Golden Gate University
Doctor of Business Administration Program
DISSERTATION
Title: Activity Based Costing Model to Cost Academic Programs and Estimate Costs for Support Services in California Community Colleges
By: Steven M Kinsella
Trang 2UMI Number: 3070613
Copyright 2003 by Kinsella, Steven Mark
All rights reserved
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Trang 3ABSTRACT
Activity Based Costing Model to Cost Academic Programs and Estimate Costs for Support Services in California Community Colleges
Using a case study approach, a conceptual Activity Based Costing model was developed from information obtained from a multiple college, California community college district This study was conducted to determine if an Activity Based Costing model could be used: 1) to provide an objective and quantifiable methodology to illustrate the linkage between student instruction and support services, 2) to illustrate the cause and effect relationships between changes in scheduling of academic programs and support costs for the purpose of evaluating resource allocation requests, 3) to provide an accurate estimate of support service costs, 4) to identify the fixed and variable nature of activities performed by California community colleges, and 5) to develop common use applications of ABC to illustrate possible uses of ABC techniques
As a public agency, the West Valley-Mission Community College District routinely prepares detailed activity information regarding costs, enrollment levels, and other quantifiable data that is useful in the development of an ABC model This data was used to create a conceptual ABC model that provides information about the linkage between academic program activities and support service costs incurred The study includes illustrations of general applications of the model including: determining the cost of educational course offerings for courses scheduled on days other than the regular schedule, determining the cost of support services, and determining the cost of providing academic programs These applications can be used to evaluate institutional
Trang 4This study provides information on the interdependent relationship that exists between classroom course offerings and support service activities provided to support instruction The major focus of this study was development of a conceptual model that considers costs incurred across the organization to sustain academic program activities
Having an awareness of the total true cost of services needed to provide an academic program, the institution will have more information available to assist in resource allocation decisions
Implementation of this conceptual model would be a change in current practices
of California community colleges Like any change, a certain amount of resistance can be expected This study offers comments on resistance to implementation that may be
encountered when attempting to use ABC for resource allocation decisions but also
Trang 5ACKNOWLEDGEMENTS
I would like to extend a special thank you to the individuals that have most
directly contributed to the development of this paper:
Dr Paul Hoppe, CPA for agreeing to serve as the chair of my dissertation
committee I have studied various aspects of activity based costing throughout my
doctoral program Dr Hoppe’s participation as the chairperson of my dissertation committee allowed me to continue to develop my knowledge in ABC without changing the focus or delaying the progress of my studies
Dr Nabil Rageh for serving as a voice of reason and stable guidance through the development of this paper but more importantly through my entire course of study leading to the completion of the doctorate degree Dr Rageh’s knowledge of operations management was especially useful in considering and including where appropriate, implementation aspects into the development of this theoretical model
Trang 6DEDICATION
This paper is dedicated to my wife Linda, and my children: Jessica, Mark and Felisha For nearly twenty-three years, Linda has endured the hardships associated with a Marine Corps career; a source of our best and worst life experiences They have endured multiple relocations across the nation and on a couple occasions, assignments overseas Finally, Linda has fully supported my studies for the past four years and has sacrificed at
times when others may have been tempted to make different choices We have grown up
Trang 7Table of Contents
Page
Chapter One - Introduction 9
I, Introduction to Existing Resource Allocation Methods 9
II Background 15
A California Community Colleges Operate in a System of Constraints 15
B Interdependence Between Instruction and Support Services 16
C Problem Statement 17
D Purpose 20
E Objectives 20
F, Professional Significant of the Study 21
G Limitations of the Study 22
H Definitions of Key Terms 24
Chapter Two — Review of the Literature 26
I Activity Based Costing-An Introduction 26
II Public Entity Performance and Resource Allocation Processes 30
HH Use of ABC in the Government Sector 33
IV Considerations for Implementation of an ABC system in a
Higher Education Public Entity Environment 37
Chapter Three — Research Methods and Procedures 42
I Introduction 42
II Research Questions 43
Ill General Framework of a Practical Model 43
IV The Logic of Activity Based Costing 45
The Framework for a California community college ABC model 48
Chapter Four — Applications of the ABC Model 60
1 Introduction 60
II The Program Review Process — Improving Institutional Effectiveness 61
A Accreditation Standard Requirement 61
B State Academic Senate Perspective on Program Review 62 C The Program Review Process at West Valley-Mission
Community College District 64
III Improving Institutional Effectiveness through the use of ABC 69 A Use of ABC to Assist in Resource Allocation Decisions During
Tough Economic Times 69
B Determining the Cost of Educational Offerings by Day 72
C Determining the Cost of Support Services 74
Trang 8Chapter Six — Precautions and Consideration of Benefits of an ABC Model 81
I Introduction 81
H Impacts of Decisions on the Balance of the Curriculum 81
Ill Meeting the Needs of the Local Community 82
IV California Community Colleges Provide Services 82
V Resistance to Implementation 83
Chapter Seven — Conclusions and Areas for Future Research 85
I Conclusions 85
II Successes and Failures 85
Il Areas for Future Research 86
Appendices
Appendix A District Office Administrative Services 98
Appendix B Mission College Support Services Provided
by District Office 100
Appendix C West Valley College Support Services Provided
by District Office 101
Appendix D FTES Earned by College 102
Appendix E West Valley College President’s Office 102
Appendix F, West Valley College Summary of Instructional Costs 102 Appendix G West Valley College Student Services 104 Appendix H West Valley College Administrative Services 105
Appendix I Mission College President’s Office 105 Appendix J Mission College Instructional Cost Summary 105
Appendix K Mission College Instructional Technology 106
Appendix L Mission College Student Services 106
Appendix M Mission College Administrative Services 107
Appendix N Cost for Sunday Classes 107
Trang 9List of Figures and Tables
Figure 1 ABC Cost Reassignment Flowchart
Figure 2 An ABC Costing Model for Public Higher Education
Figure 3 Steps Used to Develop an ABC Model for California Community Colleges
Figure 4 Activities Listing
Figure 5 Districtwide Operations Matrix
Table 1 District Executive Administration Activities Table 2 Administrative Services Processes
Table 3 College Activities
Table 4 Student Activities
Table 5 Student Instruction Activities
Table 6 Student Instructional Support Activities
Table 7 West Valley College On-Site Cost Summary Table 8 Mission College On-Site Cost Summary Table 9 Cost Per FTES as listed by TOPS Code
Table 10 Service Type and Nature of Cost Pattern
Table 11 West Valley College Instructional Departments — Program Reviews Table 12 West Valley College Non Instructional Service Areas
Table 13 Mission College Instructional Departments-Program Reviews Table 14 Costs of Direct Student Support Service Support
Table 15 Cost for a Certificate in Computer Applications
Table 16 Cost ofa Certificate of Proficiency Early Childhood Development
Table 17 Cost of an Associate Degree in English Table 18 Cost of General Education Requirements
Trang 10CHAPTER ONE Introduction
I Introduction to Existing Resource Allocation Methods
Decisions to allocate resources within California community colleges are influenced by a participatory governance process that is mandated by law The result of this process is that interest groups with the most power are able to secure resources to satisfy their individual needs All interest groups are represented in the resource allocation process but the groups with the most political power generally dominate the process Labor representatives will seek to obtain resources for salaries and benefits of their members Faculty members will argue for additional faculty positions, increases in adjunct faculty budgets and increases in instructional equipment and supplies These two groups generally oppose increases in support departments for which they receive no recognizable benefit Yet, it is the lack of those support services that is the source of many complaints about the institution’s lack of support for students and faculty
Trang 11the present budgetary process is rightly or wrongly deemed unsatisfactory, then one must
alter in some respect the political system of which the budget is but an expression It makes no sense to speak as if one could make drastic changes in budgeting without also
altering the distribution of influence” (Wildavsky, 1961, pg.183-190)
Departments with great political power are successful in ensuring funds are allocated for application specific cost elements but not necessarily for the related outside the classroom costs The end result of this participatory governance process is that the power wielding groups obtain resources they request Other groups that are impacted by such things as hiring additional employees, increasing numbers of paychecks, and
additional equipment to purchase, install and maintain do not receive additional resources
to address the follow on support impacts that result from changes in department activities Simply stated, there is a lack of holistic perspective under the existing participatory governance structure used by California community colleges to allocate resources
Academicians in California community colleges resent discussions that suggest
educational institutions are like businesses It is true that public educational institutions do not have a profit motive and therefore they cannot measure results in the same way as commercial enterprises Public agencies, including higher education entities, should instead focus on maximizing services to communities that they serve With this philosophy in mind, public agencies should recognize that the techniques used by commercial entities might be adopted for use in allocating resources and measuring
results The process of allocating resources in a public agency to provide services can and
Trang 12I am not suggesting that the participatory governance process be abandoned In my opinion the process can be enhanced by using objective resource allocation tools like Activity Based Costing that utilize a systems approach when determining the cost to provide goods or services Currently, departments act as if they are independent of the remainder of the organization Department representatives lack an understanding of the interdependencies that exist between the instructional activities and-the service support departments The participatory governance process for resource allocation decisions has not been developed in a way that acknowledges how the actions of one department impact another department
Administrators who are responsible for the final resource allocations lack useful objective criteria upon which to demonstrate appropriate levels of funding for the full spectrum of costs of operating educational programs Support services are impacted by decisions made in the academic program departments The allocation of resources to academic programs is influenced by legal requirements that stipulate that a minimum of 50% of expenditures is to be for classroom activities Additionally, the state mandated minimum full time faculty obligation number (FON) requires that each college district employ a certain number of full time faculty The AB 1725 requirement that the Academic Senate participate in the budget development process gives the faculty who operate the academic program departments great power over the allocation of resources
Trang 13The result of the structure of constraints that influences resource allocation decisions is that the academic program departments are able to obtain resources for direct
instructional activities However, the effects on the follow-on support service areas are often forgotten or ignored Two examples illustrate this point
a The mathematics department has the funding to purchase twenty-four computers to establish a computer laboratory The laboratory will assist in building students’ skills in mathematics The mathematics department
modifies its curriculum and adds a requirement that students spend an hour in the computer lab for every 3 hours of classroom contact The department then places an order for the equipment Upon arrival of the
equipment, the department chairperson of the mathematics department contacts the information systems department and requests that the
equipment be set up in time for the Fall semester that begins in two weeks The director of information systems then explains that: 1) the room
identified for the laboratory does not have adequate power to operate
twenty-four computers, 2) the room does not have adequate cooling and ventilation for twenty-four computers, 3) the lighting in the room will cause problems with glare and 4) due to a shortage of computer maintenance workers, the information systems department cannot repair the computers when they fail
Trang 14course schedule to include class offerings on Sunday The department
schedules the use of two computer laboratories in the main 235,000 square foot instructional building of the college The facilities department is informed that the main building will be open on Sunday’s and is instructed to ensure heating and cooling systems are operating Since the main
building does not have separate controls for individual areas of the building, the entire building is heated and lighting is turned on The additional cost for utilities to operate the main building is determined to be $44,000 annually
The traditional resource allocation process allows individual academic
departments to determine the schedule of classes, and purchase equipment and other tools
necessary to meet department enrollment goals The problem is that the traditional model
does not consider how decisions of academic departments affect support services Total
organization wide costs are not considered when traditional allocation models are used
The focus is on one area of the organization As long as that area of the organization has funding to pay for its initiatives, the department has great latitude in going forward with its plans
Trang 15resource allocation process thereby providing the decision makers with an understanding of the full costs associated with changes in academic activities
Support services are a category of functions that assist faculty in delivery of educational services These support service systems are also designed to ensure community colleges comply with public laws applicable to public institutions of higher education Examples of support services include: libraries, computer infrastructure,
language laboratories, computer laboratories, audiovisual/web technical support and
support systems to comply with public agency reporting, purchasing and contracting and
finance related activities
Traditional cost accounting methods characterize support services as “overhead.” Overhead activities are not considered value-adding processes Minimizing overhead
costs will allow additional resources to be allocated to the primary instruction areas The participatory governance structure used to allocate resources commonly seeks to contain
overhead costs by restricting allocations to those departments that provide support
services This characterization has led some observers to the mistaken conclusion that
such expenditures are extra luxuries that drain funds away from mission critical activities In fact, “overhead” expenditures are frequently critical in meeting operational objectives;
they add value and make a significant contribution to overall output In a public agency
environment, some activities may be considered non-value added but are required by law
Trang 16Il, Background
A California Community Colleges Operate in a System of Constraints Public agencies are regulated through laws designed to protect the expenditure of taxpayers’ money Laws overlay a series of constraints on public institutions of higher education As examples, revenue sources are restricted while at the same time minimum expenditure requirements are placed on the amount of funds provided for classroom instruction Add these constraints to the requirement of a participatory resource allocation process and a California community college district finds itself in a very unusual
environment whereby it must struggle to meet the legal requirements while still providing a level of support services that will satisfy internal users and students
State laws influence the budget process by which colleges allocate resources and
expend funds The 50% law!, the AB 1725 goal of 75/25” full time versus part faculty
ratio, and Title 5, California Code of Regulations, that imposes a minimum Faculty Obligation Number (FON) all influence resource allocations for academic costs Although the majority of constraints relate to the use of faculty employees, constraints also influence the use of support service employees who work in what is known as the “classified” service Classified employees have rights under the California Education Code such as the 195-day rule’, and laws that limit use of substitute and short-term employees The main emphasis of these laws is to ensure that permanent full time employees are used when the jobs performed are on-going work requirements
' The 50% law requires that 50% of the cost of education be spent on classroom instruction
2 AB 1725 established a goal that of 75% of instruction would be taught by full time faculty and not more than 25% of instruction would be taught by part time faculty This is only a goal, no funds were provided for this goal to be achieved
Trang 17Permanent employees receive a full range of paid benefits including health insurance, vacation, illness leave, holidays and a retirement plan in the Public Employee Retirement System (PERS) Constraints like these prevent extended use of part-time intermittent employees in lieu of permanent employees and increase the permanent cost structure of the institution Support positions are required to provide service to faculty and students in academic programs Hence, a linkage exists between activities occurring in academic programs and the service support areas
The result of the public agency environmental constraints is an unavoidable base layer of costs that will be directed to ensure a minimum percentage of expenditures will be incurred for faculty and classroom activity costs Although complying with a law that stipulates that 50% of funds will be expended on classroom activities does not seem to be a relatively difficult requirement to achieve, what is not obvious is that only certain types of expenditures count toward achieving the 50% requirement Other unavoidable costs incurred that are also related to classroom activity do not qualify for inclusion in the 50% calculation
B The Interdependence Between Instruction and Support Services
Trang 18In public agencies that operate with taxpayer provided resources, it is not always possible to expand the amount of funds that can be brought into the organization Even when new funds are provided, those funds are subjected to the same constraints that exist over all other funds, e.g the 50% rule Currently, support needs are not adequately addressed in the resource allocation process because there is no objective model that is used to highlight the impact on other departments as academic program changes are made The same is true when there are changes in administrative areas that have
unanticipated consequences on the operations of another department
The amount of revenue received by a college is limited by the State’s budget and
the laws that control what fees can be charged Faculty costs are also set at minimum
levels established by laws Colleges operate in the public entity domain that restricts procurement, contracting, financial reporting and other activities that provide public access to information about the operation of public agencies Each of these requirements
increases the cost of operations and are unavoidable
Solutions to operating in an environment of constraints can best be identified when it is acknowledged that there are constraints and that there are interdependencies that exist between direct services and support system requirements Improvements can be achieved in both areas by evaluating operating activities, recognizing and properly
planning for support services as well as direct instructional activities and by also
concentrating on maximizing productivity in all areas C Problem Statement
Activity Based Costing can assist in resource allocation decisions by identifying
Trang 19services so that all activities required for student instruction are evaluated during the resource allocation process
Traditional budgeting and cost accounting methodologies have not provided community college administrators with effective resource allocation tools that demonstrate the need to allocate minimum levels of resources to accomplish support service activities This has occurred because the linkage between program actions and support service requirements is not clear No specific and quantifiable activity association exists in traditional budget methods In the public higher education environment,
administrators require budgeting tools to identify the support services funding levels required to meet student needs Some will argue that an approach that highlights support service costs is merely an attempt to divert funds from instructional activities to support activities The question they need to see answered is: “what benefit accrues to the student or the faculty who support the student?” Indeed, the question is difficult to answer using objective information
The presence of support services is frequently unnoticed Support services are most notable when their absence creates a problem or results in the failure of another activity in a different part of the organization ABC techniques can be useful in forming a basis to identify the cost of support services incurred in order to support students The follow-on action of determining whether the costs incurred are providing the right kinds of support services will open the door to constructive discussions about what support services are truly needed
Trang 20ABC is a function oriented cost accounting allocation methodology rooted in the manufacturing environment In recent years it has been successfully employed in both
government and service industries Standards of support service costs are not available
on an industry wide basis and this makes measurement difficult This model can be used in other California community colleges to assist administrators to make decisions about the allocation of resources for support service Wide implementation of an ABC model in California community colleges can result in colleges establishing and budgeting for support services using standards
Sound management principles dictate the elimination of activities that do not directly support an organization’s mission In practical terms such activities are defined as those that do not support the production and delivery of a product or service Hicks notes: “In traditional cost accounting systems, many of the non-throughput or direct costs are charged to cost objectives through value-adding or direct activities These are
activities taking place that turn the things a company buys (or has consigned to it) into the things that it sells or that are directly attributable to the service being provided” (Hicks, 1998 pg.61) In following these common practices in a community college environment, the focus of effort is from the classroom backward to the student with the spotlight on the classroom activity Elimination of non-value adding activities requires an understanding of value adding processes The perception of value adding may be much more narrow than an analysis of activities may actually indicate
Trang 21illustrating the connection between academic activity and support service activity ABC can identify the resources needed to provide support services for a course of study It can also assist administrators in determining the amount of resources that are needed to support academic programs
An international survey of management techniques used by governmental entities in the United States, Canada and United Kingdom showed that Activity Based Costing and Activity Based Management techniques are gaining in popularity as a way of meeting the challenges of increased accountability (Kidwell, Shin-Jen, et.al 2002) The report showed that the most popular performance measurement tool was benchmarking at 78.8 percent of those organizations that use a performance measurement tool followed by process reengineering at 60.6% (Kidwell, Shin-Jen, et.al 2002, pg 63) Even though ABC and ABM are used less today than benchmarking and process reengineering, they are reported to be the more effective tools (Kidwell, Shin-Jen, et.al 2002, pg 65) As the public demands more accountability over public resources and as governments move toward performance based accountability measures, ABC may become a more widely used performance accounting methodology
D Purpose
This study was conducted to develop an activity based costing framework for use in evaluating resource decisions in a multiple college California community college district
E Objectives
Trang 22instruction and support services, 2) illustrate the cause and effect relationships between
changes in academic program scheduling and costs to provide support services, 3) identify the fixed and variable nature of activities performed by California community colleges, and 4) develop common use applications of the activity based costing to illustrate possible uses of ABC techniques
F Professional Significance of the Study
Funding for public agencies is limited yet demands for services are not Choices have to be made about what services are provided However, when options to offer services are made, there is no systematic analysis of the costs that will be incurred to
provide the services ABC techniques can be used to determine the cause and effect relationship that result in the consumption of resources (Kinsella 2002) Using these techniques, it is possible to develop a resource allocation model that reflects the
underlying economics of the cost of providing educational services Currently, traditional
budgeting models are used to distribute resources Performance measurement is not common practice within California community colleges The development of an easy to use activity based costing model can be used in the following ways:
1 To determine the actual cost of academic programs including support services
Trang 233 To determine how public agency reporting requirements affect the underlying
cost structure of a community college
4 To assisi in the development of budgets for activity based management
purposes
5 To assist in the implementation of performance based budgeting
This study is unique in that it evaluates the existing cost structure of a multiple
college, community college district to create a working ABC budget development model This study combines the theory of activity based costing, and the techniques and practices used in service related operations management functions to create an ABC model that can be quickly implemented by administrators to assist in decisions about resource
allocations, The ABC model proposed in this study is an easy to use and easy to communicate resource allocation model that incorporates the fundamental principles of
ABC
There is no working model for public higher education in widespread use at this
time If the model proves to be useful for decision making purposes because of its ease of
use and applicability to common decision problems, it is possible that an ABC model similar to this one can be used for portions of self studies conducted in preparation for the accreditation process of each college The model accurately demonstrates the
consumption of resources that occur when there are changes in academic programs thereby assisting in evaluating the institutional effectiveness of the college The value of the model will depend on how the information is used by the institution
G Limitations of the Study
Trang 24This model was created using the organizational structure and cost data from one California community college district Use of this model at other
institutions will require adaptation to recognize the differences in organizational structures that will impact cost patterns
Data reported on publicly available reports and transmitted to the State of California are presumed to be accurate for purposes of this study
Cost data compiled to illustrate the costs of employees assigned to
departments shown on the organizational charts were calculated using mid- step placement on the standard salary schedule Actual costs for specific employees assigned to the departments may have altered the cost data Data reporting full time equivalent students by academic class are assumed to
be accurate and complete
This model provides an objective and verifiable presentation of data arranged in a manner that assists in raising questions about the adequacy of resource allocation decisions Resource allocations are influenced by social and political factors that were not included in this study
Applications used to illustrate the use of activity based costing are intended to address common decision problems encountered by California community colleges Additional applications may be appropriate for other institutions of higher education
Trang 258 Testing of the acceptance of the applications included in this study by other administrators was not conducted because of the time needed to educate other administrators on the proper development of data and use of activity based costing techniques Replication of study results at other California community colleges will require that personnel developing the applications have a background in cost accounting methodologies
H Definitions of Key Terms
Activity Based Costing: a cost management system that assigns costs to products or services based on the resources consumed in order to produce the product or deliver the service (O’Guinn, 1991)
Activity: describes what an organization does to convert resources (inputs) into outputs (products or services) (Brimson, 1991)
Assignable Costs: these costs vary with changes in an activity measure or some other volume indicator
Cost Driver: elements of an activity that is responsible for the consumption of resources
Full Time Equivalent Students (FTES): A full time equivalent student is equal to 525 student contact hours FTES is a unit of measure for instruction It is the basis for funding in California community colleges
Trang 26Organizational Costs: For purposes of this study, organizational costs is a term
used for costs that cannot be assigned to a specific activity The costs may be necessary
anid unavoidable but cannot be directly traced to the occurrence of an event
Weekly Student Contact Hours (WSCH): The amount of classroom instruction time per week for any one class This is the amount of direct classroom contact between
the instructor and the student
Academic Programs: includes all credit earning courses that are applicable to a certificate, a degree or for transfer to a university
Service Support Functions: includes all functions that directly service employees or students These functions include payroll, employee relations, employee benefits, custodial, grounds, building maintenance and any other area that directly provides
services to employees or students
Administrative Support Functions: include areas of accounting, finance, executive administration and public agency required activities
Student Support Functions: includes those areas that provide direct students to
services for other than instructional purposes Included in this area are admissions and
Trang 27CHAPTER TWO
Review of the Literature I Activity Based Costing — An Introduction
ABC assists organizations to understand the underlying economics of a business
It identifies the functions that generate or create costs It is a system for costing products, developing budgets, measuring performance and valuing inventory (O’Guin, 1991) By determining what really drives costs, ABC allows management to attack and reduce, if necessary, the so-called fixed costs including items like sales force expense, engineering, planning and depreciation (O’Guin, 1991, pp 32)
Cooper and Kaplan published the seminal work on ABC in 1988 These authors
challenged traditional cost accounting by concluding cost information is distorted: “Distorted cost information is the result of sensible choices made decades
ago, when most companies manufactured a narrow range of products Back then,
the costs of direct labor and materials, the most important production factors,
could be traced easily to individual products” (Cooper and Kaplan, 1988 pg.96) In the earlier days of manufacturing, indirect factory overhead and other corporate burdens were relatively minor in relation to labor and material costs Today’s companies have larger amounts of overhead due to the extensive nature of overhead functions but these companies are attempting to allocate costs by the diminishing amounts of direct labor that are applied to each project “Historical cost methods are not an appropriate allocation methodology since the allocation base bears little resemblance to the creators of cost” (Kinsella, 2002, pg.53) Recognizing that direct labor is no longer a good
Trang 28project's total cost, it has become apparent that the historical cost methods do not meet
the demands of today's competitive marketplace,
Cooper and Kaplan state: “The profitability picture that emerges from the ABC
analysis helps managers focus their attention and energy on improving activities that will
have the biggest impact on the bottom line” (Cooper, Kaplan, 1991 pg 2.) The use of traditional cost allocation methods may actually result in companies’ losing money on certain products, orders, projects, or customer engagements even though their accounting systems may indicate a profitable transaction has occurred (Cooper, Kaplan 1991) The
primary reason for this is that because the cost tracking mechanism does not adequately recognize the cause and effect relationship that exists between indirect costs and direct costs (Kinsella, 2002)
“Virtually all of a company’s activities exist to support the production and delivery of today’s goods and services They should therefore all be considered product
costs” (Cooper, Kaplan, 1988 pg.97) A problem with traditional accounting is that “The
ledger information, although accurate, fails to report the business-process costs that run cross-functionally — that is, across an organization’s department boundaries, it fails to show the true total cost of fulfilling a customer order that passes through many hands” Cokins, 1999, pg.37) According to Cooper and Kaplan, “managers in companies selling multiple products are making important decisions about pricing, product mix, and process technology based on distorted cost information What's worse, alternative information rarely exists to alert these managers that the product costs are badly flawed Most companies detect the problem only after their competitiveness and profitability have
Trang 29Cooper and Kaplan indicate that many of the engineering and technology efficiencies have already generated substantial savings and changes in these areas now yield fewer results than in the past The focus of effort now needs to shift to indirect costs ABC is useful in examining indirect costs by grouping costs into the four broad levels of facility sustaining, product sustaining, batch level and unit level activities Through the process of examining cost components, it is possible to eliminate non-value added costs because they are distant from the physical product and may be eliminated or changed without adversely affecting the finished product The benefit is lower overall cost
Existing accounting systems provide data in terms of generally accepted accounting principles Hicks states: “ No matter how closely the activity-based distribution of costs to activities, products or services reflects actual cause and effect relationships, the final answers will be wrong if the process starts with inaccurate or irrelevant cost information” (Hicks, 1998 pg.28) He continues on in his discussion of generally accepted accounting principles and how the data provided by their use is not an accurate measure of operating performance Hicks (1998) concludes that any accounting data developed under GAAP and used for day-to-day and strategic decision making will need to separate the inaccuracies that distort activity before an analysis is conducted
Trang 30managers to understand the economic conditions of a business Given the volume of information processed today and recognizing that most accounting systems are automated, the use of computers over the past ten years since ABC gained widespread use has greatly improved the ability of many organizations to benefit from ABC (Hicks
1998) Figure i shows how ABC reassigns resource costs to cost objects Figure 1-ABC Cost Reassignrent Flonchat | Resource Costs | mm Suppat ar sts = | = = | f E Maria Produtsenice | Ï | Adwie $10 Activities $15 | : -§10, — $f6- — | | i Đi Custorrer Infrasbucture = Adivties | | Sustaining $20 $25 | ị | | | : ! ! aN ¥ Ỷ Ỷ | ( Price \ ——\ External Custorrer/Orders | \ Data | ———y $70 NY ma Í tư Giữa G19 pg.9%
ABC as atota systemin this exarrple begins with $70 It then reassigns and \
accurrulates the costs into the final cost objects (outputs) tothe $70 /
Trang 31II Public Entity Performance and Resource Allocation Processes
Historically, public agencies struggle with allocation of taxpayer resources in a
way that balances the needs of all users with the amount of resources available to provide services In 1952 Verne B Lewis commented:
The $64.00 question on the expenditure side of public budgeting is: On what
basis shall it be decided to allocate X dollars to Activity A instead of allocating
them to Activity B, or instead of allowing the taxpayer to use the money for
individual purposes? Over a decade ago V.O Key called attention to the lack of
budgetary theory which would assist in arriving at an answer to this question (Key, Jr 1940, pg.1137-44) Pointing out that budgeting is essentially a form of
applied economics, since it requires the allocation of scarce resources among
competing demands, Professor Key urged that this question be explored from the point of view of economic theory.” (Lewis, 1952, pg.43-45)
Today, the budgetary problem noted by Key in 1940 and Lewis in 1952 is the same as it was then Governmental entities are service organizations responsible for providing a
wide range of services on a limited budget Lewis notes “It is perfectly true, as Key
points out, that budgeting involves questions of value preferences which must be based on philosophy rather than science or logic” (Lewis, 1952 pg.44)
The Government Accounting Standards Board (GASB) provides a financial reporting framework that is helpful in understanding the general nature of governmental
Trang 32five characteristics of governmental entities that influence the objectives of financial reporting:
1 Taxpayers are involuntary resource providers
2 The amount of taxes paid seldom bears a direct relationship to the services received
3 No “exchange” relationship exists between services rendered and resources provided
4 Governments often monopolize certain services
5 It is difficult to measure the optimal quantity or quality of service.” (GASB Concepts Statement No 1, paragraph 17)
Trang 33The focus on performance has caused governmental entities including public institutions of higher education to focus not on inputs but on outputs According to Melkers and Willoughby, “The current wave of budgeting reform focuses on the performance of government agencies and programs and is reflected in state efforts to
introduce performance-based budgeting (PBB) In the ideal this budget system requires
measurement of results, outcomes, and impacts” (Melkers and Willoughby, 1998, p.¢5) This emphasis on outputs creates an opening for new evaluation techniques to be used within the governmental sector Without a profit motive, governmental entities have few universal measures by which to judge their performance
Commercial entities have been able to measure performance through profits, return on investments, price earnings ratios and other universal measurement indexes Governmental entities rely on benchmarking, and business process engineering to maintain services without increasing costs (Kidwell, Shin-Jen, et.al 2002) While these techniques are useful they may actually only be measuring what is perhaps one inefficient organization against another also inefficient organization While the benchmarking technique was the most supported form of performance evaluation (Kidwell, Shin-Jen et.al 2002) it is still only viewed as being moderately useful to government
Trang 34IH Use of ABC in the Governmental Sector
“Governments around the world are under great pressure to control their costs and
improve their service In response to chronic fiscal constraints, local governments are
considering management tools used in the private sector, such as activity based costing (ABC), activity based management (ABM), total quality management (TQM),
benchmarking, process engineering, and the balanced scorecard Some government
leaders believe that such tools are helpful in meeting the challenges of increased
accountability while others dismiss them as merely another fad” (Kidwell, Shih-Jen, et.al
2002, pg 63)
Use of ABC to reduce or eliminate non-valuing adding costs or to assist in
identifying changes in costs that can occur as a process change, is a technique that can be employed by any service company including governmental entities In recent years accounting professionals and managers in the public sector have exhibited increased
interest in the applicability of ABC within the government environment Several studies
have suggested that ABC methodology provides public sector managers with improved Metrics against which organizational performance may be managed One study reviewed
the installation of ABC in a division of the United States Internal Revenue Service
(Geiger, 1993/1994) Geiger concluded that ABC generated improved metrics upon which to base key management decisions These metrics proved especially valuable on issues of personnel allocation, space utilization, and deployment/allocation of support
services staff
Other studies also identified the value of ABC in the development of improved
Trang 35ABC in a publicly owned hospital in Victoria, Australia (Evans and Bellamy, 1995) The authors of that study observed that ABC methodology drove managers to reexamine cost factors in service delivery and develop improved metrics that better tie into their quality management program Evans and Bellamy concluded that, for this reason, the ABC implementation process provides public sector organizations with greater benefit than
does the “end result” It is interesting to note that cost avoidance appears to be the
common thread between governmental system resource allocations and the private sector applications of ABC This feature is one to be exploited if ABC is to become commonly used in the governmental sector
A third study reported on the use of ABC by the United States Department of
Defense (LaPlante and Alter, 1994) These authors examined the Defense Department’s use of ABC methodology to support reengineering and benchmarking efforts Through ABC the Department identified costs of providing specific types of services and compared their costs with that of other organizations providing similar products or services The Defense Department was then able to use this benchmarking data to identify less costly means of producing the same product or delivering an equivalent service This study is not inconsistent with the results of the Kidwell, Shin-Jen, et al research study in 2002 that found that benchmarking was expected to gain in popularity in the upcoming years
Probably the most notable effort to use activity based costing was in the City of Indianapolis, Indiana Stephen Goldsmith, Mayor of the City of Indianapolis, decided in
1992 that the City it could no longer conduct business in the manner to which it had
Trang 36driving force to use an activity based costing system to price governmental services Those principles were:
e People governed least are governed best ® Government should be a rudder, not an engine e People know better than government
e Government should be measured the same way every other enterprise is measured: by its results (Kaplan and Ridenor, 1996, pg.2)
The approach used by the City of Indianapolis was described in five phases (Kaplan and Ridenor, 1996, pg 12) The five phases are:
1 Identify project objectives, department activities and outputs 2 Collect and analyze costs and cost drivers
3 Collect other direct and indirect cost information 4 Develop an ABC Model
5 Summarize cost information
Trang 37In recent years two separate studies on the implementation of ABC in municipal government have been published In one study the author describes how the City of Indianapolis, Indiana has implemented ABC and the value the City derived for an improved understanding of its costs in providing services The City of Indianapolis regularly used ABC data to drive internal competition among city departments and as an aid in making procurement and outsourcing decisions (Meyer, May/June 1998)
Another review of ABC efforts published in 1999 examines the results of the City of Wooster, Ohio, a small midwestern city (Brown, Myring, and Gard, 1999) The authors conducted a study of Wooster’s conversion to ABC for selected departments They discovered that the implementation process provided operations managers with a better understanding of the full costs associated with tasks related to the delivery of services or products The cost of implementation, however, proved significant The City abandoned the implementation because of the cost of implementation efforts and the conclusion by senior management that the additional information collected would not substantially result in different financial decisions
Trang 38acceptable level of understanding of its cost structure and would not receive substantially
better information as a result of ABC techniques
The studies referenced above suggest that use of ABC in the public sector offers management significant advantages in understanding the costs of delivering specific services and/or products and provides a sound basis for constructing organizational performance measures, Even in the Wooster, Ohio case where ABC was not fully implemented, the city government derived an improved understanding of their costs by
going through the process It is true that public sector institutions of higher education
have not yet incorporated ABC into their budget methodology However, the use of ABC and the methodology used to develop ABC decision making applications will offer such
institutions with the same type of benefits as that obtained by the City of Indianapolis, the
United States Department of Defense, the United States Internal Revenue Service, and a public hospital in Victoria, Australia While ABC originated in a production
environment, its effective area of deployment has clearly expanded to include the government sector
IV Considerations for Implementation of an ABC System in a Higher Education Public Entity Environment
Public institutions of higher education including California community colleges face the same problems as all governmental entities; the need to balance an endless list of demands against a finite amount of resources Approaching the development of an ABC
model should follow the same principles that have been found effective in private
Trang 391 Focus on expensive resources
2 Look at resources whose consumption varies significantly from project type and product
3 Look for resources whose demand patterns are not consistent with traditional activity or volume measures such as direct labor, processing time or materials (Cooper & Kaplan, 1988)
Convincing a political body to allocate resources requires communication of a concise and convincing argument ABC may be a vehicle that provides sufficient data to illustrate
the true cost of programs Knowing the actual cost of a program to an organization will provide governing boards with information about the level of service that can be provided
given a certain amount of resources
In California community colleges, financial information needs to be converted to information that is useful for operating decisions The financial system will not provide
information that is organized in a manner that easily illustrates the cost of prograrns
ABC management software is being changed as a result of the use of intelligent system demands (Cooper, Slagmulder 2000) Software has to support both a strategic costing model and an operational improvement program Strategic costing systems will consider as few as 20 activities but no more than 60 activities (Cooper, Slagmulder, 2000) This system is used predominately for pricing products and determining profitability The operational improvement system on the other hand is intended to assist organizations in becoming more efficient Operational improvements are achieved when business processes are redesigned and when incremental improvements are made to existing
Trang 40Cooper and Slagrnulder also state: “ There are three fundamental ways that a firm
profitability can be increased: acquire the resources consumed by the firm at lower prices, perform the firm’s activities more efficiently, and become more effective at generating
profits selling a more profitable mix of products or services to a more profitable
collection of customers through a more profitable set of distribution channels” (Cooper and Slagmulder 2000, pg.63) Substitution of the profit motive with service delivery allows use of the fundamental principles of ABC to be applied to governmental services Governmental entities do not have a profit motive but remain responsible for maximizing