ACTIVITY-BASED COST MANAGEMENT IN PUBLIC SECTOR

In recent years, government organizations have begun to look to private industry for ideas about how to improve their business practices and their efficiency in resource use. Activity based cost management (ABC/M) is one of the most important tools being introduced in the effort to achieve these ends. ABC/M provides fact-based data. In the absence of facts, anybodys opinion is a good one. And usually the most important opinion, which may be the opinion of a supervisor or the supervisor the supervisor of a supervisor, wins. To the extent that decision makers are making decisions based on intuition, gut feel, or misleading data, an organization is at some risk. In its initial stages, ABC/M has often met with a mixed response, despite widespread discontent with traditional accounting mechanisms and despite its proven track record. Activity based concepts are very powerful techniques for creating valid economic cost models of organizations. By using the lens of ABC/M, organizations of all sizes and types can develop the valid economic models required for executives and managers to be able to make value-creating decisions and take actions to improve their productivity and resource use and ultimately to better serve their constituencies.

POLITICAL PRESSURES TO HOLD DOWN COSTS Public sector organizations at all levels and of all types are facing intense pressure to do more with less. Federal, national, state, country, municipal, and local governments in almost all countries are feeling some sort of fiscal squeeze. This pressure affects departments, administrations, branches, foundations, and agencies of all kinds. In United States, the federal government is shifting some responsibilities to state and local governments but is providing only limited funding to fulfill those obligations. Regardless of where the pressure is coming from, it sends the same messages: better, faster, cheaper.

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ABC/M and its integration with strategy mapping and balanced scorecards (that is, performance measures) offer potential solutions to the problem. Providing meaningful, factbased information to government officials, managers, and employee teams can be a costeffective means of bringing about beneficial change and improved performance in government and not-for-profit environments. Intuition and political persuasion are becoming less effective means for decision making. The pressure on the public sector is undeniable. People want government to work better and to cost less. To do so, public sector managers will have to change their way of thinking about the true costsand valueof the services they provide.

A SIMPLE WAY TO UNDERSTAND ABC/M Here is a simple way to understand the basic principles of ABC/M. imagine that four friends go to the restaurant. One orders a small salad. And the other each order the most expensive item on the menu, a prime rib steak. When the waiter and waitress brings the bill, the other say, lets split the check evenly. How would the first friend feel? He or she would find this suggestion unfair and inequitable. This is similar to the effect on many products and service lines in the cost-accounting system when accountant take a large amount of the indirect and shared support overhead expenses and allocate it as cost without any logic. There is minimal or no relationship to how the products or service lines actually consumed the expenses. This system is inequitable and unfair to each products or services cost. It is somewhat like taxation without representation. ABC/M gets it right. In the restaurant example, ABC/M is equivalent to the waiter or waitress providing four individual checks each person is charged for what he or she consumed. Allocating cost using broad averages is flawed, inaccurate, and misleading. In the end, many managers dismiss the calculated costs from their accounting system as a bunch

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ACTIVITY-BASED COST MANAGEMENT IN PUBLIC SECTOR

of lies. They may accurately in total, but in the pieces. ABC resolves this problem by tracing activity costs to product using factors that reflect cause-and-effect relationship. When managers and employees team do not reliably know what the cost are for their current outputs, they have a difficult time knowing what the future cost may be for future levels of demand or for changes in requests for their outputs. Most manager consciously or subconsciously stick with the primary view of the cost they are familiar with-their spending.

FROM THE SPENDING VIEW TO THE ACTIVITY AND OUTPUT VIEW ABC/M extends the minimal information in the departmental spending report to make manager and employee team smarter. This extended information is then used for making decisions-better decisions then are made without the ABC/M data. ABC/Ms strength is that it gives insights based on understanding past costs, not just past spending, allowing managers to apply the same data to make better decisions. Some more realities can be added to this description of government and defense organizations as service providers. Consider the key players- public sector workers, taxpayers, and users of the government services: a. The civil service worker or military member might simply prefer the status quo or whatever may be a little bit better for him or her. b. The taxpayer prefers to be taxed less. c. The user of government services desire more and higher quality service. d. The functional manager defends the existing level of his or her resources and fiscal budget. By adding the financial view of the outputs to the financial view of the resources, managers and employee teams can much better understand the behavior of the cost

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structure. The visibilities that come from knowing the costs of outputs become the stimulant for understanding the cost structure.

REALIZING TRUE COST SAVINGS OR FUTURE COST AVOIDANCE Staff members in many organizations imagine that if they introduce productivity improvements and streamlining actions, they will automatically save costs. But being more efficient does not equate to realizing savings in expensesas opposed to costsunless resources are removed (or unless, when volume increases, extra resources do not have to be acquired). Where do cost savings come from? All things being equaland if there are no significant changes in revenues or funding following a change in services the only positive effect on cash flow must come from reduced variable costs. If purchased materials and supplies are reduced a certain percentage, those costs are totally variable and are consumed as needed. The financial savings are real. That is, the cost savings are truly realized as savings in cash outlays for expenses. As efficiencies are produced, managers can realize cost savings or avoid future costs in staffing in only two ways: a. They can fill the freed-up workers time with other meaningful work, ideally addressing new volumes of customer orders. b. They can remove the capacity by removing the workers, realizing savings in staffing expense.

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