Author:Mohr, Zachary


Cost accounting has been used and studied by organizations and researchers for over 100 years. In spite of its long history and potential, cost accounting remains understudied in the context of government organizations (Rivenbark, 2005). Many books give descriptions of how to do cost accounting (Coe, 2007; Finkler, Purtell, Calabrese, and Smith, 2012) and from time to time a small amount of research is published on cost accounting in government (Ammons, Coe, & Lombardo, 2001; Coe & O'Sullivan, 1993; Geiger, 2010; Mullins & Zorn, 1999; Rivenbark, 2005). Generally, the assessment about cost accounting is much the same as it was more than 70 years ago. While cost accounting has received renewed interest by those that want to make government more efficient in recent years, there is little current research on the topic (Lorig, 1936; Rivenbark, 2005).

An exception to this general dearth is a recent study that indicates that management cost accounting continues to have many relevant purposes for U.S. cities (Mohr, 2015). This study found significant relationships between cost accounting and two common uses: rate setting and cost management. Additionally, cost accounting and service costs have a strong link with benchmarking and performance (Ammons & Rivenbark, 2008), grant overhead cost recovery (Coe, 2007), and decisions to contract out services (Stein, 1990). As the recent study on the uses of cost accounting notes in its discussion, the big unanswered question is what is impeding the general use and further development of cost accounting in government? This present research presents a partial explanation to this question by analyzing the effects of transaction costs on cost accounting plans.

This paper uses transaction cost theory to explain the use of indirect cost measurement for specific services in public cost accounting plans. The public organizations are large U.S. cities that are utilizing centralized cost accounting plans to allocate indirect costs down to individual products and to measure costs of individual services. The statistical models of Table 3 show that transaction costs are related to fewer indirect cost measures for high asset specific services, but services with outcomes that are more difficult to measure are actually related with a greater likelihood of indirect cost measurement. This may be explained by the observation that services that have outcomes that are difficult to measure may be more appropriate to measure at the input or cost level. This conclusion is further supported by cost measurement's relationship to performance measurement. This research provides a plausible explanation for what may be limiting cost accounting in U.S. local governments, but it also highlights the need for understanding the different dimensions of transaction costs for cost accounting and performance measurement.


Cost Accounting: An Introduction

Cost accounting has been discussed as an important innovation in government financial management for over 100 years (March & Olsen, 1989; Pinkett, 1965). The reformers of Theodore Roosevelt's Committee on Departmental Methods thought about how cost accounting could be implemented in the government so that managers could understand their unit costs. This preoccupation with unit costs was a hallmark of scientific management and cost accounting was an important precursor to modern budgeting and performance (Williams, 2003; 2004). Even today, cost accounting and cost measurement are important, if seldom discussed topics, of public administration and public financial management (Rivenbark, 2005). This may be partially attributable to the observation that the use of advanced cost accounting techniques such as Activity Based Costing (ABC) to measure a service's direct and indirect costs can lead to organizational resistance and rejection of the cost accounting system. However, cost accounting is often utilized during periods of fiscal stress to better allocate resources and manage costs (Brimson, Antos, & Collins, 1999; Kehoe, 1995; Levine, 1985). So, given the current fiscal environment, the topic has received more attention recently as governments are being asked to do more with less (Mohr, 2015).

Cost accounting fills an important gap in the development of costs beyond just basic budgets or financial records. Departmental budgets, which are often regarded as the amount spent to provide a service, are insufficient to determine the expense of a service or activity for three basic reasons (Coe, 2007; Finkler et al., 2012). First, overhead services that are necessary for service production such as administration, payroll, accounting, information technology and other overhead costs are not typically included in the departmental budget. Second, capital costs such as building expenses and equipment expenses may be included in a separate capital improvement budget. Finally, departments generally have many services that they perform for all services, or indirect costs, which need to be distributed down to individual services within the department to get an accurate product or service cost (Kaplan & Cooper, 1998). Cost accounting allows an organization a method or system for developing better estimates of the cost of services than using only the budget or basic accounting records.

Unlike businesses that need to have good cost accounting to correctly price their services, governments use cost accounting generally for five reasons: to collect grant overhead costs, to measure performance, to manage their costs, to allocate resources efficiently and to develop the cost for services that are paid with user charges (Coe, 2007; Geiger, 2010; Rivenbark & Carter, 2000). These purposes are especially relevant for handling fiscal stress. Getting more resources from other units of government through grants and user charges are traditional ways that cities raise resources during periods of fiscal stress. Likewise, performance measurement and management may be useful for increasing the efficiency of the organization over the long term. When governments are being asked to do more with less and when local governments are given opportunities to shift some of the overhead costs to the upper levels of government through grants, cost accounting may receive more attention from management.

One of the most recent innovations in cost accounting is the use of ABC to improve the cost of products and services (Kaplan & Cooper, 1998). The insight of ABC is that the traditional cost accounting systems are not accurate enough to measure costs sufficiently for a competitive global environment. To address these challenges Cooper and Kaplan developed ABC to measure costs more accurately and give managers the ability to control their costs. In resource scarce environments, organizations need to be as cost effective and efficient as is reasonably possible.

The key understanding and innovation of ABC is the recognition that indirect costs, besides just traditional overhead, importantly influence the cost of products, such as the cost of set up, the cost of departmental managers' time, and other departmental or service related indirect expenses (Kaplan & Cooper, 1998). The recognition of these expenses allowed for more accurate estimates of individual product and service costs.

These costs were also to be measured in ways that would be more useful to the managers to control the total cost of their products and services. This was accomplished by using unambiguous cost drivers to link the consumption of indirect resources to the production costs of activities. ABC was heralded as a key innovation for saving American industry and government (Turney, 2010) because accurate product and service costs were seen as an essential element of allocating an organization's scarce resources. Individual products and services could be compared in a more meaningful way to determine profitability or other values to the company (Kaplan & Cooper, 1998; Kaplan & David, 1992).

Important contributions toward the use of ABC in government were noted in cities like Indianapolis and Charlotte where governments used the information from ABC to evaluate whether services could be contracted out to the private sector (Brimson et al., 1999; Weiss, 1997). Experience showed that when governments knew their costs they could work to manage their costs and make their services competitive with outside contractors (Weiss, 1997). ABC was also criticized for being inappropriate for government contracting decisions because it fails to take into account contract monitoring and maintenance costs (Mullins & Zorn, 1999). While it would be insufficient to rely solely upon ABC to inform the decision of whether to contract a public service, the information that ABC provides can highlight product and service costs, and managers can take actions to reduce them (Geiger, 2010). Along with the use of performance information, ABC has been argued to be an important consideration for government financial management in areas such as budgeting (Melkers, 2003; Premchand, 2006) and performance management (Rivenbark & Carter, 2000).

In spite of the arguments for the efficacy of ABC and the extensive measurement of indirect costs, implementation and utilization remains a problem for government cost accounting (Mohr, 2015). First of all, extensive cost accounting, like ABC, intrudes upon the managers and employees of the services and processes that it intends to measure. If organizational leaders want to measure indirect costs, then they have to know the processes of the departments sufficiently to understand and link the indirect costs with their consumption during the production of the good or service. This leads to a typical three-step procedure of activity analysis, development of cost drivers, and then linking them together to develop a cost plan or cost system. This is accomplished by...

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