into five types: performance
measurement; cost reduction and control;

determination of reimbursements and fee or price

setting; program authorization, modification, and

discontinuation decisions; and decisions to

contract out work or make other changes in the

methods of production.

53. To meet these needs, managerial cost

accounting should use basic cost data and nonfinancial or programmatic data. For example, it

tracks units of output produced and input used

including the amount of labor in terms of

employees or employee-hours. Sometimes,

information from cost analysis is used to compare

actual to predetermined or anticipated costs. An

organization may use cost estimates, cost studies,

and cost finding techniques.

54. While managerial cost accounting is concerned

not only with past costs and future costs, one of

its most important features is the use of present

costs to assist management. This current cost

aspect of managerial cost accounting is referred

to in the Objectives of Federal Financial

Reporting where is states that "accounting data

may be further assigned, allocated, or associated

with units of activity or production, segments of

organizations, etc., within the same time period.

These kinds of intraperiod allocations are

developed most extensively in the branch of

accounting called cost accounting. Neither the

FASB nor the GASB has devoted much attention to

this branch of accounting, but the FASAB, because

of its unique mission, will need to do

so."[Footnote 14] Managerial cost accounting

information pertaining to present costs is most

often used for controlling and reducing those

costs, controlling work processes, and measuring

current performance.

[Footnote 14: Statement of Federal Financial

Accounting Concepts No. 1, "Objectives of Federal

Financial Reporting," par. 174, page 56.]

Reporting Relationships
55. Proper financial management requires that the

three accounting processes work closely together

to provide useful reporting to both internal and

external users. The internal-external dual focus

of federal reporting has been established in the

Objectives of Federal Financial Reporting. It

states that "The FASAB and its sponsors believe

that any description of federal financial

reporting objectives should consider the needs of

both internal and external users and the decisions

they make." In addition, it says that "the

FASAB...considers the information needs of both

internal and external users. In part, this is

because the distinction between internal and

external users is in many ways less significant

for the federal government than for other

entities." It goes on to classify the users of

financial information into four major groups:

program managers, executives, the Congress, and

citizens.[Footnote 15] These categories include

both internal and external users.

[Footnote 15: Ibid., pars. 23, 25, page 9; and par.

75, page 26.]

56. Federal financial reporting encompasses

general and special purpose reports to meet the

needs of the four user groups. Information

produced by managerial cost accounting appears in

or influences both types of reports.[Footnote 16]

As discussed above, managerial cost accounting

should provide information for use by both

financial accounting and budgetary accounting.

That information is used by those processes in

producing both general purpose and special purpose

reports.

[Footnote 16: The types of general purpose and special

purpose reports are discussed in Statement of Federal

Financial Accounting Concepts No.1, "Objectives of

Federal Financial Reporting," Chapter 7.]

57. Managerial cost accounting also results in

reports of its own. Most often these are special

purpose reports designed for internal users,

typically program and line managers. However,
they may be for groups generally considered

external users.

58. One of the most important aspects of

reporting in which managerial cost accounting

plays a large role is that of performance

reporting. Measuring and reporting actual

performance against established goals is essential

to assess governmental accountability. Cost

information is necessary in establishing strategic

goals, measuring service efforts and

accomplishments, and relating efforts to

accomplishments. The importance of cost

information in relation to performance measurement

and performance reporting has been recognized in

the Objectives of Federal Financial Reporting,

which said "One reason for performing cost

accounting is to assist in performance

measurement" and it also stated that "The topics

of cost and performance measurement are related

because it is by associating cost with activities

or 'cost objectives' that accounting can make much

of its contribution to reporting on

performance."[Footnote 17]

[Footnote 17: Ibid., par. 174, page 56; and par. 192,

page 63.]

Basis of Accounting and

Recognition/Measurement Methods

59. Costs may be measured, analyzed, and reported

in many ways. A particular cost measurement has

meaning only when considering its purpose. The

measurement of costs can vary depending upon the

circumstances and purpose for which the

measurement is to be used. In Objectives of

Federal Financial Reporting, it is stated that

"the Board's own focus is on developing generally

accepted accounting standards for reporting on the

financial operations, financial position, and

financial condition of the federal government and

its component entities and other useful financial

information. This implies a variety of measures

of costs and other information that complements
the information available in the budget [emphasis

added]."[Footnote 18]

[Footnote 18: Ibid., par. 191, page 62.]

60. In addition, it is stated that "In defining

the proper measurement, assignment, and allocation

of cost for a given purpose, selecting the

appropriate accounting method and whether to use

full costing should be carefully

considered."[Footnote 19] Further, it added that

"The accrual basis of accounting generally

provides a better matching of costs to the

production of goods and services, but its use and

application for any given purpose must be

carefully evaluated."[Footnote 20]

[Footnote 19: Ibid., par. 196, page 64.]

[Footnote 20: Ibid., par. 197, page 64.]

61. Therefore, managerial cost accounting should

provide cost information using a basis of

accounting and recognition/measurement standards

that are appropriate for the intended use of the

information. When managerial cost accounting is

used to supply information for use by financial

accounting and financial reporting, that

information should be consistent with the basis of

accounting and recognition/measurement standards

required by federal accounting principles.

Traditionally this has meant the use of accrual

accounting and historical cost measurement,

particularly in general purpose reports.

62. When managerial cost accounting is used to

supply information for the preparation and review

of budgets, cost data should be consistent with

the basis of accounting and

recognition/measurement used in financial

reporting, but may be adjusted to meet the

budgetary information needs.

63. Special purpose cost studies and analyses are

sometimes performed for decision making. In those

studies and analyses, management may need to
develop cost data beyond those currently reported

in general purpose financial reports. For

example, in making planning decisions, management

may develop replacement costs and capital costs.

However, the basis and methods used should be

appropriate for the circumstances and consistent

with the intended purposes.

Reconciliation of Information

64. Different bases of accounting will produce

different costs for the same item, activity, or

entity. This can confuse users of cost

information. Therefore, reports that use

different accounting bases or different

recognition and measurement methods should be

reconcilable, and should fully explain those bases

and methods. Regardless of the type of report in

which it is presented, cost information should

ultimately be traceable back to the original

common data source.

65. To be reconcilable, the amount of the

differences in the information reported should be

ascertainable and the reasons for the differences

should be explainable. In some situations,

informational differences may be clearly

understandable without further explanation.

However, other cases may require a narrative

statement concerning the differences. In

complicated situations, a schedule or table may be

required to fully explain the differences.

66. Financial reporting has long recognized the

necessity for reconciliation between information

reported on different accounting bases.

Reconciliations have been required in federal

financial reports to show and explain significant

differences between budget reports and financial

statements prepared in accordance with generally

accepted accounting principles.

*******************************************************

MANAGERIAL COST ACCOUNTING STANDARDS
REQUIREMENT FOR COST ACCOUNTING

Each reporting entity [Footnote 21] should

accumulate and report the cost of its activities on a

regular basis for management information purposes.

Costs may be accumulated either through the use of cost

accounting systems or through the use of cost finding

techniques.

[Footnote 21: The term "reporting entity" as used in

this docoment conveys the same meaning as defined in

FASAB Statement of Recommended Accouynting Concepts No.

2, "Entity and Display" (May 1995).]

67. Cost information is essential to effective

financial management and should play an important

role in federal financial reporting. Managerial

cost accounting processes are the means of

providing cost information in an efficient and

reliable manner on a continuing basis.

Need for Consistent Cost

Accounting on a Regular Basis

68. To perform managerial cost accounting on a

"regular basis" means that entities should

establish procedures to accumulate and report

costs continuously, routinely, and consistently

for management information purposes. Consistent

and regular cost accounting is needed to meet the

second objective of federal financial reporting

which states information should be provided to

help the user determine the costs of providing

specific programs and activities and the

composition of, and changes in those costs. That

objective also requires the reporting of

performance information of federal programs and

the changes over time in that performance in

relation to the costs.

69. The requirement for managerial cost

accounting on a regular and consistent basis

supports recent legislative actions. The CFO Act

of 1990 states that agency CFOs shall provide for

the development and reporting of cost information
and the periodic measurement of performance. In

addition, the GPRA of 1993 requires each agency,

for each program, to establish performance

indicators and measure or assess relevant outputs,

service levels, and outcomes of each program as a

basis for comparing actual results with

established goals. The nature of these

legislative mandates requires reporting entities

to develop and report cost information on a

consistent and regular basis.

70. The managerial cost accounting processes

consist of collecting data from the common data

source, processing that data, and reporting cost

and output information in general purpose and

special purpose reports. Appropriate procedures

and practices should also be established to enable

the collection, measurement, accumulation,

analysis, interpretation, and communication of

cost information. This can be accomplished

through the use of a cost accounting system or the

use of cost finding techniques and other cost

studies and analyses. A cost accounting "system"

is an organized grouping of methods and activities

designed to consistently produce reliable cost

information.

Basic Cost Accounting Processes

71. Regardless of whether a reporting entity uses

a cost accounting system or cost finding

techniques, the methods and procedures followed

should be designed to perform at least a certain

minimum level of cost accounting and provide a

basic amount of cost information necessary to

accomplish the many objectives associated with

planning, decision making, control, and reporting.

The more important of these minimum criteria for

cost accounting are associated with the standards

in the remainder of this statement. Others are

also important.

 -- Responsibility Segments - Cost information

should be collected by responsibility

segments which have been identified by

management and outputs should be defined for
each responsibility segment.[Footnote 22]

[Footnote 22: See standard in this statement

concerning responsibility segments.]

 -- Full Costing - Each reporting entity should

measure the full cost of outputs so that

total operational costs and total unit costs

of outputs can be determined. "Full cost"

includes the cost of goods or services

provided by other entities when the

applicable criteria are met.[Footnote 23]

[Footnote 23: See standard concerning full costs and

standard concerning inter-entity costing.]

 -- Costing Methodology - The costing methodology

used (e.g., activity-based costing, job order

costing, standard costing, etc.) should be

appropriate for management's needs and the

operating environment.[Footnote 24]

[Footnote 24: See standard concerning costing

methodology.]

 -- Performance Measurement - Cost accounting

should provide information needed to

determine and report service efforts and

accomplishments and information necessary to

meet the requirements of the GPRA or

interface with a system that provides such

information. This includes the quantity of

inputs and outputs and other non-financial

information needed in the measurement of

performance.

 -- Reporting Frequency - Cost information should

be reported in a timely manner and on a

regular basis consistent with the needs of

management and the requirements of both

budgetary and financial reporting.

 -- Standard General Ledger - Managerial cost

accounting should be integrated with general

financial accounting. Both depend on the

standard general ledger for basic financial
transaction data.

 -- Precision of Information - Cost information

supplied to internal and external users

should be reliable and useful in making

evaluations or decisions. At the same time,

unnecessary precision and refinement of data

should be avoided.

 -- Special Situations - The managerial cost

accounting processes should be designed to

accommodate any of management's special cost

information needs that may arise due to

unusual or special situations or

circumstances. If such cost information is

needed on a regular basis, appropriate

procedures to provide it should be developed.

 -- Documentation - All managerial cost

accounting activities, processes, and

procedures should be documented by a manual,

handbook, or guidebook of applicable

accounting operations. This reference should

outline the applicable activities, provide

instructions for procedures and practices to

be followed, list the cost accounts and

subsidiary accounts related to the standard

general ledger, and contain examples of forms

and other documents used.

Complexity of Cost Accounting Processes

72. While each entity's managerial cost

accounting should meet the basics discussed above,

this standard does not specify the degree of

complexity or sophistication of any managerial

cost accounting process. Each reporting entity

should determine the appropriate detail for its

cost accounting processes and procedures based on

several factors. These include the:

 -- nature of the entity's operations;

 -- precision desired and needed in cost

information;
 -- practicality of data collection and

processing;

 -- availability of electronic data handling

facilities;

 -- cost of installing, operating, and

maintaining the cost accounting processes;

and

 -- any specific information needs of management.

73. Some entities may find that they can purchase

basic "off-the-shelf" cost accounting programs,

systems, or processes, or adapt those of other

federal agencies. All entities should consider

using similar or compatible cost accounting

processes throughout their component units to

facilitate comparison and consolidation of cost

information.

Cost Findings, Studies, and Analyses

74. A cost accounting system is a continuous

and systematic cost accounting process which may

be designed to accumulate and assign costs to a

variety of objects routinely or as desired by the

management. Such a system may be best for some

reporting entities.

75. Some entities may not need a sophisticated

system to perform detailed cost accumulation and

assignment. They need to accumulate and report

costs regularly as required by this standard, but

they may determine and analyze costs through

special cost studies and analyses. Also, some

entities may use a combination of a system

supplemented by cost studies.

76. Cost information may be developed and savings

achieved in some cases by the use of special cost

studies or cost analyses to develop information

helpful in certain decision making situations. In

addition, cost finding techniques may be used to

determine the cost of products or services. Cost

finding is a method for determining the cost of
producing goods or services using appropriate

procedures. Cost finding techniques may also be

useful for computing costs in cases where the

information is not needed on a recurring basis.

RESPONSIBILITY SEGMENTS

 Management of each reporting entity should define

and establish responsibility segments. Managerial cost

accounting should be performed to measure and report

the costs of each segment's outputs. Special cost

studies, if necessary, should also be performed to

determine the costs of outputs.

77. The standard states that the management of

each reporting entity should define and establish

responsibility segments. This section explains

the concept of responsibility segment, purposes of

segmentation, and how responsibility segments can

be structured.

Defining Responsibility Segments

78. A responsibility segment is a component of a

reporting entity[Footnote 25] that is responsible

for carrying out a mission, conducting a major

line of activity, or producing one or a group of

related products or services. In addition,

responsibility segments usually possess the

following characteristics:

[Footnote 25: The term "reporting entity" referred to

in this document conveys the same meaning as defined in

FASAB Statement of Recommended Accounting Concepts No.

2 Entity and Display (May 1995).]

 (1) Their managers report to the entity's

 top management directly;

 (2) Their resources and results of

 operations can be clearly distinguished

 from those of other segments of the
 entity.[Footnote 26]

[Footnote 26: These two characteristics make

responsibility segments, as the term is used in this

document, differ from cost centers. A cost center can

be at any level of an organization and may not report

to the top management directly. As will be explained

later, a responsibility segment can contain cost

centers in itself.]

79. A responsibility segment is a unit for

which managerial cost accounting is performed.

Entities may use a centralized accounting system

or segment-based systems to provide cost

information for each segment. For each segment,

managerial cost accounting should:

 (1) Define and accumulate outputs, and if

 feasible, quantify each type of output

 in units;

 (2) Accumulate costs and quantitative units

 of resources consumed in producing the

 outputs; and

 (3) Assign costs to outputs, and calculate

 the cost per unit of each type of

 output.

80. Some reporting entities may have only one

responsibility segment, if they perform one single

mission or one type of service. Other reporting

entities may have several responsibility segments.

Also, a sub-organization of the federal government

may be a reporting entity in itself and, at the

same time, it may also be a responsibility segment

of a higher level reporting entity to which it

belongs. The Forest Service, for example, may be

a reporting entity because it may meet the

reporting entity criteria. As such, it may

establish responsibility segments for itself. At

the same time, the Forest Service may be regarded

as a responsibility segment of the Department of

Agriculture, of which it is a component.

81. However, for a given reporting entity, its
management should establish one or more

responsibility segments to perform managerial cost

accounting functions.

Purposes of Segmentation

82. A basic purpose of dividing an entity into

segments is to determine and report the costs of

services and products that each segment produces

and delivers. Many federal departments and

agencies manage programs that produce a variety of

goods and services. Accounting for entity-wide

revenues and expenses in aggregate would serve

financial reporting for the entity, but would not

serve costing purposes. In order to determine

the cost of each type of service or product, it is

necessary to divide an entity into segments such

that each segment is responsible for certain types

of services or products. Each segment can then be

used as a vehicle for accumulating costs incurred

by the segment to match with its outputs. Each

segment can use a cost methodology that is best

suited to its operations.

83. Another important purpose of segmentation is

to facilitate cost control and management. Cost

information provided for each segment helps

managers to examine costs of specific resources

consumed and activities performed in each segment.

Managers can analyze cost variances in both

dollars and the units of resources consumed

against budgets or standards. Since each segment

performs a particular pattern of processes and

activities to produce its output, managers can

analyze those processes and activities to compare

their costs with the value they contribute to the

output.

84. For entities that consist of components

engaging in diverse lines of activities, it is

desirable to provide financial reports that

display information for significant components

individually and of the entity in its

entirety.[Footnote 27] Some entities may find

costs accumulated by segments useful in support of

financial reporting by components.
[Footnote 27: This point is discussed in FASAB

Statement of Recommended Accounting Concepts No. 2,

"Entity and Display," pars. 75-76, pages 25-26.]

85. For internal management, segmentation could

also facilitate performance measurement. Since

each segment is responsible for a mission, or a

line of activity to produce a certain type of

output, performance goals can be set for each

segment based on its specific tasks and operating

patterns. Information on costs, outputs, and

outcomes related to each segment can be used to

measure its performance against the goals. The

results of the segment performance measurement

could also support external reporting on

performance measures for the entire reporting

entity or its major programs.

Structuring Responsibility Segments

86. Reporting entity management should define

and structure its responsibility segments. The

designation of responsibility segments should be

based on the following factors: (a) the entity's

organization structure, (b) its lines of

responsibilities and missions, (c) its outputs

(goods or services it delivers), and (d) budget

accounts and funding authorities. However, the

predominant factor is the reporting entity's

organization structure and its existing

responsibility components, such as bureaus,

administrations, offices, and divisions within a

department.

87. The U.S. General Services Administration, for

example, provides five distinct services: (1)

managing public buildings, (2) distributing

supplies, (3) providing travel and transportation

services, (4) managing information resources

(including communication and data processing

services), and (5) disposal of real properties.

Each of those service areas could be designated as

a responsibility segment. The Department of

Veterans Affairs (VA), among its other services,

provides health care to veterans, pays veterans'
compensation and pension benefits, and provides

home loans and home loan guarantees to veterans.

Each of these program areas could constitute a

responsibility segment.

88. Since responsibility segments are major parts

of an entity, some segments may carry more than

one program. Some programs may be jointly managed

by two or more segments. Thus, each segment must

accumulate costs for each type of output produced

for various programs. To accomplish this, a

network of cost centers can be established within

a segment to accumulate costs. Managers of each

cost center will be provided with information to

control and manage costs within their area of

responsibility. Depending on operational patterns

and cost methods, cost centers can be structured

along different dimensions, such as organizational

units, operating processes, and activities.

FULL COST

Reporting entities should report the full costs of

outputs in general purpose financial reports. The full

cost of an output produced by a responsibility segment

is the sum of (1) the costs of resources consumed by

the segment that directly or indirectly contribute to

the output, and (2) the costs of identifiable

supporting services provided by other responsibility

segments within the reporting entity, and by other

reporting entities.

89. This standard states that reporting entities

should measure and report the full costs of their

outputs in general purpose financial reports.

"Outputs" means products and services generated

from the consumption of resources. The full cost

of a responsibility segment's output is the total

amount of resources used to produce the output.

This includes direct and indirect costs that

contribute to the output, regardless of funding

sources. It also includes costs of supporting

services provided by other responsibility segments
or entities. The standard does not require full

cost reporting in federal entities' internal

reports or special purpose cost studies. Entity

management can decide on a case-by-case basis

whether full cost is appropriate and should be

used for internal reporting and special purpose

cost studies.

Direct Costs

90. Direct costs are costs that can be

specifically identified with an output. All

direct costs should be included in the full cost

of outputs. Typical direct costs in the

production of an output include:

 (a) Salaries and other benefits for

 employees who work directly on the

 output;

 (b) Materials and supplies used in the work;

 (c) Various costs associated with office

 space, equipment, facilities, and

 utilities that are used exclusively to

 produce the output; and

 (d) Costs of goods or services received from

 other segments or entities that are used

 to produce the output (See discussions

 and explanations in the next section on

 "Inter-Entity Costs").

Indirect Costs

91. Indirect costs are costs of resources that

are jointly or commonly used to produce two or

more types of outputs but are not specifically

identifiable with any of the outputs. Typical

examples of indirect costs include costs of

general administrative services, general research

and technical support, security, rent, employee

health and recreation facilities, and operating

and maintenance costs for buildings, equipment,

and utilities. There are two levels of indirect
costs:

 (a) Indirect costs incurred within a

 responsibility segment. These indirect costs

 should be assigned to outputs on a cause-and-

 effect basis, if such an assignment is

 economically feasible, or through reasonable

 allocations. (See discussions on cost

 assignments in the "Costing Methodology"

 section.)

 (b) Costs of support services that a

 responsibility segment receives from other

 segments or entities. The support costs

 should be first directly traced or assigned

 to various segments that receive the support

 services. They should then be assigned to

 outputs.

92. A reporting entity and its responsibility

 segments may incur general management and

 administrative support costs that cannot be

 traced, assigned, or allocated to segments and

 their outputs. These unassigned costs are part of

 the organization costs, and they should be

 reported on the entity's financial statements

 (such as the Statement of Net Costs) as costs not

 assigned to programs.[Footnote 28]

[Footnote 28: A similar explanation is provided in

FASAB Statement of Recommended Accounting Concepts No.

2, Entity and Display, par. 95, page 33.]

Certain Cost Elements

93. Costs of Employees' Benefits

 Employee benefits include:

 (a) Health and life insurance benefits for

 current employees covered in part by the

 government's contribution to health and life

 insurance premiums;

 (b) Pension benefits for employees, their

 survivors, and dependents, covered by defined
 pension plans such as Civil Service

 Retirement System (CSRS), Federal Employees

 Retirement Plan (FERS), and Military

 Retirement System (MRS);

 (c) Health and life insurance benefits for

 retired employees, their survivors and

 dependents, covered in part by the

 government's contribution to health and life

 insurance premiums, and referred to as "other

 retirement benefits" (ORB) in this document;

 (d) Other postemployment benefits (OPEB) for

 terminated and inactive employees, which

 include severance payments, training and

 counseling, continued health care, and

 unemployment and workers compensation.

94. Most of the employee benefit programs are

covered by trust funds administered by the Office

of Personnel Management (OPM) and the Department

of Defense (DoD). Contributions to the trust

funds come from three sources: current and retired

employees, employing agencies, and direct

appropriations. The management expenses of the

trust funds are paid with the funds' receipts.

95. Federal financial accounting standards

require that the employing entity accrue the costs

to the federal government of providing pension and

ORB benefits to employees and recognize the costs

as an expense when the benefits are

earned.[Footnote 29] The employing entity should

recognize those expenses regardless of whether the

benefits are funded by the reporting entity or by

direct appropriations to the trust funds. This

principle should also be applied to health and

life insurance benefits for current employees and

comparable benefits for military personnel. The

costs of employee benefits incurred by

responsibility segments should be directly traced

or assigned to outputs.

[Footnote 29: FASAB Exposure Draft, "Accounting for

Liabilities of the Federal Government" (November 7,

1994), pars. 62-99, pages 26-46.]
96. OPEB costs include severance payments,

counseling and training, health care, and workers

compensation benefits paid to former or inactive

employees. OPEB costs are often incurred as a

result of such events as reductions in force or

on-the-job injuries of employees. Federal

financial accounting standards require that OPEB

costs be reported as an expense for the period

during which a future outflow or other sacrifice

of resources is probable and measurable on the

basis of events occurring on or before the

accounting date.[Footnote 30]

[Footnote 30: Ibid., pars. 100-102, page 47.]

97. Since the recognition of OPEB costs is linked

to the occurrence of an OPEB event rather then the

production of output, in many instances, assigning

OPEB costs recognized for a period to output of

that period would distort the cost of output. In

special purpose cost studies or cost findings,

management may distribute OPEB costs over a number

of years in the past to determine the costs of the

outputs that the OPEB recipients helped to

produce.

Costs of Public Assistance and Social Insurance

Programs

98. Major costs of welfare, insurance, and grant

programs are the costs of resources transferred

from the federal government to individuals and

state and local governments. Some of them are

referred to as "transfer payments." The following

are some typical public assistance and insurance

programs:

-- Grants, such as aid to state and local

governments;

 -- Subsidies, such as agricultural commodity

price support and stabilization programs;

 -- Credit and insurance costs, such as the

Family Education Loan Program and Savings
Association Insurance;

 -- Welfare payments such as Aid to Families with

Dependent Children (AFDC); and,

 -- Social insurance, such as the Old Age,

Survivors, and Disability Insurance

Program.

99. The full cost of such a program includes: (a)

the costs of federal resources that have been or

will be transferred to individuals and state/local

governments, and (b) the costs of operating the

programs. These two types of costs should be

recognized on a basis of accounting that is

prescribed within the Federal Financial Accounting

Standards. These two types of costs should be

separately identified so that each can be used for

different analytic purposes.

100. The costs resulting from transfer payments

are determined by the level of grants, subsidies,

entitlement benefits, credit subsidies, or loss

payments made under insurance and guarantee

agreements. They are also determined by the

number of eligible persons who receive the

transfer payments. The program cost of AFDC, for

example, depends on the average payment per

family, the number of eligible families, and the

federal government's share in the payments (some

payments are made by state and local governments).

Information on this type of cost is useful for

making policy decisions about levels of subsidies

or benefits, eligibility of recipients, and how

transfer payments are made. This cost information

is also useful for measuring the costeffectiveness of a transfer payment program.

101. Program operating costs, on the other hand,

are costs of managing the program and delivering

the payments. They include the costs of

personnel, supplies, equipment, and offices. The

costs are related to such activities as screening

benefit recipients for eligibility, keeping their

accounts, making payments and collections,

answering inquiries, etc. Information on this
type of cost is useful in measuring the efficiency

of program operations.

Costs related to Property, Plant and Equipment

102. Depreciation expense. General property,

plant, and equipment are used in the production of

goods and services. Their consumption is

recognized as depreciation expense. The

depreciation expense incurred by responsibility

segments should be included in the full costs of

the goods and services that the segments produce.

103. Recognizing property acquisition costs as

expenses. The costs of acquiring or constructing

federal mission and heritage property, plant, and

equipment may be charged to expenses at the time

the acquisition costs are incurred.[Footnote 31]

Since the recognition of these expenses is linked

to property acquisition rather than production of

goods and services, those expenses should not be

included in the full costs of goods and services.

However, they are part of the costs of the entity

or the program that makes the property

acquisitions.

[Footnote 31: In FASAB Exposure Draft, "Accounting for

Property, Plant, and Equipment," the Board proposed

that the costs of acquiring or constructing "federal

mission" and "heritage" property, plant, and equipment

be recognized as expenses when the costs are incurred.

See the ED, pars. 98-117, pages 29-34.]

Non-production costs

104. A responsibility segment may incur and

recognize costs that are linked to events other

than the production of goods and services. Two

examples of these non-production costs were

discussed earlier: (1) OPEB costs that are

recognized as expenses when an OPEB event occurs,

and (2) certain property acquisition costs that

are recognized as expenses at the time of

acquisition. Other non-production costs include

reorganization costs, and nonrecurring cleanup

costs resulting from facility abandonments that
are not accrued. Since these costs are recognized

for a period in which a particular event occurs,

assigning these costs to goods and service

produced in that period would distort the

production costs. In special purpose cost

studies, management may have reasons to determine

historical output costs by distributing some of

these costs to outputs over a number of past

periods. Such distribution may be appropriate

when: (a) experience shows that the costs are

recurring in a regular pattern, and (b) a nexus

can be established between the costs and the

production of outputs that may have benefited from

those costs.

INTER-ENTITY COSTS

Each entity's full cost should incorporate the

full cost of goods and services that it receives from

other entities. The entity providing the goods or

services has the responsibility to provide the

receiving entity with information on the full cost of

such goods or services either through billing or other

advice.

Recognition of inter-entity costs that are not

fully reimbursed is limited to material items that (1)

are significant to the receiving entity, (2) form an

integral or necessary part of the receiving entity's

output, and (3) can be identified or matched to the

receiving entity with reasonable precision. Broad and

general support services provided by an entity to all

or most other entities should not be recognized unless

such services form a vital and integral part of the

operations or output of the receiving entity.

105. As stated in the preceding standard, to fully

account for the costs of the goods and services

they produce, reporting entities should include

the cost of goods and services received from other

entities. Knowledge of these costs is helpful to

top level management in controlling and assessing

the operating environment. It is also helpful to
other users in evaluating overall program costs

and performance and in making decisions about

resource allocations and changes in programs.

Inter-Entity Activities

106. Within the federal government, some reporting

entities rely on other federal entities to help

them achieve their missions. Often this involves

support services, but may include the provision of

goods. Sometimes these arrangements may be

stipulated by law, but others are established by

mutual agreement of the entities involved. Such

relationships can be classified into two types

depending upon funding methods.

-- Provision of goods or services with

reimbursement -- In this situation, one

entity agrees to provide goods or

services to another with reimbursement

at an agreed-upon price. The

reimbursement price may or may not be

enough to recover full costs. Usually

the agreement is voluntarily established

through an inter-agency agreement.

Revolving funds can also be included in

this group, because they are usually

established to recover costs through

sale of their outputs to other

government entities. They are usually

meant to be self-sustaining through

their sales, without receiving

additional appropriations. However,

they do not always charge enough to

cover full costs.

-- Provision of goods or services without

reimbursement -- One entity provides

goods or services to another entity free

of charge. The agreement may be

voluntary, legally mandated, or

inherently established in the mission of

the providing entity.

107. Recently, consideration has been given to
expanding the concept of inter-entity support

within the federal government. Under this

concept, entities could sell their outputs on a

competitive basis. Entities would have the

authority to purchase goods or services from any

federal or private provider. This is seen as a

way to improve government efficiency through

competition since inefficient government providers

would be forced to improve or stop providing these

goods or services. This could result in

consolidating support services in fewer

governmental entities. Underlying this concept is

the requirement that all costs be recognized in

developing the price at which goods and services

would be sold to other entities.

 Accounting and Implementation Guidance

108. If an entity provides goods or services to

another entity, regardless of whether full

reimbursement is received, the providing entity

should continue to recognize in its accounting

records the full cost of those goods or services.

The full costs of the goods or services provided

should also be reported to the receiving entity by

the providing entity.

109. The receiving entity should recognize in its

accounting records the full cost of the goods or

services it receives as an expense or, if

appropriate, as an asset (such as work-in-process

inventory). The information on costs of nonreimbursed or under-reimbursed goods or services

should be available from the providing entity.

However, if such cost information is not provided,

or is partially provided, a reasonable estimate

may be used by the receiving entity. The estimate

should be of the cost of the goods or services

received (the estimate may be based on the market

value of the goods or services received if an

estimate of the cost cannot be made). To the

extent that reimbursement is less than full cost,

the receiving entity should recognize the

difference in its accounting records as a
financing source.[Footnote 32] Inter-entity

expenses/assets and financing sources would be

eliminated for any consolidated financial

statements covering both entities.

[Footnote 32: See Statement of Recommended Federal

Accounting Concepts No. 2, Entity and Display, par. 65,

page 21. See also, FASAB Exposure Draft, Accounting

for Liabilities of the Federal Government, pars. 62-99,

pages 26-46, which addresses accounting for pensions

and other retirement benefits (ORB). The payment of

pension and ORB costs for an entity by another entity

has often been likened to providing goods and services.

In the case of pensions, employees of the reporting

entity provide services to that entity and part of the

salary-related cost is paid by a different entity. The

pension administering entity does not provide goods or

services to the reporting entity (other than normal

pension administration services), but rather pays their

costs directly. The difference is subtle but

important. However, the accounting is similar. This

document is consistent with the section of the

liabilities exposure draft dealing with accounting for

pensions and other retirement benefits.]

110. Implementation of this standard on interentity costing should be accomplished in a

practical and consistent manner by the various

federal entities. Therefore, the Office of

Management and Budget, with assistance from the

FASAB staff, should identify the specific interentity costs for entities to begin recognizing.

OMB should then issue guidance identifying these

costs. These particular inter-entity costs should

be specified in accordance with this standard

including the recognition criteria presented

below. The OMB should consider information and

advice from Treasury, GAO, and other agencies in

developing the implementation guidance. It is

anticipated that the largest and most important

inter-entity costs will be identified first. As

entities gain experience in the application of the

standard, recognition of other inter-entity costs

may be specified in future guidance or required by

future standards.
Recognition Criteria

111. Ideally, all inter-entity costs should be

recognized. This is especially important when

those costs constitute inputs to government goods

or services provided to non-federal entities for a

fee or user charge. The fees and user charges

should recover the full costs of those goods and

services.[Footnote 33] Thus, the cost of interentity goods or services needs to be recognized by

the receiving entity in order to determine fees or

user charges for goods and services sold outside

the federal government. Such recognition,

however, should be made in accordance with the

implementation guidance issued by OMB as discussed

above.

[Footnote 33: OMB Circular A-25 addresses user charges

by federal entities.]

112. However, the situation is often different

with goods or services transferred within the

federal government that do not involve eventual

sales to entities outside the federal government.

The federal government in its entirety is an

economic entity. Therefore, it is reasonable to

expect some flow of goods or services between

reporting entities as those entities assist each

other in fulfilling their missions and operating

objectives. There are some cases in which the

cost of non-reimbursed or under-reimbursed goods

or services received from other entities need not

be recognized as part of the cost of the receiving

entity. The following general criteria are

provided to help in determining the types of --

inter-entity costs that should or should not be

recognized.

 -- Materiality -- As with other accounting

standards, the provisions of this standard

need not be applied to immaterial items.

However, in the context of deciding which

inter-entity transactions are to be

recognized, materiality, as used here, is

directed to the individual inter-entity
transaction rather than to all inter-entity

transactions as a whole. Under this concept,

a much more limited recognition is intended

than would be achieved by reference to the

general materiality concept.

In this context, then, materiality should be

considered in terms of the importance of the

inter-entity transaction to the receiving

entity. The importance of the transactions,

and thereby their recognition, should be judged

in light of the following factors:

* Significance to the entity -- The cost of the

good or service is large enough that

management should be aware of the cost when

making decisions.

* Directness of relationship to the entity's

operations -- The good or service provided is

an integral part of and necessary to the

output produced by the entity.

* Identifiability -- The cost of the good or

service provided to the entity can be matched

to the entity with reasonable precision.

The determination of whether the cost is

material requires the exercise of considerable

judgment, based on the specific facts and

circumstances of each transaction.

 -- Broad, general support -- Some entities

provide broad, general support to many, if

not all, reporting entities in the federal

government. Most often this type of support

involves the establishment of policies and/or

the provision of general guidance. The costs

of such broad services should not be

recognized as an expense (or asset) by the

receiving entities when there is no

reimbursement of costs. Thus the standard

does not apply when support is of a general

nature provided to all or most entities of

the federal government.
An example of this situation can be found in

the Office of Management and Budget which

establishes policy and provides general

guidance to all parts of the executive branch

of government. The costs of OMB should not be

spread over all reporting entities because the

services provided are (1) general and broad in

scope, (2) provided to almost all reporting

entities in the executive branch, and (3) not

specifically or directly tied to the receiving

entity's outputs.

On the other hand, some services provided,

under certain circumstances, should still be

recognized even though they may be considered

broad and general in nature if such services

are integral to the operations of the receiving

entity. Such services include check writing by

the Department of Treasury or legal activities

performed by the Department of Justice. For

example, when the issuance of checks is

integral to the operations of an entity (e.g.,

the Internal Revenue Service and the Social

Security Administration), the receiving entity

should include the full cost of issuing checks

in the full cost of its outputs. However, if

the issuance of checks is insignificant and

incidental to the operations of an entity, the

entity should not normally recognize that cost.

113. The decision as to whether the cost of nonreimbursed or under-reimbursed goods and services

should be recognized requires the use of

judgement. None of the criteria listed above are,

by themselves, fully or exclusively determinative.

They should be considered in combination.

Ultimately, inclusion or exclusion of the cost

should be decided based on the specific facts and

circumstances of each case, with consideration of

the degree to which inclusion or exclusion would

change or influence the actions and decisions of a

reasonable person relying on the information

provided.

Accounting Example
114. The following tables provide an example of

the accounting entries to be made when the

receiving entity (Agency R) recognizes an expense

for services received from a providing entity

(Agency P) on a non-reimbursable basis. In the

example, the full costs of these services to

Agency P are $100,000.

115. Agency R recognizes an "Expense of services

provided by Agency P" equal to the full cost of

the services received. It also recognizes a

financing source, "Services provided by Agency P,"

equal to the amount not reimbursed, which in this

case is the full $100,000. Agency P recognizes an

"Expense of services provided to Agency R" equal

to the full cost of the services provided with a

credit to "Appropriations used."

 Table 1: Agency R's Accounting Entries *

 Debit Credit

Expense of services

 provided by Agency P: $100,000

Services provided by

 Agency P: $100,000

* This example shows the cost recognized as an expense.

However, as discussed in the text, it may be an asset.

 Table 2: Agency P's Accounting Entries

 Debit Credit

Expense of services

 provided to Agency R: $100,000

Appropriated capital $100,000

Fund balance with

 Treasury $100,000

Appropriated capital

 used $100,000
COSTING METHODOLOGY

Costs of resources consumed by responsibility

segments should be accumulated by type of resource.

Outputs produced by responsibility segments should be

accumulated and, if practicable, measured in units.

The full costs of resources that directly or indirectly

contribute to the production of outputs should be

assigned to outputs through costing methodologies or

cost finding techniques that are most appropriate to

the segment's operating environment and should be

followed consistently.

The cost assignments should be performed by the

following methods listed in the order of preference:

(a) directly tracing costs wherever feasible and

economically practicable, (b) assigning costs on a

cause-and-effect basis, or (c) allocating costs on a

reasonable and consistent basis.

116. This standard addresses two aspects of

costing: cost accumulation and cost assignment.

Each of them is explained and discussed below.

Cost Accumulation

117. Cost accumulation is the process of

collecting cost data in an organized way. The

standard requires that costs be accumulated by

responsibility segments. The accumulation is for

costs incurred within each responsibility segment,

and does not involve the assignment or allocation

of costs incurred by other supporting segments,

which will be discussed in the latter part of this

section.

118. In the section of this document relating to

"Responsibility segments," it was explained that:

"A responsibility segment is a component of a

reporting entity, that is responsible for carrying

out a mission, conducting a major line of
activity, or producing one or a group of related

products or services." The accumulation of costs

by responsibility segments does not mean that each

responsibility segment must have its own

accounting system. The reporting entity may have

a centralized accounting system, but the system

should be capable of identifying costs with

responsibility segments.

119. This standard also requires that the

accumulated costs be classified by type of

resource, such as costs of employees, materials,

capital, utilities, rent, etc. When appropriate

and cost effective, information on quantitative

units related to various cost categories should be

maintained. For example, staff-days may be

reported for staff salaries and benefits, and

gallons of gasoline consumed for gasoline costs.

The quantitative units are useful for cost

assignments, and are indispensable for measuring

efficiency in using resources.

Cost Assignment

120. The term "cost assignment" refers to the

process that identifies accumulated costs with

reporting periods and cost objects. The

assignment of costs to time periods is to

recognize costs either as expenses or assets for

each reporting period. It is governed by

accounting standards on recognition of assets and

expenses, and will not be addressed in this

document. This section addresses cost assignment

to cost objects. The word "assignment" used in

this document includes various methods of

attributing costs, such as direct tracing, causeand-effect basis, and cost allocations.

121. The term "cost object" refers to an activity

or item whose cost is to be measured.[Footnote 34]

In a broad sense, a cost object can be an

organizational division, program, activity, task,

product, service, or customer. However, the

purpose of cost accounting by a responsibility

segment is to measure the costs of its outputs.

Thus, the final cost objects of a responsibility
segment are its outputs: the services or products

that the segment produces and delivers, the

missions or tasks that the segment performs, or

the customers or markets that the responsibility

segment serves. There may be intermediate cost

objects that are used in the course of the cost

assignment process.

[Footnote 34: Some literature, the CASB pronouncements

for example, use the term "cost objective" for the same

meaning.]

122. Some responsibility segments of an entity may

provide supporting services or deliver

intermediate products to other segments within the

same entity. The costs of the supporting services

and intermediate products should be assigned to

the segments that receive the services and

products. This is referred to as the intra-entity

cost assignments. Also, in accordance with the

inter-entity cost standard discussed in the

preceding section, an entity should recognize

inter-entity costs for goods and services received

from other federal entities. The inter-entity

costs should also be assigned to the

responsibility segments that use the inter-entity

services and products.

123. Thus, with respect to each responsibility

segment, the costs that are to be assigned to

outputs include: (a) direct and indirect costs

incurred within the responsibility segment, (b)

costs of other responsibility segments that are

assigned to the segment, and (c) inter-entity

costs recognized by the receiving entity and

assigned to the segment. If a responsibility

segment produces one kind of output only, costs of

resources used to produce the output are assigned

to the output.

124. This standard is intended to establish a

principle, rather than a methodology, for cost

assignment. Also cost assignments may be

performed in cost findings and studies or may be

performed within a system on a regular basis. In

principle, costs should be assigned to outputs in
one of the methods listed below in the order of

preference:

 (a) Directly tracing costs wherever economically

 feasible;

 (b) Assigning costs on a cause-and-effect basis;

 and

 (c) Allocating costs on a reasonable and

 consistent basis.

125. These principles apply to all levels of cost

assignments including: (1) assigning inter-entity

costs to segments, (2) assigning the costs of

support services and intermediate products among

segments of an entity (the intra-entity cost

assignments), and (3) assigning direct and

indirect costs to outputs.

Directly tracing costs to outputs

126. Direct tracing applies to resources that are

directly used in the production of an output.

Examples of such resources include materials that

are used in the production, employees who directly

worked on the output, facilities and equipment

used exclusively in the production of the output,

and goods or services received from other entities

that are directly used in the production of the

output.

127. The method of direct cost tracing usually

relies on the observation, counting, and/or

recording of the consumption of resource units,

such as staff hours or days that are spent on a

project or assignment, or gallons of fuel consumed

in a transport mission. Direct tracing also

applies to specific resources that are dedicated

to particular outputs.

128. Direct cost tracing often minimizes

distortion and ensures accuracy in cost

assignments. However, it can be a relatively

costly process. It should be applied only to

items that account for a substantial portion of
the cost of an output and only when it is

economically feasible. For example, it is usually

unnecessary to trace the cost of office supplies

(pens, papers, computer disks, etc.) to various

activities or outputs. The cost of so doing

usually outweighs the benefit of the increased

accuracy in assigning the resources.

 Assigning costs on a cause-and-effect basis

129. For the costs that are not directly traced to

outputs, it is preferable that they be assigned to

them on a cause-and-effect basis. As mentioned

earlier, the ultimate cost objects of a

responsibility segment are its outputs. For costs

that are not traced to the ultimate objects

(outputs), intermediate objects can be established

as links between resource costs and outputs. The

links reflect a cause-and-effect relationship

between resource costs and outputs. Costs that

have a similar cause-and-effect relationship to

outputs can be grouped into cost pools. (This

similar relationship is referred to in some

literature as the "cost pool homogeneity

concept.")

130. Activities or work elements that contribute

to or support the production of outputs are

commonly used as intermediate objects. This is

based on the premise that on one hand, outputs

require the performance of certain activities, and

on the other hand the activities cause costs.

Thus, an activity is considered a linkage between

the cause and the effect. (See also, discussions

on Activity-Based Costing later in this section.)

In its policy statement, the Cost Accounting

Standards Board expressed a similar view:

 "The preferred presentation of the

 relationship between the pooled cost and the

 benefiting cost objectives is a measure of

 the activity (input) of the function or

 functions represented by the pool of cost.

 This relationship can be measured in
 circumstances where there is direct and

 definitive relationship between the function

 or functions and the benefiting cost

 objectives."[Footnote 35]

[Footnote 35: Cost Accounting Standards Board,

Restatement of Objectives, Policies and Concepts, par.

2915.]

131. For example, a computer technology department

provides technical support to other departments of

an organization. The costs of the department may

be assigned to other departments on a cause-andeffect basis through two steps. In the first

step, the costs are assigned to the activities of

the department, such as hardware installation and

maintenance, software design and installation, or

programming adjustments. In the second step, the

costs of these activities are further assigned to

other departments based on their consumption of

the technical services.

132. Sometimes, an intermediate product, rather

than an activity, can be used as a link between

the costs and outputs. For example, a hospital

laboratory's costs can first be assigned to

various medical tests it runs. The costs of the

tests can then be assigned to the operating units

of the hospital that ordered the tests.

Allocating costs

133. Sometimes, it might not be economically

feasible to directly trace or assign costs on a

cause-and-effect basis. These may include general

management and support costs, depreciation, rent,

maintenance, security, and utilities associated

with facilities that are commonly used by various

segments.

134. These supporting costs can be allocated to

segments and outputs on a prorated basis. The

cost allocations may involve two steps. The first

step allocates the costs of support services to

segments, and the second step allocates those

costs to the outputs of each segment. The cost
allocations are usually based on a relevant common

denominator such as the number of employees,

square footage of office space, or the amount of

direct costs incurred in segments.

135. Suppose the total cost of a personnel

department for a fiscal year is $500,000, and it

is allocated to two segments based on the number

of employees of the two segments: segment A has

300 employees, and segment B has 200 employees.

On the prorated basis, segment A should be

allocated 60 percent, or $300,000 of the personnel

cost, and segment B should be allocated 40

percent, or $200,000 of the personnel department

cost. The allocation is shown below:

 Table 3: The Allocation of the

 Personnel Dept. Costs

Segment Employees Percent Allocated amount

A 300 60 $300,000

B 200 40 $200,000

Total 500 100 $500,000

136. For cost allocation purposes, indirect costs

may be grouped into pools, and each pool is

subject to one allocation base. Costs grouped

into one pool should have similar characteristics.

The allocation base should be used consistently to

allow cost comparison from one period to another.

137. Cost allocation is a relatively simple method

of assigning indirect costs to cost objects.

Users of the cost information should be aware that

distortions in product costing often result from

arbitrary cost allocations. In most cases, there

is little correlation between an indirect cost and

the allocation base, and the allocation is

arbitrary. To assist cost analyses and cost

findings, cost accounting should segregate costs

that are traced or assigned to outputs from costs

that are allocated to outputs.

Assigning common costs
138. Facility and personnel resources may be

shared by two or more activities either at the

same time or in different times during a fiscal

year. For example, a military aircraft maintained

for war readiness may be used in peacetime to

transport cargo. As another example, a plant may

be used to process two or more products.

139. The cost assignment principles discussed in

this section should apply to assigning costs to

activities or outputs that share the use of

resources. Costs that can be traced to each of

the activities (or outputs) should be assigned to

them directly. These include direct operating

costs of each of the activities. For the military

aircraft used in peacetime to transport cargo, for

example, the costs of fuel and supplies,

additional personnel who worked on the cargo, and

other costs incidental to the transportation

should be directly assigned to the transportation

services.

140. To determine the full cost of each of the

activities or outputs that share resources,

indirect common costs should be assigned to those

activities. The term "common costs" refers to the

costs of maintaining and operating facilities and

other resources that cannot be directly traced to

any one of the activities or outputs that share

the resources.[Footnote 36 Common costs should be

assigned to activities either on a cause-andeffect basis, if feasible, or through reasonable

allocations.

[Footnote 36: This definition is adapted from

Statement No. 1 on Management Accounting: Management

Accounting Glossary, published by the National

Association of Accountants (Montvale, New Jersey:

1991), page 15.]

141. Sometimes management may find it useful to

designate primary and secondary activities that

share resources. Primary activity is the primary

purpose or mission for which the resources are

made available. Secondary activities are those
activities that are performed only if they will

not interfere with the primary activity.

Management can then determine two types of costs:

(1) the costs that are necessary for the primary

activity and are unavoidable even without the

secondary activities, and (2) the costs that are

caused by the secondary activities and are

incremental to the costs of the primary activity.

This type of cost information can be produced

through cost findings, and may help management in

making resource allocation and capacity

utilization decisions.

Cost-benefit considerations

142. Throughout the discussions of this section,

it is stated that a cost accumulation and

assignment method would be used when it is

economically feasible. A method is economically

feasible if the benefits resulting from

implementing the method outweigh its costs. It is

not advantageous to use a costing method if it

requires a large amount of resources and yet

produces information of little value to users.

143. As a general rule, directly tracing costs and

assigning costs on a cause-and-effect basis are

more expensive than cost allocations, because they

require detailed analyses and record-keeping for

costs and activities. However, they are

preferable because they produce more reliable cost

information than cost allocations.

Selecting a Costing Methodology

144. This standard does not require the use of a

particular type of costing system or costing

methodology. Federal entities are engaged in a

broad range of diverse operations. A costing

system appropriate for one type of operation may

not be appropriate for other operations. At many

federal agencies, cost accounting practices are

either relatively new or experimental. It is too

early to tell which cost systems are best for

specific types of operations. As experience and

research in cost accounting progress, reporting
entities and responsibility segments may find a

preferred costing methodology for their

operations.

145. Agency and program management is in the best

position to select a type of costing system that

would meet its needs. In making the selection,

management should evaluate alternative costing

methods and select those that provide the best

results under its operating environment.

146. The standard requires that a costing

methodology, once adopted, be used consistently.

Consistent use provides cost information that can

be compared from year to year. However, this

requirement does not preclude necessary

improvements and refinements to the system or

methodology, so long as the effect of any change

is documented and explained. On the contrary,

improvements are encouraged.

147. Several costing methodologies have been

successful in the private sector and in some

government entities. Four are briefly described

below for agency consideration. It should be

noted in particular that activity-based costing

has gained broad acceptance by manufacturing and

service industries as an effective managerial

tool. Federal entities are encouraged to study

its potential within their own operations. In the

following paragraphs, activity-based costing will

be introduced with other well known costing

methodologies, namely job order costing and

process costing. Standard costing is also

mentioned as an important cost management tool.

It is important to note that those costing

methodologies are not mutually exclusive. Both

activity-based costing and standard costing can be

applied to job order or process costing systems.

Activity-based costing (ABC)

148. ABC focuses on the activities of a production

cycle, based on the premises that (a) an output

requires activities to produce, and (b) activities
consume resources. ABC systems use cost drivers

to assign costs through activities to outputs.

The ABC cost assignment is a two-stage procedure.

The first stage assigns the costs of resources to

activities and the second stage assigns activity

costs to outputs. The procedure is illustrated in

the following figure.[Footnote 37]

[Footnote 37: The figure and the accompanying

discussions are based on Robin Cooper, Robert S.

Kaplan, Lawrence S. Maisel, Eileen Morrissey, and

Ronald M. Oehm, Implementing Activity-Based Cost

Management (Montvale, NJ: Institute of Management

Accountants, 1992), pages 9-1.]

Figure 2: The Activity-Based

Two Stage Costing Procedure

RESOURCES ...(first stage)....ACTIVITIES

ACTIVITIES...(second stage)...OUTPUTS

149. Implementing an ABC system requires four

major steps: (1) identify activities performed in

a responsibility segment to produce outputs, (2)

assign or map resources to the activities, (3)

identify outputs for which the activities are

performed, and (4) assign activity costs to the

outputs. Each of the steps is briefly explained

below.

(1) Identify activities. This step requires an

in-depth analysis of the operating processes

of each responsibility segment. Each process

may consist of one or more activities

required by outputs. Activities may be

classified into unit-level, batch-level,

product sustaining, and facility sustaining

activities.{Footnote 39] Management may

combine related small activities into larger

activities to avoid excessive costing

efforts.

[Footnote 39: Cooper, Kaplan, et. al., page 20.]
(2) Assign resource costs to activities. This

step assigns resource costs to the

activities identified in step 1. The

resource costs include direct and indirect

costs usually recorded in general ledger

accounts. Depending on feasibility and costbenefit considerations, resource costs may be

assigned to activities in three ways: (a)

direct tracing; (b) estimation based on

surveys, interviews, or statistical sampling;

or (c) allocations.

(3) Identify outputs. This step identifies all

of the outputs for which activities are

performed and resources are consumed by a

responsibility segment. The outputs can be

products, services, or customers (persons or

entities to whom a federal agency is required

to provide goods or services). Omitting any

output would result in overcharging costs to

other outputs.

(4) Assign activity costs to outputs. In this

step, activity costs are assigned to outputs

using activity drivers. Activity drivers

assign activity costs to outputs based on

individual outputs' consumption or demand for

activities. For example, a driver may be the

number of times an activity is performed in

producing a specific type of output (the

transaction driver), or the length of time an

activity is performed (the duration driver).

150. ABC can be used in conjunction with job

 order costing or process costing. For example,

 making direct loans to the public involves a series

of processes, such as loan origination, credit review

for individual applicants, preparing loan

documents, valuation of collateral, making loan

disbursements, computing fees and periodic

payments, keeping records, and making collections.

These are the "first category" activities that

directly affect individual loans. ABC can be

applied to this category of activities.
151. The direct loan operations also involve

"second category" activities, such as those

performed by loan officers to review and assess a

portfolio of loans and make policy changes that

affect an entire portfolio. If ABC is not used,

the costs of the loan officers may be allocated to

direct loans based on the number of loans

disbursed, or based on the staff hours spent on

processing all the loans. However, such an

allocation tends to be arbitrary, because some

loans require more of their time than others.

Under ABC, the costs of loan officers would first

be assigned to their portfolio review and workout

activities that they perform, then the activity

costs would be assigned to the groups of loans for

which the activities are performed.

152. A major advantage of using ABC is that it

avoids or minimizes distortions in product costing

that result from arbitrary allocations of indirect

costs. By tracing costs through activities, ABC

provides more accurate service or product costs.

Experience in the private sector shows that by

providing accurate cost measures, ABC has helped

improve product costing, strategic pricing, and

profit planning.

153. Also important is that ABC encourages

management to evaluate the efficiency and costeffectiveness of activities. Some ABC systems

rank activities by the degree to which they add

value to the organization or its outputs.

Managers use such value rankings to focus their

cost reduction programs. ABC encourages

management to identify and examine (a) what

activities are really needed (value-added

activities) in order to accomplish a mission,

deliver a service, or meet customer demand, (b)

how activities can be modified to achieve cost

savings or product improvements, and (c) what

activities do not actually add value to services

or products (non-value-added activities). ABC

integrates with cycle time analysis and valueadded analysis.
 Job order costing

154. Job order costing is a costing methodology

that accumulates and assigns costs to discrete

jobs. The word "jobs" refers to products,

projects, assignments, or a group of similar

outputs.

155. Each job has a number or code to accumulate

costs. Resources spent are identified with the

job code. Costs are traced to individual jobs to

the extent economically feasible. Costs that

cannot be directly traced are assigned to jobs

either on a cause-and-effect basis or allocation

basis.

156. Job order costing is appropriate for

responsibility segments that produce special order

products, or perform projects and assignments that

differ in duration, complexity, or input

requirements. Typical situations in the federal

government in which job order costing would be

appropriate are legal cases, audit assignments,

research projects, and repair work for ships,

aircraft, or vehicles.

 Process costing

157. Process costing is a method that accumulates

costs by individual processing divisions

(organization divisions that perform production

processes). These processing divisions are

involved in a continuous production flow, with

each division contributing towards the completion

of the end products. The output of a processing

division either becomes the input of the next

processing division or becomes a part of the end

product.

158. Each division accumulates costs, assigns the

costs to its outputs, and calculates the unit cost

of its output. For each period, divisions prepare

a cost and production report, showing the costs,

the completed units, and the work-in-process

volume. When a certain number of completed units

are transferred from a division to the next
division, the costs of those units are also

transferred and are eventually incorporated into

the costs of the end product. Thus, the cost flow

follows the physical flow of the production. The

unit cost of the end product is the sum of the

unit costs of all the divisions.

159. Process costing is appropriate for production

of goods or services with the following

characteristics: (a) the production involves a

regular pattern of process, (b) its output

consists of homogeneous units, and (c) all units

are produced through the same process procedures.

In the private sector, process costing is used by

such industries as flour mills, steel foundries,

oil refineries, and chemical processing plants.

In government, it may be used by some activities

that involve repetitive process procedures to

deliver a large volume of similar goods or

services. An example would be making entitlement

benefit payments, which involves a series of

consecutive processes for reviewing applications

to establish their eligibility, computing the

amount of benefits, and issuing checks.

 Standard costing

160. Standard costs are carefully predetermined or

expected costs that can be applied to activities,

services, or products on a per unit basis.

Horngren describes standard costing as follows:

"A set of standards outlines how a task

should be accomplished in nonfinancial terms

(minutes, board feet) and how much it should

cost. As work is being done, actual costs

incurred are compared with standard costs for

various tasks or activities to reveal

variances. This feedback helps discover

better ways of adhering to standards, of

altering standards, and of accomplishing

objectives."[Footnote 39]

[Footnote 39: Horngren, Charles T. and George Foster,

Cost Accounting, A Managerial Emphasis, 7th ed.

(Prentice Hall, Englewood Cliffs: New Jersey, 1991),
page 222.]

161. Many organizations frequently review and

update the standards to assure that they encourage

improvements in efficiency and are within an

attainable range.

162. Standard costing helps managers to formulate

budgets, control costs, and measure performance.

It can be used in conjunction with job order

costing, process costing, and activity-based

costing. It can be applied to specific outputs or

activities, and it can also be applied to a

responsibility segment in aggregate by comparing

total actual costs with total standard costs based

on outputs produced within a certain time period.

Typical situations in the federal government in

which standard costing would be appropriate are

operations that produce services or products on a

consistently repetitive basis. Agencies are

encouraged to use standard costing in those

situations.

******************************************************

APPENDIX A:

BASIS FOR CONCLUSIONS

The Nature of Concepts and Standards

163. The difference between accounting concepts

and standards is significant. Statements of

concepts are more general than statements of

standards. Standards are intended to be specific

guidance and authoritative in nature. Concepts

generally do not contain specific recommendations

that would, when issued by the Board's sponsors,

become authoritative requirements for federal

agencies. Concepts, instead, provide general

guidance both to the Board and others. They are

also intended to help preparers and users of

financial information better understand federal

accounting and financial reporting. While the

differences can be easily stated, in reality the

line between concepts and standards is often broad
and presents many gray areas for interpretation.

164. When the Board began the project on

managerial cost accounting, it anticipated the

issuance of a recommended Statement of Concepts.

Given the meager use of cost accounting within

many federal agencies, a Statement of Concepts

would provide both the Board and preparers of

federal financial reports with overall guidance in

the area and an indication of the future direction

the Board might take in developing standards.

However, as the Board and staff began working on

the project, it became clear that action was

needed to recommend standards for the development

of cost information.

165. Cost accounting standards were needed because

users of financial information, especially

taxpayers and members of Congress, began putting

more emphasis on the cost of government programs,

products, and activities. The efforts to reduce

government spending, control the deficit, and

improve government functions necessitated

information about the true costs of government.

In addition, passage of the CFO Act and the GPRA

required agencies to provide cost information as a

part of improving their financial management and

reporting. Furthermore, the NPR issued a

recommendation that the Board move rapidly to

recommend cost accounting standards.

166. The Board established the Cost Accounting

Task Force to provide advise and guidance on the

cost accounting project. On the task force were

many individuals knowledgeable about cost

accounting in the private sector as well as the

limited federal cost accounting activities. The

task force also recommended the establishment of

cost accounting standards.

167. The Board issued the exposure draft as a

recommended statement of standards. The Board

knew, however, that since cost accounting is

relatively new in the federal environment, the

final statement necessarily would contain some

conceptual material. Although the exposure draft
did not present any direct questions concerning

whether parts of the draft should be viewed as

concepts, the issue did arise in public hearings

held in November 1994, and January 1995. In

addition, a few respondents who mailed in their

comments addressed the point.

168. Most of those commenting on the issue stated

that they viewed the exposure draft as being

somewhat conceptual in nature. Many of those

thought that this was appropriate and supported

the document and the conceptual material it

presented. A few respondents were concerned about

the ability to audit some of the standards because

of the conceptual nature of the document. Several

suggested that the final statement be segregated

into concepts and standards and both be issued in

one statement.

169. The Board decided that some parts of the

final statement would contain information that

should be presented as concepts while other parts

would be better presented as standards.

Therefore, the final statement should be a

"hybrid" issuance containing both concepts and

standards. The title of the document was changed

to "Managerial Cost Accounting Concepts and

Standards for the Federal Government." (The

Board decided that the material presented in the

exposure draft as the first standard that

addressed the relationship among managerial cost

accounting, financial reporting, and budgeting

should be presented as concepts. The other

materials were more in the nature of standards.)

Relationship Among Cost

Accounting, Financial

Reporting, and Budgeting

170. The Board considers it important for

financial preparers and users of financial reports

to understand the relationship of cost accounting

to the more traditional areas of general financial

accounting, financial reporting, and budgeting.

It views cost accounting as a basic and integral

part of an entity's financial management system.
Therefore, the Board included a standard on this

relationship within the exposure draft.

171. The standard addressed the role of managerial

cost accounting in financial management and

explained how it provides cost information

relevant to budgeting, financial reporting,

management control, and many decision making

processes. The standard discussed the use of a

common data source for cost accounting, financial

accounting, and budgeting. It explained how the

costs may be determined using different bases of

accounting and different recognition and

measurement methods depending upon the intended

use of the information. It also emphasized the

need for reconciliation of cost data which may be

presented differently in various financial

reports. The standard stated that all cost

information, regardless of how presented, should

be traceable back to the original common data

source.

172. Most exposure draft respondents who provided

comments on this standard stated that the level of

detail presented was about right given the desire

of the Board to address cost accounting at a high

level. Most respondents agreed with the need to

draw cost accounting data from a common data

source that is also the source of financial and

budgetary data. Some respondents were concerned

that the use of the term "data source" was too

closely allied with automated or computerized

operations and that the term may be

misinterpreted. The Board, however, believes that

the term is adequately explained. In fact, the

exposure draft clearly stated that this term was

not meant to imply the use of computerized systems

for source information.

173. Data reconciliation for reports containing

cost information developed on different bases of

accounting or using different recognition or

measurement methods received overwhelming support

from respondents to the exposure draft. They said

that the ability to reconcile differing cost

information is necessary to ensure data integrity,
avoid confusion on the part of financial statement

users, and support stewardship responsibilities.

174. Many who commented on whether the exposure

draft should be viewed as a statement of concepts

or a statement of standards implied that this

particular standard on relationships of cost

accounting to other financial management functions

was basically conceptual in nature. The Board

agreed and concluded that this section is more in

the nature of an explanation of how cost

accounting provides useful information and how it

fits in with the overall financial management

system as opposed to a standard which places a

requirement on an entity. The Board decided that

this material would be better presented in the

final statement as recommended concepts.

Requirement for Cost Accounting

175. The cost accounting task force recommended

that a standard be included in the exposure draft

requiring each reporting entity to establish cost

accounting systems and procedures for its

activities. They believed this was necessary to

ensure the generation of required cost

information.

176. The Board agreed to include the standard in

the exposure draft. The standard defined "system"

in a broad way as simply an organized grouping of

methods and activities designed to consistently

produce reliable cost information. The

explanations and discussions section of the

exposure draft contained information on several

factors that would help managers decide how

complex and sophisticated their cost accounting

system should be. It noted that the system could

be constrained by the (1) nature of the entity's

operations, (2) precision needed in cost

information, (3) practicality of data collection

and processing, (4) availability of electronic

data handling, (5) expected cost of the system

itself, and (6) any specific management

information needs.
177. The exposure draft also listed ten minimum

criteria that should be met by all managerial cost

accounting systems. Four of these were related

directly to the other standards in the exposure

draft (responsibility segments, full costing,

costing methodology, and unused capacity costs).

The six remaining criteria were concerned with

ensuring that the cost data produced was reliable,

consistent, and useful. These criteria were (1)

ensuring the ability to assist in measurement of

performance, (2) reporting information on a timely

and consistent basis, (3) integrating cost

accounting with the standard general ledger, (4)

determining a reasonable and useful level of data

precision, (5) accommodating special information

needs of management, and (6) documenting the

system through a manual or handbook. The standard

also allowed for the use of cost finding

techniques and special cost studies or analyses.

178. A large number of respondents to the exposure

draft supported the requirement for cost

accounting systems. They stated that such a

requirement is necessary to ensure that

appropriate cost data are recorded. They also

said that having a requirement for cost systems

will help agencies to more easily meet the

requirements of the CFO Act and the GPRA. Some

qualified their support by stating that the

standard should allow an exemption for small

entities since establishment of a full cost

accounting system may not be cost-beneficial to

them. The Board decided that such an exemption

would be inappropriate since the standards should

apply to all federal activities. Furthermore, it

should be far easier for small entities to perform

managerial cost accounting in most cases.

179. Those who were negative toward the standard

provided several reasons. Several expressed

concern about whether accounting standard-setting

bodies should require or determine how accounting

data are produced. They noted that other

accounting standard-setting organizations have

stated only what information is required and how

that information is displayed in financial
statements, not how the information is developed.

180. The Board believes that it should not be

constrained by what other standard-setters do.

Other standard-setters so far have concerned

themselves mainly with entities' external

reporting. This is understandable because their

mission is to assure that the financial position

and results of operations are presented in a fair,

reliable, and consistent manner to financial

statement users who are external to the reporting

entity.

181. FASAB is different in that it has determined

that some of the users of federal government

financial reports are internal to the government.

Given the nature and size of the federal

government, internal users often do not have the

same type of access to cost information that may

be available in commercial enterprises. In

addition, the Board views cost accounting

information as vital to both internal and external

users. The Board has previously determined in its

Objectives of Financial Reporting that cost

information should be reported to meet the needs

of Congress, federal executives, and others.

182. Some respondents to the exposure draft were

concerned that the requirement for a cost

accounting system, along with the system criteria,

would not allow management enough flexibility.

They seemed to consider the requirement for a

system to mean that cost accounting activities had

to be automated with computers and that software

had to be developed and employed in a "full-blown"

system, as one put it. They believe that such an

elaborate system may not be needed in some cases

where informal procedures or methods would

suffice.

183. The Board does not intend to prescribe an

elaborate managerial cost accounting system for

every federal organization. It believed that the

standard proposed in the ED was sufficiently broad

to allow managerial flexibility in the system

design. However, the Board does recognize that
the term "system" may connotate to some a

requirement for computerization and sophisticated

methodologies.

184. Others stated that establishing the

requirement for cost systems should be the

responsibility of OMB or JFMIP. Some of the

respondents were concerned about the degree to

which the standard may overlap with JFMIP's

responsibility to set requirements for cost

accounting systems. The NPR recommends setting

requirements for cost accounting systems as a

responsibility of JFMIP, while asking the Board to

provide the cost accounting standards.[|fOOTNOTE

40]

[Footnote 40: Office of the Vice President, Improving

Financial Management, Accompanying Report of the

National Performance Review (September 1993), page 24.]

185. The Board proposed the requirement for

systems to ensure that cost information is

 produced and reported in a reliable and consistent

 manner, and emphasized that this was the intent.

 The point is not whether the information is

 produced through the use of a system or through

 other techniques. The Board believes that, in

 many cases, cost accounting systems will be

 established as a natural consequence of requiring

 cost information. Many government agencies are

 very large and complex organizations, and it is

 unrealistic to think that they can develop cost

 data without relying on a system to do so. Other

 small agencies or reporting entities may not need

 a system to develop cost data in a regular,

 consistent, and reliable manner.

186. The Board, therefore, changed the standard to

 emphasize producing cost accounting information in

 a reliable and consistent manner. This can be

 done through the use of cost accounting systems or

 cost finding techniques. In either case, the main

 intent of the original standard is preserved. In

 addition, the concerns expressed over whether the

 Board or some other organization should establish
 the requirement for cost "systems" are solved.

Responsibility Segments

187. As stated in the ED, a responsibility segment

 is a component of a reporting entity that is

 responsible for carrying out a mission, conducting

 a major line of activity, or producing one or a

 group of related products or services.

188. The proposal for using responsibility

 segments in the ED was based on the view that most

 federal departments and agencies are engaged in

 more than one line of activity, or producing more

 than one type of service or product. Furthermore,

 the activities that an agency performs may differ

 from each other significantly in required

 resources and operations. The ED used the

 Department of Veterans Affairs (VA) as an example.

 Among its activities, VA administers hospitals and

 nursing homes to provide health care to veterans,

 and it also administers direct home loan and loan

 guarantee programs. These lines of activities are

 significantly different in operation patterns.

 The Board believes that for entities that are

 engaged in diverse activities, identifying

 responsibility segments is necessary for

 identifying resources consumed by a distinct line

 of activity with the outputs of that activity.

189. A majority of respondents supported the

 requirement for responsibility segments and agreed

 with the advantages of the requirement. They

 expressed the view that segmentation provides a

 basic framework to trace and assign costs to

 outputs. They also believed that segmentation

 provides management with the flexibility of

 choosing a costing methodology that is best suited

 for a line of activity. The respondents also

 stated that information generated by

 responsibility segments can be used to measure

 performance and to assess accountability.

190. Several respondents, however, presented

 arguments against using responsibility segments.

 One such argument was that responsibility segments
 would constitute an unnecessary layer that

 conflicts with financial reporting and budgeting

 systems. The Board disagrees with this view. A

 responsibility segment is not, and should not be,

 an additional layer to the organization and the

 budget structure. It is an accounting mechanism

 to capture data generated in operations by various

 components of an organization in its existing

 structure. Organization and budget structures can

 be changed for better management but not for the

 sake of accounting. Accounting may influence but

 cannot dictate such changes.

191. The Board believes that accounting by segment

 will help provide information useful to program

 managers and other users of financial reports.

 Entity-wide financial reports provide information

 on the overall financial position and operating

 results of an entity in aggregate. Such reports,

 although useful for many purposes, are not

 sufficient for cost management. A fundamental

 undertaking of managerial cost accounting is to

 match costs with activities and outputs. The

 purpose of segmentation is to segregate entity-

 wide data by major lines of activities and their

 outputs. Information related to each segment

 should tell managers and other users of financial

 reports about the segment's specific outputs, the

 activities performed, and resources consumed to

 produce the outputs.

192. Furthermore, segment-based reporting need not

 be in conflict with entity-wide financial

 reporting. They can use a common source of data,

 such as accounting data collected by the standard

 general ledger or the budget execution reports.

 To perform segment-based accounting and reporting,

 the general accounting or budget execution data

 can be traced and assigned to segments. The

 Statement of Federal Financial Accounting Concepts

 No. 2, Entity and Display, discusses a reporting

 approach similar to the segment-based accounting

 and reporting:

"With some organizations, and even

suborganizations, the activities of one or
more programs or other components are as

important to the readers of financial

statements as are activities of the entity as

a whole. This would be particularly true for

a department composed of many bureaus,

administrations, agencies, services, etc.,

and particularly if their programs are

dissimilar. In those instances,

consideration should be given to the

preferability of reporting the assets,

liabilities, revenues, expenses, etc., of

both the significant components individually

and of the entity in its entirety."[Footnote

41]

[Footnote 41: FASAB Statement of Recommended

Accounting Concepts 2, Entity and Display, par. 75,

page 25.]

193. Another argument against requiring

 responsibility segments was that the requirement

 is overly prescriptive and would constrain agency

 management from selecting among various cost

 collection methods. The Board believes the

 standard gives management adequate flexibility in

 structuring cost accounting. As the standard

 states, it is for the management of each entity to

 decide how segments should be defined, and how

 similar products and services can be grouped into

 one segment.

194. Furthermore, segments are the largest

 components of an entity. Management has the

 flexibility to use any cost collection method

 within each segment. Within a segment, management

 may define sub-units, functions, projects,

 business processes, activities, or a combination

 of them as cost centers to accumulate costs. The

 costs accumulated at lower levels can then be

 aggregated to the segment level.

195. In fact, a segment may contain multiple

 levels of responsibility or cost centers. For

 example, if veterans health care is defined as one

 of the DVA's responsibility segments, this segment

 may define its hospitals, clinics, and nursing
 homes as responsibility centers. Each hospital,

 clinic, and nursing home may further define their

 functional units, activities, or business

 processes as cost centers.

196. Some respondents correctly pointed out that

 requiring broad responsibility segments, rather

 than prescribing traditional cost centers,

 provides opportunity for entities to use activity-

 based costing or any other costing methods that

 they may find appropriate.

197. Several respondents who supported the use of

 responsibility segments interpreted the wording of

 the proposed standard as requiring that each

 segment perform managerial cost accounting. They

 pointed out that for some entities, it is more

 effective and economical to perform centralized

 managerial cost accounting. Such centralized

 accounting is capable of accumulating costs by

 segments and assigning costs among them. The

 respondents requested that the wording be revised

 to provide this flexibility.

198. The Board agrees with this request. The

 Board believes that entity management should have

 the discretion to decide whether managerial cost

 accounting is performed at the entity or segment

 level, so long as the segment cost information is

 provided to managers and other users. Thus, the

 standard recommended in this statement does not

 require that responsibility segments perform

 managerial cost accounting.

Full Cost

199. As stated in the ED, the full cost of an

 output produced by a responsibility segment is the

 sum of direct and indirect costs that contribute

 to the output, including the costs of supporting

 services provided by other segments and entities.

200. The outputs of a responsibility segment are

 considered as cost objects.[Footnote 42] However,

 in most circumstances, the full costs of

 intermediate objects, such as activities,
 processes, projects, programs, or organization

 units, must also be measured in order to derive

 the full costs of their outputs. (See ED Par.

 173) The full cost information related to outputs

 as well as those intermediate objects are useful

 in measuring efficiency and cost-effectiveness.

[Footnote 42: "Cost object" is defined as an activity,

output, or item whose cost is to be measured. In a

broad sense, a cost object can be an organizational

division, a function, task, product, service, or a

customer. See Glossary.]

 Usefulness of full cost information

201. Program evaluation and authorization. Most

 respondents supported the full cost standard.

 They recognized that it is particularly important

 to determine and report the full cost of a

 program. Information on full costs of programs

 can be used in program evaluations. Such

 evaluations typically relate the full costs of

 programs to their outputs and outcomes. Decision-

 makers in the Congress and the federal government

 at all levels as well as the public should be

 provided with information on the full costs of

 programs and their outputs. The full cost

 information, when used with information on program

 outputs and outcomes, can aid the Congress and

 federal executives in making decisions on program

 authorization and modifications.

202. Cost awareness. Most respondents also agreed

 that the standard has the advantage of promoting

 cost awareness. Entity and segment managers

 should be aware of the costs that are incurred or

 assigned to their operations. Without the

 awareness, managing and controlling costs are

 impossible. The full cost information has not

 been available and will not likely to be without

 an accounting standard requiring it.

203. Setting fees and prices for government goods

 and services. Many respondents agreed that full

 cost should be considered as a primary basis for

 setting fees and reimbursements for government
 goods and services. As pointed out in the ED, it

 is a federal policy that, with certain exceptions,

 user charges (prices or fees) should be sufficient

 to recover the full cost of goods, services, and

 resources provided by the federal government as

 sovereign.[Footnote 43] The policy further states

 that when the government sells goods and services

 under business-like conditions rather than in a

 sovereign capacity, user charges should be based

 on market prices and may yield a net revenue in

 excess of the full cost. The objectives of the

 policy are to: (1) ensure that government goods

 and services are provided on a self-sustaining

 basis, (2) promote efficient allocation of

 national resources, and (3) allow fair competition

 with comparable goods and services provided by the

 private sector.

[Footnote 43: OMB Circular No. A-25, User Charges.]

204. To implement the policy, full cost

 information is necessary. Only with reliable full

 cost information can management ensure that user

 charges fully recover the costs.[Footnote 44]

 Even in some exceptional cases in which user

 charges are exempted or restricted by law,

 agencies that provide the goods and services would

 nevertheless need the full cost information to

 assess the extent to which costs are not

 recovered.

[Footnote 44: The standard of determining full cost

discussed in this document, however, should not be

construed as a standard for setting fees, prices, and

reimbursements. Federal entities should comply with

laws and regulations related to pricing policies in

general and for specific types of goods and services.

Those laws and regulations (including OMB Circular A25) may prescribe costing requirements other than the

full cost standard discussed in this document. Full

cost defined by this standard can serve as a point of

reference for managerial decisions. However, it is not

intended to supersede any costing concept that

management is required or permitted by law to use in

pricing goods and services.]
205. Making cost comparisons. Respondents agreed

 that the full cost of outputs provides a valid

 basis for cost comparisons. One of them

 emphasized the importance of calculating the unit

 cost of output on the full cost basis. The Board

 agrees with his view. If an output can be

 measured in units, its unit cost should be

 calculated on the full cost basis.

206. The unit cost of a service or product,

 calculated on a full cost basis, can be compared

 with a similar service or product produced by

 other entities either in the federal government or

 in the private sector. The comparison would not be

 valid if it is not conducted on a full cost basis.

207. One of the available cost management tools is

 trend analysis. In trend analysis, unit costs of

 a service or product over a number of consecutive

 periods are examined to find a trend of increases

 or decreases. This analysis can be valid only

 when the unit costs of all periods are measured on

 a consistent basis, such as the full cost basis.

 When the full cost basis is used, the analyst can

 further examine the components of the unit cost,

 such as direct labor and material costs, overhead

 costs, and costs of services received from other

 segments or entities. Through examining the

 various components of the full unit cost, program

 managers can pinpoint specific areas that

 contributed to cost increases or decreases.

208. If activity-based costing is used, the cost

 components would be associated with activities.

 The trend analysis for activity-based cost

 components can provide information related to the

 efficiency of the activities. Managers can also

 analyze the extent that the individual activities

 add value to program outputs and objectives.

 Limitations of Full Cost Information

209. Several respondents cautioned the Board

 against "uncritical advocacy" of full costs. They

 pointed out that full cost is not relevant to all

 decision-making situations. They explained that
 some decisions require other cost concepts such as

 variable, differential, or incremental costs.

 Thus, some of them said that the Board should not

 singularly emphasize full cost.

210. The Board is aware of the notion that

 different cost concepts should be used for

 different purposes so that the use of a cost

 concept is relevant to a particular decision-

 making purpose. For this reason, the Board

 discussed the limitations and usefulness of full

 cost in the ED at length. (See ED pars 133

 through 146.) Quoting from Anthony and Young,

 the ED pointed out that full costs are not

 appropriate for alternative choice decisions such

 as the decision to (1) add or drop a product or

 service, (2) perform work in-house or contract out

 for it, and (3) accept or reject a special

 request. For these decisions, the appropriate

 information is differential costs.[Footnote 45]

[Footnote 45: Robert N. Anthony and David W. Young,

Management Control in Nonprofit Organizations, 5th ed.

(Burr Ridge, Illinois: Richard D. Irwin Co., 1994) page

235.]

211. However, the full cost standard is an

 accounting standard, rather than a cost analysis

 or decision-making standard. It requires that

 full cost information be compiled and reported

 through cost accounting. In no way does it limit

 cost analysts and decision-makers to the use of

 full cost alone in all situations. The Board

 believes that when the full cost information,

 instead of any portion of it, is made available,

 analysts and decision-makers will have a

 comprehensive data source to develop the cost

 concepts that they need in their analyses.

212. Some respondents pointed out that full cost

 requires a complex process of cost assignments and

 allocations. The Board believes that the

 assignment of indirect costs is a necessary

 procedure to obtain full cost. It can be

 performed through an appropriate costing

 methodology. As discussed in the costing
 methodology section of the ED, some modern costing

 methodologies are available to make rational and

 reliable cost assignments. However, the Board

 must caution that the full cost information, like

 any other accounting information, can only be as

 good as how it is prepared. For example, it can

 be unreliable or inaccurate, if arbitrary or

 irrational cost allocations are used excessively.

 Thus, the Board recommended a costing methodology

 standard. Program managers should critically

 review costing methodologies and techniques used

 to derive the cost information.

 Inclusion or Exclusion of Certain Costs

213. A number of respondents were opposed to the

 inclusion of accrued employee benefit costs and

 costs of services provided by other entities that

 are not reimbursed. (The subject of inter-entity

 costs will be discussed in the next section.)

 They argued that these costs are not funded with

 their budgetary resources and are beyond their

 control. A large portion of employee benefit

 costs, including accrued retirement benefit costs,

 are funded through appropriations to trust funds

 managed by OPM and DoD. The Board believes that

 as a principle, full cost should include the costs

 of all resources applied to a program, activity,

 and its outputs, regardless of funding sources.

 For financial reporting, the Board has stated its

 position that the full costs of employee pension

 and other retirement benefits determined on an

 actuarial basis, including the amounts that are

 funded to the trust funds directly, should be

 recognized as an expense in the employer entity's

 financial reports.[Footnote 46] The Board does

 not find a good rationale to depart from this

 principle in managerial costing.

[Footnote 46: FASAB Exposure Draft, Accounting for

Liabilities of the Federal Government (Nov. 1994),

pars. 80-99, pages 32-46.]

214. The ED states that some costs should be

 recognized as a period expense rather than the

 costs of goods and services (output costs).
 Examples include the costs of "other post

 employment benefits" (OPEB), reorganization costs,

 and acquisition costs of Federal "mission" and

 "heritage" property, plant, and equipment which

 are recognized as expenses at the time of

 acquisition.[Footnote 47] These costs will be

 recognized as expenses for the period in which the

 related events take place, and are referred to as

 "period expenses." The ED explained that since

 these expenses do not contribute to the outputs of

 the period in which they are incurred, they should

 not be included in the output costs.

[Footnote 47: "Federal mission PP&E" and "heritage

assets" are explained in FASAB Exposure Draft,

Accounting for Property, Plant, and Equipment (February

28, 1995), pars. 98-115, pages 29-33.]

215. The OPEB costs, for example, may be

 recognized as expenses for a period in which a

 reduction in force or an employee injury takes

 place.[Footnote 48] It is not appropriate to

 attribute the entire OPEB costs to the output

 costs of that period. Several respondents

 expressed the view that OPEB costs should be

 included in full cost. There is no doubt that

 OPEB costs, as well as other period expenses, are

 part of the full cost of an entity or a program.

 They may also be part of the full costs of outputs

 over many years in which the employees contributed

 to the production of the outputs. However, they

 are not the production costs for the period during

 which they are incurred. Thus, the Board

 concluded that in cost studies, management may

 distribute some of the period expenses, such as

 OPEB costs, to outputs over a number of past

 periods if (a) experience shows that the OPEB

 costs are recurring in a regular pattern , and (b)

 a nexus can be established between the OPEB costs

 and the outputs produced in those past periods.

 The Board finds no reason to change this position.

[Footnote 48: FASAB Exposure Draft, Accounting for

Liabilities of the Federal Government (Nov. 7, 1994),

pars. 100-102, pages 47-48.]
216. Some respondents contended that full cost

 should include unused capacity costs. As will be

 explained in a later section on unused capacity

 costs, the Board has decided not to recommend a

 standard on measuring unused capacity costs.

 Thus, to assure valid cost comparisons, full costs

 should not exclude unused capacity costs.

 Controllable and Uncontrollable Costs

217. Some respondents believed that the managers

 of a responsibility segment should be held

 accountable only for costs that they can control,

 and their performance should not be evaluated for

 costs beyond their control. They found that the

 full cost reporting would obscure the distinction

 between controllable and uncontrollable costs.

 For performance measurement or other purposes,

 some entities may want to make a distinction

 between controllable and uncontrollable costs with

 respect to an individual responsibility segment or

 a cost center. The full cost information need not

 interfere with this distinction. This standard

 does not require the use of full cost for internal

 reports. If some entities choose full cost for

 internal reporting, the internal reports can

 provide a distinction between controllable and

 uncontrollable costs with respect to individual

 segments.

218. Ultimately, most costs are controllable at a

 certain level of the entity. If some of them are

 not controllable at a lower level of the

 organization, they may very well be controllable

 at a higher level. Each segment should concern

 itself with the costs that are assigned to it on a

 cause-and-effect basis. These costs are often

 incurred because of a segment's demand and use of

 services from other segments or entities.

 Although the service-receiving segment has no

 control over the efficiency in producing the

 service, it can influence the costs by changing

 the demand for the service. For an entity's top

 management, full cost reporting provides it with

 an overview of how the entity's various costs,

 including the general and administrative costs,
 are incurred and assigned to the entity's

 segments. The full cost reporting also makes the

 entity's top management aware of the costs of

 services that it receives from other entities.

 The management can closely review those costs and

 determine whether actions are needed to control

 them.

 Centralized Accounting

219. The proposed standard in the ED states that

 "Responsibility segments should be capable of

 measuring the full costs of their outputs."

 Several respondents stated that the full costs of

 segments, programs, and their outputs can be more

 effectively measured by entities through

 centralized accounting, rather than by individual

 segments. They further stated that it would not

 be cost-beneficial for segments to measure and

 report the full costs of their activities and

 outputs on a regular basis (such as monthly

 basis). The Board agrees that many entities may

 find it more economical and effective to measure

 full costs through centralized accounting.

 Moreover, the Board believes that it should be for

 entity management to decide as to how frequently

 the full cost information should be made available

 in its internal reports. Thus, the wording of the

 standard has been changed. The full cost

 requirement is now limited to external reporting

 via general purpose financial reports.

 Costs of Outcomes

220. A respondent suggested that in addition to

 the full cost of outputs, the standard should also

 require reporting the full cost of program

 outcomes. As discussed in the ED, the Board

 believes that performance measurement of a program

 requires three major elements: the full cost of

 the program, its outputs, and its outcomes. (See

 ED pars 37 and 38) The full cost of a program and

 its outputs, once measured according to this

 standard can be related to the outcome of the

 program to measure its cost effectiveness.
221. This standard does not require a direct

 measurement of the cost of outcomes because in

 most instances, program outcomes need to be

 measured with methodologies beyond those discussed

 in this document. GPRA defined "outcome measure"

 as an "assessment of the results of a program

 activity compared to its intended

 purpose."[Footnote 49] Many programs' policy

 objectives and intended results are socio-economic

 or scientific in nature, or involve national

 defense. The assessment of the program results

 require expert knowledge in those areas. Thus,

 unlike costs and outputs, outcomes are not always

 measured in quantitative or monetary terms.

[Footnote 49: The Government Performance and Results

Act of 1993, PL 103-62, sec 4.]

222. Moreover, unlike costs and outputs that are

 measured for each accounting and reporting period,

 such as a quarter or a year, outcome measurement

 may be long-term in nature. For example, the

 Senate Report on GPRA states that "Outcome

 measurement cannot be done until a program or

 project reaches a point of maturity (usually at

 least several years of full operation for programs

 continuing indefinitely) or at completion."

 Although all programs cost money, some of them may

 produce positive results, while others may produce

 no results or negative results.

223. Because of the complexities in measuring

 outcomes, the costing principles and methodologies

 discussed in this document cannot be used to

 measure the cost of outcomes. The Board believes

 that the full cost of a program and its outcome

 should be measured independently, using

 methodologies appropriate to costs and to

 outcomes. Once each of them is measured, they can

 then be related to review the cost-effectiveness

 of the program.

Inter-Entity Costs

224. It is not unusual in the federal government

 for one agency to provide goods or services to
 another agency. Sometimes this may be required by

 law, and often it is a very efficient method of

 conducting business for the agencies involved and

 for the government as a whole. In many cases, the

 agency receiving such goods or services will

 reimburse the providing agency in accordance with

 some agreed-upon price. Often, however, there is

 no charge, or there is a charge that is not

 sufficient to cover the providing agency's full

 cost. When such "free" or lower-than-cost items

 are used in the production of the receiving

 agency's outputs, the result can be an

 understatement of the full cost of final outputs

 by the receiving agency.

Survey of Non-Reimbursed Costs

225. The Board recognized that these

 non-reimbursed or under-reimbursed goods and

 services could distort the determination of a

 reporting entity's full cost of outputs, but it

 was uncertain of the extent to which this occurs.

 To identify examples of non-reimbursed inter-

 entity costs, the Board conducted a limited survey

 of federal agencies. Of the 22 agencies

 responding to the survey request, 13 indicated

 that they provide some type of service or good

 that is not reimbursed. These covered a wide

 range of activities, but most of the costs

 involved were for salaries and salary-related

 benefits of those employees performing the work.

 In most cases, the costs were funded through

 direct appropriations to the providing agencies;

 however, those agencies could not specifically

 identify the total amounts involved. Several

 provided estimates, which ranged from $360

 thousand dollars per year to about $180 million

 per year. Several examples of non-reimbursed

 inter-entity activities identified in the survey

 are listed below by providing entity:

 -- Department of Agriculture -- Provides market

data, pesticide data, food specification

information, water supply forecasts, and
other agricultural information. Thirty-six

federal agencies regularly receive all or

some of this information.

 -- Department of Commerce -- Provides accounting

and grant administration services, computer

access and reports, and consultation services

to several agencies.

 -- Department of State -- Provides space and

facilities for other agencies in its

buildings in the U.S. and overseas.

 -- General Services Administration -- In some

cases, it provides policy and regulatory

development services, property management

services, and contract award and

administration to other agencies without

reimbursement.

 -- National Science Foundation -- Administers a

research grant program on engineering and

computer science for the Department of

Defense.

226. The Board noted that the survey was

restricted to non-reimbursed costs between

different agencies. As such, the results did not

necessarily represent all of the kinds and amounts

of transactions and costs between different

reporting entities. The survey was also limited

to those non-reimbursed costs which the agencies

could easily identify in order to respond quickly

to the questionnaire. Nevertheless, there were

indications that some non-reimbursed costs may be

significant in amount.

Usefulness of Recognition

227. Some respondents to the exposure draft

stated

that recognition of inter-entity[Footnote 50]

costs would have limited usefulness for managers

since they cannot control the cost of items

provided by other agencies. In some

circumstances, they cannot control the amounts of
inter-entity goods or services that must be used

in the production of their outputs.

[Footnote 50: Full cost, as discussed in the full cost

standard, contemplates both intra-entity costs and

inter-entity costs applicable to a responsibility

segment. This standard elaborates on inter-entity

costs. Intra-entity costing is accomplished through

the costing methodology selected for use within the

reporting entity since these costs are passed among

responsibility segments.]

228. The Board realizes that recognition of nonreimbursed or under-reimbursed inter-entity costs

will not always have the same degree of usefulness

for all levels of management. However, as stated

in the standard on full costs, to fully account

for the costs of the goods and services they

produce, reporting entities will need to include

the cost of goods and services received from other

entities. Cost reduction and control, performance

evaluation, and process improvement depend on

knowledge of the full costs of producing outputs,

including production costs incurred by other

federal entities. These costs are most important

for use by the entity's top-level management (and

to a lesser degree by line managers) in

controlling and assessing the operating

environment and in making decisions about how best

to acquire those goods and services. Knowledge of

full cost, including the extent of inter-entity

costs, is also important to external users,

especially the Congress and taxpayers, in making

decisions concerning various programs and

allocating resources throughout the government.

229. In addition, the Board believes that,

without

the recognition of non-reimbursed and underreimbursed inter-entity costs, the receiving

entity has little incentive to control the use of

these resources. While they may appear to be

"free" to the receiving entity, the costs are

absorbed somewhere in the government. If the

receiving entity were charged for these costs,

top-level management would then have more
incentive to economize and control the use of

these resources as well as make better decisions

concerning how and where to acquire them. This

would help reduce overall costs to the taxpayer

and provide the other benefits associated with

full-costing by responsibility segment.

230. The recognition of all inter-entity costs is

also important when an entity produces goods or

services that are sold outside of the federal

government. For the entity to recover the

government's full cost on the sale, knowledge of

the total cost, including costs incurred by other

federal entities, is vital to the establishment of

an appropriate price.

The Use of Estimates

231. The standard places the responsibility on

the

providing entity to supply the receiving entity

with information on the full costs of nonreimbursed or under-reimbursed inter-entity goods

and services. This is appropriate since only the

providing entity is likely to have such

information. Implementation of the standard on

full costing should make this requirement fairly

easy for the providing entity to fulfill. If, for

some reason, the providing entity cannot or does

not supply the cost information, the receiving

entity has no way to recognize the costs other

than through estimation.

232. The Board anticipated this possibility, and

requires the receiving entity to use an estimate

of the cost of those goods and services if the

actual cost information is not provided. The

estimate must be reasonable and should be aimed at

determining realistic costs incurred by the

providing entity. However, if such a cost

estimate cannot be made, the receiving entity may

base the estimate on the market value of the goods

or services.

233. Some respondents to the exposure draft

stated
that the use of estimates would be too problematic

and unreliable and that the receiving entity would

not have enough information to make the estimate.

Some were concerned that the use of estimates

would cause arguments between reporting entities

over the cost. Others were concerned that some

entities do not have experienced personnel to make

such estimates. A few were concerned about the

audit implications of using an estimate.

234. Some respondents expressed concern over the

possible use of market values in making the

estimate. Some of these respondents stated that

government-type goods and services are not often

produced outside government and, therefore, such

market values may not exist. Others stated that

market value does not always bear a direct

relationship to true cost or that market values

change too rapidly to be of any use.

235. The Board realizes the problems associated

with the use of estimates. However,

implementation of the other managerial cost

accounting standards in this statement by the

providing entities should considerably lessen the

need for receiving entities to make estimates of

inter-entity costs. The Board also believes that,

if the inter-entity costs meet the recognition

criteria established by the standard, and cost

information is not received, then use of a

reasonable estimate of cost is preferable to no

recognition at all.

236. Estimates are often used in accounting and

financial reporting. The recognition of cost

based on estimation is not new and can be reliable

so long as the estimate is reasonable and based on

a rational and systematic method. The Board also

realizes that the use of estimation necessarily

implies the use of professional judgement. This

does not negate the value of the estimate to users

of the financial information and should not

present a problem in relation to audit

requirements.

237. The Board realizes that market values may
not

always be available for many kinds of inter-entity

goods and services. Nevertheless, if such values

are available, they can be a good basis for

estimating cost if no other basis can be

established. Although market values may not be

directly related to costs of production and they

may fluctuate, they may also be viewed as a fairly

reliable guide to the costs an entity might have

to incur to obtain inter-entity goods and services

from a non-governmental source. As with the

determination of all estimates, use of market

values as an estimation basis requires the use of

judgement and professional care.

238. The Board also realizes that there may be

some implementation problems such as disagreements

with providing entities over an estimated cost or

with the lack of trained personnel to make

estimates. These problems are of a practical

nature and can be resolved by management. In that

regard, they are not unlike other problems faced

when implementing any new or changed accounting

standard such as making changes to systems and

methods and training personnel on the new

requirements. Both providing and receiving

entities should work closely with each other to

resolve any costing problems just as they would to

solve any non-accounting related situations.

Recognition Criteria

239. It is clear to the Board that the

recognition

of each and every non-reimbursed or underreimbursed inter-entity cost is not possible. The

federal government is a very large and complex

entity and it is normal to expect some flow of

goods and services between its activities as a

natural and reasonable method of completing

missions and objectives. The Board decided that

only certain non-reimbursed or under-reimbursed

inter-entity costs should be addressed. The

standard, therefore, includes criteria for

recognition which will limit the application of

the standard to only those items deemed most
significant and important.

240. The criteria address the materiality of the

non-reimbursed inter-entity cost, whether it is a

part of broad and general support for all

entities, and whether it is needed to help

determine a price to non-governmental entities.

The materiality criterion considers materiality in

the context of the importance of the item to the

receiving entity. Under this criterion, whether

an item of inter-entity cost is recognized depends

upon three points. The first of these is

significance to the receiving entity, i.e. whether

the item is important enough that management

should be aware of its cost in decision making

circumstances. The second is the degree to which

the goods or services are an integral and

necessary part of the receiving entity's output.

The third is the degree to which the good or

service can be matched to the specific receiving

entity with reasonable precision.

241. The criterion of broad and general support

recognizes that some entities provide support to

all or most other federal entities, generally as a

matter of their mission. The costs of broad and

general services should not be recognized by the

receiving entity when no reimbursement has been

made. However, if the service is an integral and

necessary part of the receiving entity's

operations and outputs, those costs should be

recognized.

242. The criteria also recognize that there are

certain cases in which inter-entity costs need to

be recognized because there could be an effect

upon a resulting price to a non-governmental

entity. If a federal entity sells outputs to a

non-federal entity, it is usually required to

recover the full cost of those goods or services.

While cost is not the sole determinant of final

price, knowledge of the actual full cost of

production to the government as a whole is

necessary to ensure that the price is

appropriately established at a level that will

recover all costs.
243. Most of the respondents to the exposure

draft

agreed with the recognition criteria. However, a

few were concerned about how the criteria might be

interpreted and whether the standards were too

general in nature. The Board realizes that

considerable judgement is required to apply these

criteria and notes that the specific facts and

circumstances in each case must be considered.

This concern, along with other implementation

concerns, led the Board to make certain decisions

about implementation discussed below under

"Implementation Issues."

Consolidation

244. The standard requires that, when nonreimbursed or under-reimbursed inter-entity costs

are recognized, the receiving entity should

recognize the full costs of the goods or services

received as an expense (or asset) and, to the

extent that reimbursement is less than full cost,

the difference is to be recognized as a financing

source. At the same time, of course, the

providing entity would continue to recognize the

full costs of goods and services provided, and any

off-setting reimbursements, in its accounting

records. Several respondents to the exposure

draft were concerned about the possibility of

"double-counting" of costs and others raised

concerns about the ability to eliminate these

transactions in consolidations.

245. Both the providing entity and the receiving

entity are separate reporting entities. Each

should recognize in its accounting records and

financial reports the true costs of operations and

any revenues received. The providing entity

incurs a cost in providing the goods or services

even though they are sent to another entity. It

may also receive a partial payment or

reimbursement. These transactions and events

should be reflected in its accounting. The

receiving entity, as a separate reporting entity,

should also recognize its total cost of
production. The full cost of non-reimbursed or

under-reimbursed goods or services ultimately

contributing to its outputs should be reflected in

the costs of production. To the extent that

reimbursement is not made for those costs, the

receiving entity is utilizing a separate source of

financing, namely the providing entity. Again,

this fact is reflected in the accounting. The

result is that costs recognized but not actually

paid are off-set by the imputed financing source.

While the entity's financial position is not

affected, the real costs of production are

reflected.

246. The only possibility for "double-counting"

of

costs occurs when consolidated financial reports

are prepared for a reporting entity that includes

both the providing entity and the receiving

entity. In preparing such statements, the

standard calls for elimination of the inter-entity

transactions. In effect, this is no different

from the elimination of transactions for which

full reimbursement has been made. The only

additional transaction to be eliminated is the

recognition of the imputed financing source by the

receiving entity. The recognition of costs by

both the providing entity and the receiving entity

and any actual reimbursements would be eliminated

anyway if payment for the inter-entity costs were

made.

247. The Board realizes that identification and

tracking of transactions that must be eliminated

for consolidated reports can become complex and

difficult. However, this is a practical

implementation problem that management should be

able to overcome through the use of transaction

coding or some other identification method. It

likely will require changes in methods and systems

currently in use and may require additional

training of personnel. The Board has decided upon

a method to ease implementation problems as

discussed below.
Implementation Issues

248. As discussed above, the Board realizes that

there may be problems in implementing the standard

on inter-entity costing. Recognition of nonreimbursed or under-reimbursed inter-entity costs

is a new concept to federal entities and involves

a new way of thinking about costs. There is

concern that application of the standard may be

inconsistent among federal entities. In addition,

there could be problems, particularly at first, in

developing estimates of costs; in revising

accounting systems and procedures to accommodate

these requirements; and in training personnel to

accomplish the task. Furthermore, the Board

recognizes the concern that some have about the

elimination of inter-entity cost transactions for

consolidated reporting since the accounting

procedures may be complicated.

249. As a result of these problems and concerns,

the Board has expressed the need to take a

measured, step-by-step, practical approach to

implementation of this standard. Therefore, the

Board has decided that, in implementing the

standard, it recommends that OMB, with assistance

from the FASAB staff, should identify the specific

inter-entity costs for entities to begin

recognizing and OMB should then issue guidance

identifying those costs. OMB should consider the

requirements of the standard including the

recognition criteria in developing the guidance

and it should also consider suggestions and

information provided by Treasury, GAO, and other

agencies. The Board anticipates the largest and

most important inter-entity costs will be

identified first, followed by others as entities

gain experience in the application of the

standard. This approach is seen as a practical

way to ensure uniformity in the application and

implementation of the standard and to provide time

and experience in overcoming any other practical

problems which may arise. Also, the Board may

recommend specific inter-entity costs for

recognition in possible future recommended
standards.

Costing Methodology

250. The ED discussed cost accumulation and

assignment principles. The ED states that costs

should be accumulated by responsibility segments,

and the accumulated costs should be classified by

type of resource such as costs of employees,

material, capital, utilities, rent, etc. The ED

states that "The accumulation of costs by

responsibility segments does not mean that each

responsibility segment must have its own

accounting system. The reporting entity may have

a centralized accounting system, but the system

should be capable of identifying costs with

responsibility segments." (See ED par. 170)

251. The ED discussed three cost assignment

principles: (a) directly tracing costs wherever

feasible and economically practical, (b) assigning

costs on a cause-and-effect basis, or (c)

allocating costs on a reasonable and consistent

basis. These principles apply to costs of

services provided by a segment to other segments,

as well as assigning costs to ultimate outputs of

a segment.

252. The ED then provided brief descriptions of

available costing methodologies: activity-base

costing (ABC), job order costing, process costing,

and standard costing. The ED pointed out that

these costing methodologies are not mutually

exclusive. For example, standard costing can be

used within ABC. ABC and standard costing

combined can then be used with either job order

costing or process costing.

253. Most respondents believed that the

requirement for cost accumulation by

responsibility segment is appropriate. Some of

them stated that costs are accumulated at levels

lower than segments such as cost centers,

processes, or activities within a segment. Such

accumulation is consistent with the standard so

long as the costs will be aggregated at the
segment level. Some of the respondents stated

that the requirement is currently feasible because

their systems are designed to accumulate expenses

by segments and by resource types. Others,

however, stated that they must upgrade their

general accounting systems in order to meet the

standard requirement.

254. All the respondents agreed with the cost

assignment principles. One respondent, while

supporting the principles, stated that the

principles should be explicitly ranked by

preference. The Board intended to express an

preference among the principles. It stated in the

proposed standard that direct cost tracing should

be used "wherever it is feasible and economically

practical." The Board further stated in the ED

that "for the costs that are not directly traced

to outputs, it is preferable that they be assigned

to them on a cause-and-effect basis." (See ED

par. 182) However, for cost-benefit

considerations, assigning costs by allocations

cannot be avoided. The Board emphasized that cost

allocations should be performed on a rational

basis. It also cautioned that allocations can be

arbitrary and thus may result in distortions.

(See ED par. 190) To make the intent of

preference more explicit, the Board has added

words to the standard to indicate that the

principles are listed by preference.

255. All the respondents approved the

descriptions

of available costing methodologies. Some of them

stated that the materials included are clear and

provide adequate guidance. The respondents agreed

with the Board's position that because federal

activities are highly diverse, it is not practical

to require a particular costing method for a

particular type of activity at this time.

However, it is appropriate to require that each

entity select a costing methodology that is best

suited to its operations and use that methodology

consistently.

256. The Board encouraged government entities to
study the potential use of ABC in their operations

(ED par. 200). This was well received by the

respondents. Eighteen respondents supported ABC.

Most of them said that ABC can be effective when

combined with any of the other costing

methodologies. Seven respondents from federal

agencies stated that they believed ABC is

appropriate for their activities and were

considering using it. In addition, two

respondents stated that the use of standard

costing should also be encouraged. The Board

continues to believe that as federal agencies are

going through stages in the development of their

managerial costing, more sophisticated and refined

costing methods, such as ABC and standard costing,

should be considered and used to minimize

arbitrary cost allocations and to improve full

cost information.

257. The Board considered whether the costing

methodology section should be recommended as a

concept or a standard. It concluded that it

should be a standard. The Board believes that

cost accumulation and assignment principles

contained in this section are definitive and

should be followed by federal entities. Only by

adhering to the principles and by continuous

refinement of costing methodologies, can reliable

full cost information be achieved.

 Unused Capacity Costs

258. The ED proposed a standard, which, if

adopted, would have required that entities measure

the cost of unused operating capacity and report

it as a separate expense. For this purpose, some

entities, such as DoD, must separate operating

capacity from "readiness capacities" which are

reserved for war and emergency mobilization rather

than normal operations. The operating capacity

can be measured in terms of "practical capacity"

which is the maximum units of output that the

available capacity can produce taking the normal
stoppage and interruptions into consideration.

Unused capacity is the excess of practical

capacity over actual outputs.

259. A number of respondents appreciated the

importance of the proposed requirement. They

stated that capacity cost information would be

very useful in improving the cost and capacity

management of federal agencies. Several

respondents from the private sector urged that the

proposal be adopted immediately.

260. Most respondents from federal agencies,

however, stated that capacity measurements involve

very complex issues and are not feasible to

implement at this time. If the proposed

requirement were adopted, agencies would encounter

two major types of difficulties. First, they lack

guidance on defining and measuring various types

of capacity. For example, respondents from DoD

stated that it is difficult to develop criteria

that can be used to differentiate defense

operating capacity costs from mobilization

capacity costs. Civilian agencies engaging in

administrative, policy making, and regulatory

activities also indicated difficulties in defining

their practical capacities. Second, respondents

of many agencies stated that they do not have the

accounting capability to provide reliable capacity

measures. Without such capability, unused

capacity costs could be improperly estimated and

the resulting information could be misleading.

261. Many respondents were also opposed to the

proposed standard on the basis of cost-benefit

considerations. They estimated that accounting

for capacity costs would require substantial time

and efforts to implement. This would require the

use of their limited accounting personnel and

equipment. Respondents from some agencies do not

perceive that they have an over-capacity problem.

Thus, it is very uncertain whether capacity

accounting results, if produced, could be used to

improve their operations.

262. After considering the responses to the ED,
the Board is convinced that it is premature to

recommend capacity accounting either as a standard

or as a concept. The Board is aware that federal

agencies have limited personnel and other

resources for accounting. They must devote those

limited resources to improving general financial

reporting and to establishing the more fundamental

elements of managerial cost accounting. Thus, it

would not be cost beneficial to implement capacity

costing at this time.

263. Managing capacity costs is a part of cost

management. Although this document does not

recommend a standard for measuring capacity costs,

the full cost information required by the full

cost standard will help management in identifying

capacity utilization problems. Some respondents

stated that the capacity accounting concepts would

be useful to capital intensive, industrial-type

activities and activities that deliver repetitive

services that are measurable in units. The Board

is aware that there are on-going research efforts

on the subject in the private accounting

communities. Thus, the Board may reconsider

capacity accounting in the future.

Effective Date

264. The Board holds the view that managerial

cost

accounting has been needed across the federal

government for a long time. Since the standards

are quite general and address only the highest

levels of cost accounting, the Board felt that

they should be implemented quickly. The earlier

managerial cost accounting is started, the earlier

the benefits will be seen in managing and

controlling federal programs and activities. The

Board also believes that an effective date far

into the future would not serve to quickly change

the government's tendency to neglect cost

accounting. Therefore, in the exposure draft, the

effective date was set for fiscal periods

beginning after September 30, 1995 (i.e.,

beginning in fiscal year 1996).
265. A majority of respondents to the exposure

draft commented that this date was too early and

said that they foresee problems with

implementation at September 30, 1995. Many

reasons were given for a delay in implementation.

Chief among these were (1) difficulty in obtaining

funding to make necessary changes in financial

systems before September 30, 1995, (2) a lack of

trained accounting personnel and equipment, and

(3) a need for time to develop or modify

appropriate cost accounting methodologies and

systems and develop management awareness and

support. Respondents suggested implementation

dates ranging from one to five years after the

fiscal year 1996 date given in the exposure draft.

266. The Board recognized the validity of the

concerns of many respondents over funding,

training, and development of costing activities.

However, it also recognized that federal agencies

must be able to develop cost information very soon

to meet the requirements of the GPRA. It also

noted that reporting entities do not have to

possess sophisticated cost accounting systems to

meet the requirements in these standards. Federal

agencies can take a gradual approach to the

development of cost systems, if necessary, while

developing basic cost information through other

means in the short term.

267. Nevertheless, the Board agreed that the

implementation date in the exposure draft may be a

problem for many federal agencies since cost

accounting is relatively new to most of them and

the recommended implementation date is very near.

The Board decided, therefore, to delay the

implementation date by one additional year and

make the standards effective for periods beginning

after September 30, 1996, with earlier

implementation encouraged.

268. Early on in the development of the

managerial

cost accounting project, the task force determined

that many problems can result in cost accounting

from the use of similar terms to mean different
things. It concluded that the use of consistent

cost accounting terminology is necessary to avoid

confusion and mis-communication. Therefore, it

recommended that the Board attach a glossary to

the exposure draft which would define many of the

cost accounting terms used.

269. The Board agreed with this recommendation.

It also decided that the establishment of uniform

cost accounting terminology within the federal

government is so important that the glossary

should contain not only definitions for terms used

in the statement, but also definitions for other

important cost accounting terms even if those

terms are not used directly in the text of the

statement. This glossary would serve as the

beginning of a uniform and consistent cost

accounting terminology for use within the federal

government.

270. Comments were received from only one

respondent to the exposure draft concerning the

glossary. That respondent did not suggest

changing any of the definitions provided in the

glossary, but only suggested some additions. The

Board decided that the glossary is sufficient for

the time being and should be retained in the final

statement as an appendix. However, it also

decided that it may issue additions to the

glossary at a later date as more federal agencies

gain experience in the development of cost

information, and as the need for additional

standard definitions becomes apparent.

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APPENDIX B:

GLOSSARY

Activity - The actual work task or step performed in

producing and delivering products and services. An

aggregation of actions performed within an organization

that is useful for purposes of activity-based costing.

Activity Analysis - The identification and description
of activities in an organization. Activity analysis

involves determining what activities are done within a

department, how many people perform the activities, how

much time they spend performing the activities, what

resources are required to perform the activities, what

operational data best reflect the performance of the

activities, and what customer value the activity has

for the organization. Activity analysis is

accomplished with interviews, questionnaires,

observation, and review of physical records of work.

It is the foundation for agency process value analysis,

which is key to overall review of program delivery.

Activity-Based Costing - A cost accounting method that

measures the cost and performance of process related

activities and cost objects. It assigns cost to cost

objects, such as products or customers, based on their

use of activities. It recognizes the causal

relationship of cost drivers to activities.

Actual Cost - An amount determined on the basis of cost

incurred including standard cost properly adjusted for

applicable variance.

Avoidable Cost - A cost associated with an activity

that would not be incurred if the activity were not

performed.

Common Cost - The cost of resources employed jointly in

the production of two or more outputs and the cost

cannot be directly traced to any one of those outputs.

Common Data Source - All of the financial and

programmatic information available for the budgetary,

cost, and financial accounting processes. It includes

all financial and much non-financial data, such as

environmental data, that are necessary for budgeting

and financial reporting as well as evaluation and

decision information developed as a result of prior

reporting and feedback.

Controllable Cost - A cost that can be influenced by

the action of the responsible manager. The term always

refers to a specified manager since all costs are

controllable by someone.
Cost - The monetary value of resources used or

sacrificed or liabilities incurred to achieve an

objective, such as to acquire or produce a good or to

perform an activity or service.

Cost Accounting Practice - Any disclosed or established

accounting method or technique which is used for

measurement of cost, assignment of cost to accounting

periods, and assignment of cost to cost objects.

Cost Allocation - A method of assigning costs to

activities, outputs, or other cost objects. The

allocation base used to assign a cost to objects is not

necessarily the cause of the cost. For example,

assigning the cost of power to machine activities by

machine hours is an allocation because machine hours

are an indirect measure of power consumption.

Cost Assignment - A process that identifies costs with

activities, outputs, or other cost objects. In a broad

sense, costs can be assigned to processes, activities,

organizational divisions, products, and services.

There are three methods of cost assignment: (a)

directly tracing costs wherever economically feasible,

(b) cause-and-effect, and (c) allocating costs on a

reasonable and consistent basis.

Cost Driver - Any factor that causes a change in the

cost of an activity or output. For example, the

quality of parts received by an activity, or the degree

of complexity of tax returns to be reviewed by the IRS.

Cost Finding - Cost finding techniques produce cost

data by analytical or sampling methods. Cost finding

techniques are appropriate for certain kinds of costs,

such as indirect costs, items with costs below set

thresholds within programs, or for some programs in

their entirety. Cost finding techniques support the

overall managerial cost accounting process and can

represent non-recurring analysis of specific costs.

Cost Object (also referred to as Cost Objective) - An

activity, output, or item whose cost is to be measured.

In a broad sense, a cost object can be an

organizational division, a function, task, product,
service, or a customer.

Differential Cost - The cost difference expected if one

course of action is adopted instead of others.

Direct Cost - The cost of resources directly consumed

by an activity. Direct costs are assigned to

activities by direct tracing of units of resources

consumed by individual activities. A cost that is

specifically identified with a single cost object.

Estimated Cost - The process of projecting a future

result in terms of cost, based on information available

at the time. Estimated costs, rather than actual

costs, are sometimes the basis for credits to work-inprocess accounts and debits to finished goods

inventory.

Expense - Outflow or other using up of resources or

incurring liabilities (or a combination of both), the

benefits from which apply to an entity's operations for

the current accounting period, but do not extend to

future periods.

Fixed Cost - A cost that does not vary in the short

term with the volume of activity. Fixed cost

information is useful for cost savings by adjusting

existing capacity, or by eliminating idle facilities.

Also called Non-Variable Cost or Constant Cost.

Full-Absorption Costing - A method of costing that

assigns (absorbs) all labor, material, and

service/manufacturing facilities and support costs to

products or other cost objects. The costs assigned

include those that do and do not vary with the level of

activity performed.

Full Cost - The sum of all costs required by a cost

object including the costs of activities performed by

other entities regardless of funding sources.

Incremental Cost - The increase or decrease in total

costs that would result from a decision to increase or

decrease output level, to add a service or task, or to

change any portion of operations. This information

helps in making decisions such as to contract work out,
undertake a project, or increase, decrease, modify, or

eliminate an activity or product.

Indirect Cost - A cost that cannot be identified

specifically with or traced to a given cost object in

an economically feasible way.

Inter-Entity - A term meaning between or among

different federal reporting entities. It commonly

refers to activities or costs between two or more

agencies, departments, or bureaus.

Job Order Costing - A method of cost accounting that

accumulates costs for individual jobs or lots. A job

may be a service or manufactured item, such as the

repair of equipment or the treatment of a patient in a

hospital.

Managerial Cost Accounting System - The organization

and procedures, whether automated or not, and whether

part of the general ledger or stand-alone, that

accumulates and reports consistent and reliable cost

information and performance data from various agency

feeder systems. The accumulated and reported data

enable management and other interested parties to

measure and make decisions about the agency's/segment's

ability to improve operations, safeguard assets,

control its resources, and determine if mission

objectives are being met.

Opportunity Cost - The value of the alternatives

foregone by adopting a particular strategy or employing

resources in a specific manner. Also called

Alternative Cost or Economic Cost.

Outcome - The results of a program activity compared to

its intended purposes. Program results may be

evaluated in terms of service or product quantity and

quality, customer satisfaction, and effectiveness.

Outputs - Any product or service generated from the

consumption of resources. It can include information

or paper work generated by the completion of the tasks

of an activity.

Performance Measurement - A means of evaluating
efficiency, effectiveness, and results. A balanced

performance measurement scorecard includes financial

and nonfinancial measures focusing on quality, cycle

time, and cost. Performance measurement should include

program accomplishments in terms of outputs (quantity

of products or services provided, e.g., how many items

efficiently produced?) and outcomes (results of

providing outputs, e.g., are outputs effectively

meeting intended agency mission objectives?). See

Statement of Federal Financial Accounting Concepts No.

1, Objectives of Federal Financial Reporting, page 65.

Process - The organized method of converting inputs

(people, equipment, methods, materials, and

environment), to outputs (products or services). The

natural aggregation of work activities and tasks

performed for program delivery.

Process Costing - A method of cost accounting that

first collects costs by processes and then allocates

the total costs of each process equally to each unit of

output flowing through it during an accounting period.

Process Value Analysis - Tools and techniques for

studying processes through customer value analysis.

Its objective is to identify opportunities for lasting

improvement in the performance of an organization. It

provides an in-depth review of work activities and

tasks, through activity analysis, which aggregate to

form processes for agency program delivery. In

addition to activity-based costing, quality and cycle

time factors are studied for a complete analysis of

performance measurement. Each activity within the

process is analyzed, including whether or not the

activity adds value for the customer.

Product - Any discrete, traceable, or measurable good

or service provided to a customer. Often goods are

referred to as tangible products, and services are

referred to as intangible products. A good or service

is the product of a process resulting from the

consumption of resources.

Responsibility Center - An organizational unit headed

by a manager or a group of managers who are responsible

for its activities. Responsibility centers can be
measured as revenue centers (accountable for

revenue/sales only), cost centers (accountable for

costs/expenses only), profit centers (accountable for

revenues and costs), or investment centers (accountable

for investments, revenues, and costs).

Responsibility Segment - A significant organizational,

operational, functional, or process component which has

the following characteristics: (a) its manager reports

to the entity's top management; (b) it is responsible

for carrying out a mission, performing a line of

activities or services, or producing one or a group of

products; and (c) for financial reporting and cost

management purposes, its resources and results of

operations can be clearly distinguished, physically and

operationally, from those of other segments of the

entity.

Service - An intangible product or task rendered

directly to a customer.

Standard Costing - A costing method that attaches costs

to cost objects based on reasonable estimates or cost

studies and by means of budgeted rates rather than

according to actual costs incurred. The anticipated

cost of producing a unit of output. A predetermined

cost to be assigned to products produced. Standard

cost implies a norm, or what costs should be. Standard

costing may be based on either absorption or direct

costing principles, and may apply either to all or some

cost elements.

Support Costs - Costs of activities not directly

associated with production. Typical examples are the

costs of automation support, communications, postage,

process engineering, and purchasing.

Traceability - The ability to assign a cost directly to

a specific activity or cost object by identifying or

observing specific resources consumed by the activity

or cost object.

Uncontrollable Cost - The cost over which a responsible

manager has no influence.

Unit Cost - The cost of a selected unit of a good or
service. Examples include dollar cost per ton, machine

hour, labor hour, or department hour.

Value-Added Activity - An activity that is judged to

contribute to customer value or satisfy an

organizational need. The attribute "value-added"

reflects a belief that the activity cannot be

eliminated without reducing the quantity,

responsiveness, or quality of output required by a

customer or organization. Value-added activities

should physically change the product or service in a

manner that meets customer expectations.

Variable Cost - A cost that varies with changes in the

level of an activity, when other factors are held

constant. The cost of material handling to an

activity, for example, varies according to the number

of material deliveries and pickups to and from that

activity.

Variance - The amount, rate, extent, or degree of

change, or the divergence from a desired characteristic

or state.

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*******************************************************

THE FEDERAL ACCOUNTING STANDARDS ADVISORY BOARD

The Federal Accounting Standards Advisory Board

(FASAB or "the Board" was established in October 1990

by the Secretary of the Treasury, the Director of the

Office of Management and Budget (OMB), and the

Comptroller General. The nine-member Board was

created to consider and recommend accounting principles

for the federal government.

The Board communicates its recommendations by

publishing recommended accounting standards after

considering the financial and budgetary information

needs of congressional oversight groups, executive

agencies, and other users of federal financial

information. The Board also considers comments from

the public on its proposed recommendations, which are
published for comment as "exposure drafts." The Board's

sponsors then decide whether to adopt the

recommendations. If they do, the standard is published

by OMB and GAO and then becomes effective.

The following documents related to the

establishment and mission of the Board are available

from the FASAB:

--Memorandum of Understanding among the General

Accounting Office, the Department of the Treasury, and

the Office of Management and Budget, on Federal

Government Accounting Standards and a Federal

Accounting Standards Advisory Board

--Mission Statement: Federal Accounting Standards

Advisory Board

*******************************************************

The Board expresses its appreciation to Managerial Cost

Accounting Task Force members listed below for their contribution

to developing the Exposure Draft of the Statement.

C. Morgan Kinghorn, Chairman

 Internal Revenue Service

 Rein Abel

 Cost Accounting Standards Board

 Frank Bankes

 Navel Sea Systems Command

 Regina Begliutte

 Defense Performance Review

 James Brimson

 Activity Based Management Institute

 Debra Carey

 Department of Interior

 Tom Cuny

 Congressional Budget Office

 Ted David

 . Department of Agriculture

 Joseph J. Donlon

 Internal Revenue Service
 Diane Eggert

 Department of Agriculture

 Dale Geiger

 California State University, San Marcos

 William Gilfillan

 Department of Veterans Affairs

 John Glover

 Department of Defense

 Dianne Guensberg

 General Accounting Office

 Chris Hendrix

 Ernst & Young

 Robert S. Kaplan

 Harvard Business School

 Joe Kehoe

 Coopers & Lybrand

 Richard Loeb

 Cost Accounting Standards Board

 Ronald Longo

 Office of Management and Budget

 Allan Lund

 Department of Treasury

 Pete Poulos

 Department of Defense

 Norman Richards

 General Services Administration

 Justine Rodriguez

 Office of Management and Budget

 Hank Steininger

 Grant Thornton

 John Simonette

 Coopers & Lybrand

Work Group Members:

 Clifton A. Williams

 Internal Revenue Service

 Richard C. Mayo

 FASAB

 Larry J. Modlin

 FASAB

****************************************************

FASAB BOARD MEMBERS
Elmer B. Staats, Chairman

James L. Blum

Donald H. Chapin

Martin Ives

Norwood Jackson

Gerald Murphy

James E. Reid

Cornelius E. Tierney

Alvin Tucker

**********************************************

Ronald S. Young, Executive Director

Project Staff:

Richard C. Mayo

Larry J. Modlin

Federal Accounting Standards Advisory Board

750 First Street, Suite 1001

Washington, D.C. 20002

Telephone (202) 512-7350

FAX (202) 512-7366

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END.