Activity-based costing: illustrations from the state of Iowa.

• Author: Abrahams, Mark D.

Using activity-based costing for performance monitoring and service redesign, Iowa DOT staff fits the choice of cost allocation methodology to the objective of the particular project.

Costing services is one of the biggest challenges facing governments today. How can efficiency or competitiveness be measured without knowing service costs? This article provides an introduction to activity-based costing (ABC) - a methodology that assigns costs to activities based on the activities' consumption of resources - and offers examples and guidance for implementing ABC in a governmental environment. It discusses two straightforward and manageable approaches to ABC: a "keep-it-simple methodology" (KIS) for governments that desire a simple approach to ABC, and a full-cost methodology, using the Iowa Department of Transportation (IDOT) Paint Crews for illustration. The intent is to illustrate the power of ABC for decision making and management and to demystify and simplify ABC. While the guidance is based on Iowa's experience, the concepts and steps are applicable to all governments.

The two fundamental components of ABC are costs and activities.

Costs. Costs are based on resources or inputs. These costs correspond to various governmental charts of accounts generally consisting of salaries, materials, equipment, facilities, and overhead.

Activity. Activities are the steps or sequences of events that convert inputs to outputs; they exist within programs. An activity focuses on what an agency does as measured by the number of units or outputs produced. A program is a series of activities that produce a product, service, or other output to achieve a desired result. For example, the IDOT paint crews' operations consist of three activities: 1) center line, 2) edge line, and 3) curb, island, and miscellaneous.

ABC is a tool used to identify the costs of providing government services (see Exhibit 1). Activity-based management (ABM) focuses on the management of an activity to continuously improve the efficiency of the activity (providing the outputs at a lower cost), the quality of the activity (the right response to community and customer needs), and the effectiveness of the activity (providing services that contribute positively to a result or outcome). ABM includes resource allocation, activity flow, and performance measurement analyses.

Support for Service Redesign

With activity-based data, governments are empowered to redesign processes or to apply process-improvement techniques to reduce cost, improve customer value, enhance accuracy, reduce response time, or otherwise improve efficiency and effectiveness. ABC is the tool used to identify and compute costs for activities and activity outputs. ABM uses the information in a management environment with other tools such as service redesign and process improvement. It is through ABM that ABC fits and supports Iowa's performance management and service redesign efforts.

For Iowa's transportation department, ABC costing was developed to provide total activity costs and unit costs for the paint crews' three activities. This information was then used in a process analysis to determine ways to improve the efficiency and effectiveness of the paint crews. Several improvements were identified including:

* performing work for other governments: down time was turned into productive hours resulting in approximately $200,000 of revenue; and

* unifying the speed of the trucks, which resulted in a higher overall truck speed and fewer hours worked.

Performance management - the system of managing service effectiveness, quality, and efficiency based on measurable results - is the foundation for managing for results. ABC provides the detail information on Iowa's activity costs. Activity inputs and outputs provide efficiency information. Service quality measures provide information on the timeliness, accuracy, and customer value. These measures help to determine the extent to which the program purpose is achieved and the program results (outcome) attained. The program, in turn, is aligned to one of the state's policy objectives or to one of the governor's policy objectives. Alignment and cost are the key to achieving the governor's (or any elected official's) leadership agenda in a cost-effective manner.

Activities are evaluated on their efficiency and on the extent to which they align with program and governmentwide goals. Ideally, an activity has high alignment and low cost. Conversely, an activity with high cost and low alignment is not necessarily providing value and is not efficient. An activity can fall into one of four quadrants:

* high cost, low alignment;

* high cost, high alignment;

* low cost, low alignment; or

* low cost, high alignment.

This analysis is important to reduce activity costs and enhance the alignment to results. A high-cost, low-alignment activity can be eliminated as it does not provide value and is inefficient. A high-cost, high-alignment activity is a candidate for service redesign in order to reduce cost. A low-cost, low-alignment activity is a candidate for elimination unless it can be realigned to statewide policy objectives. A low-cost, high-alignment activity is the ideal.

Activity-based data provide more informative reports than the traditional line-item or organizationally based accounting reports. Traditional accounting reports provide important...