Activity Based Costing in the Public Sector

Journal of Social Sciences 6 (3): 376-382, 2010 ISSN 19-3652 © 2010 Science Publications Activity-Based Costing in the Public Sector Athanasios Vazakidis, Ioannis Karagiannis and Anthi Tsialta Department of Applied Informatics, University of Macedonia, Egnatia 156, P.O. Box 1591, 0 06, Thessaloniki, Greece, Abstract: Problem statement: In the modern economic environment, the Public Sector aims at the continuous improvement of quality of the provided services. Thus, detailed information with regard to the cost of services is essential along with capable management to take advantage of this information. Approach: The study discussed the basic beginnings, the processes of activity-based costing and whether this costing method can be applied in the Public Sector, where the need for precise cost estimating information increases continuously. Results: It referred to the structure of a Greek Prefecture, with all the organized divisions and departments. At first, the new method of cost accounting is analyzed as mentioned in the international bibliography. Thereafter, the advantages of this method were pointed and then, follow the application in a specific Department of the prefecture where the results were delivered to the Administration of department under review, for the decision-making. Conclusion: Having analyzed the department of the prefecture, the management can depend on the results to comment on the study done and decide on future plans. Key words: Activity-based costing, cost of services, public sector, activity-based costing in the public sector and cost of service organizations INTRODUCTION It has been analyzed that more than 60% of all citizen transactions are done through Prefecture (Local Government), so its basic role cannot be other than to serve citizens (Tsialta, 2009). Even though a lot of positive steps have been made during the recent years in the Public Administration (Public Sector) in Greece, mainly by using new technologies, the current reality in the public administration continues to be characterized of bureaucracy, absence of strategic action, wastefulness of management of public resources, corruptness and absence of rational designing of places of study. As an aftermath of all the above, is the cost of the provided services that overcome the benefit that the citizen receives, meaning that these services are too expensive and usually of low quality. The standardization and the simplification of administrative processes (services) can constitute one of the more powerful mechanisms of transparency and confrontation of corruptness. Cost accounting (in our research Activity-Based Costing) can participate in this change by analyzing each part of the Local Government and in combination with appropriate manpower planning and management of the necessary resources, this mechanism can make the difference. Activity-based costing: Definition: Activity-Based Costing is a costing method based on all activities and functions that participate in a company. This method allows cost-accountants to assign all overhead cost (those that cannot be apportioned directly to the products) to the activities that take place in an organization and then these activities with the help of activity-drivers are assigned to the products-services produced. The result is to have full information about the cost of products made. According to Kirche (2002), the activities are categorized in unity, batch and order related activities: • The unity-level activities are those that have to be performed for every unit of product or service produced • The batch-level activities are those that have to be performed for each batch or setup of study performed • The order-related activities are those that enable the production of individual orders (or services) to occur. Examples include maintaining design and specification and special testing and tooling for individual orders Literature review: From 1970s Activity-Based Costing (ABC) was mainly developed to serve Corresponding Author: Athanasios Vazakidis, Department of Applied Informatics, University of Macedonia, Egnatia 156, P.O. Box 1591, 0 06, Thessaloniki, Greece Tel: 2310 1863 376 J. Social Sci., 6 (3): 376-382, 2010 Karagiannis, 2009), so as to point out the usefulness of industrial companies, but from the early years of its the method as a tool and source of information for the development, researchers have investigated the administration. possibility of using it in the service sector as well. Kaplan (1994) reports that in the early 1980 ABC Steps of activity based costing: Activity-Based was already used in the service sector by logistics Costing depends on the analysis of the activities companies, by banks and hospitals and had already participating in an organization, supposing that these developed costing models similar to the ABC. activities create-consume cost in order for the products King (1995) has made four research attempts in the or services to be produced. hospitals of England, where it concluded also that the Thus, in order to obtain the cost information British National Health System (NHS) can benefit from needed, this method not only notes the activities, but the implementation of ABC, because it is a method that also analyses all the elements regarding the time, the can easily adapt in the specific needs and particularities way, the resources of each activity or function (a of each institution. number of activities). Moreover, Brimson and Antos (1994) mention The steps that Activity-Based Costing follows are: examples of American Public Sectors where Activity- Based Costing succeeded when used. The writers quote • Recognition of cost objects (the reason of cost that Activity-Based Costing has been implemented in analysis) telecommunication companies, parcel post companies, • Defining the activities that affect each cost object hospitals, electricity and gas companies, helping them • Determining the sources of expenses that affect control their cost and letting management concentrate each activity on their customers. • Assigning the activities to the cost objects Evans and Bellamy (1995) argue the necessity of • Transfer the activity cost to the cost objects and developing this new method in order to cost the argue on the final results services of Public Sector for a better management, even though traditional methods are still in use. In Greece, The cost of activities, with this method, is focused Kostopoulos et al. (2003), apply the new method in the on the cost objects (products, services, customers) with Open Psychiatric Center of Athens Greece. Their aim is point of report the use of activities by the cost objects. to acquire information relative to the service cost of the The factors of activity offer useful information to the therapeutic organization and the service cost of the management with regard to the cost of realization of psychotherapy for the patients. The results provide the activities that create cost. information of the minimum cost of each psychotherapy session and the minimum amount of Advantages of activity-based costing: As mentioned before, ABC allocates the General Expenses (GE) patients for the economic self-sufficiency of the (Overhead Cost) first to the activities (that create them). Psychiatric not-profitable unit. Moreover, the Municipality of Argyroupolis And in the next stage, are being transferred to the (Municipality of Argyroupolis, 2005) in Athens Greece, products depending on which activities and how much via its internet site, claims that it applies the method of they influence the particular products. This way of cost Activity-Based Costing since 2005, in order to better spreading provides the following advantages over the traditional costing method: monitor and control various elements of cost that absorbs the enterprise at its every activity. • The expenses are analyzed with greater detail than In the Macedonia University of Thessaloniki the traditional methods where the expenses are Greece, Vazakidis and Karagiannis (2006) present only categorized as direct and indirect completed studies and articles which are published in • While traditional cost methods group the General journals and congresses. In 2006, they have presented Expenses (GE) (Overhead Cost) in the general for the first time a model of cost accounting for the cost-centers such as those of Production, Department of Applied Informatics of University of Administration, Disposal, Services and Research Macedonia in Thessalonica, more for internal and then, distribute them to the products; Activity-information and then for the promotion of this new Based Costing categories them according to the method in the Greek environment (Vazakidis and activities that consume them Karagiannis, 2006). Finally in 2008, they applied a new • Activity-Based Costing analyses all the activities, model of Activity-Based Costing and Activity-Based providing information to the administration of Management in a tourist organization (Vazakidis and 377 J. Social Sci., 6 (3): 376-382, 2010 general expenses. The cost of each service provided can those activities that contribute less, or, cost more be estimated when calculating the cost of each activity than they should, letting the managers abolish and at the same time connect the activities to each some of them service provided. • Detailed Activity and cost analysis present a great After quoting the general elements of an Activity-help for creating better budgets Based Costing model, it is necessary to focus on the stages of research and application of ABC in the MATERIALS AND METHODS Prefecture of Grevena. The first stage has to do with the recognition of cost objects; such can be the cost Prefecture of Grevena of Greece consists of 13 analysis of each department, the cost of each service, Divisions and 4 departments. The research that follows or, the cost of each customer-citizen serviced. begins with the data from the Internal Office of the In the 2nd stage, the aim is to determine the Prefecture. Initially through personal interviews of the activities that affect each cost object. Prefecture of general director and key employees, there has been Grevena has Divisions and Departments. Each Division noted the way the Prefecture works and whether it has its own Departments. Each Department has a Main follows the official working structure. After confirming Function (the Service provided) that needs a number of that everything functions as planned, the financial activities to be performed. At this point, the scope of economic data of the departments was requested. This this research is to note the departments and the data includes the employee payroll of the year 2007, the activities in each department, so as to create a full expenses of every division and department and the Activity table of the prefecture easily understood by inventory of the fixed assets. every reader. Thereafter, the researchers recorded the working h In the 3rd stage, the researchers need to determine of each employee as well as the total number of the resources (expenses) that affect each activity and services that each department provided along with the categorize them (direct, indirect expenses), in order to number of customers-citizens that were served. calculate the cost of each activity in the next stage. In Then, follows the creation of a model based on the the next stage, each activity is connected with the cost-international bibliography and practice. The model pools and obtains its cost. After that, each cost object is relies on the principals of Activity-Based Costing and connected with the activities that participate along with analyzes in detail: their cost. The final stage is to concentrate the cost for each cost-object to be analyzed. • The resources of the Prefecture and its cost (wages All those stages are implemented on the Division of employees, the expenses of telecommunication, of Economic Services as shown below: of water supply, of electricity, of cleaning, of stationery, the supply of books, periodicals and • The Division of Economic Services is divided to newspapers, the supply of detergents, the expenses Departments according to Internal Office for heating, for supplies and the depreciation of fixed assets) • Our research analysis consists of all the Departments of the Division of Economic Services. • The departments and the activities There are 4 departments and a Secretariat Office • A record follows of all the activities of every Before starting with the research, it is essential to department. The Internal Office of the Prefecture quote the elements of Activity-Based Costing model sets the primary activities of each department. It is when applied on Public Service Sector. The cost-object necessary to check that the activities performed are of a service sector organization could be the cost of a according to the primary ones and since everything service provided (including all kind of services works as should, the writers define the cost-objects provided by each Division or Department of Public for the analysis such as the “payment of a cheque” Sector). In our case, these services could be the receipt of an application and the forwarding to the Central • The activities need resources as means of Administration Office, or, the edition of a building pursuance, such as the assets used, the salaries of license from the Urban Division, or the edition of a the employees and other operational expenses driving license from the Traffic and Transportation • After allocating the resources, it is needed to set Division. These services need some activities to be the cost drivers, the rules that connect expenses and taken place and these activities need recourses. As activities, so as to have a first estimation of the cost recourses, are the employees and their salaries, the of activities. In this case, the main rule is the work fixed assets and their depreciation and all the other hours needed for each activity 378 J. Social Sci., 6 (3): 376-382, 2010 those spent for the whole organization. The expenses of • The next step is to allocate the cost of resources to Division of Economic Services (without the the activities according to cost-drivers depreciation cost) are 4.13% of the total expenses. • At this point, the activities carry cost and it is At this point, it is necessary to set the Limitations crucial to connect them to the cost-objects with the of the Research that follows: assistance of the activity-drivers, that bind activities to cost-objects • The last stage is to create a final table of all the • Although the whole cost of the Division is activities and the primary cost-object, which is the presented, the research analyses thoroughly only cost of each customer-citizen that the Department the Revenues and Payment Department of Economic Services served during the specific • The cost-object has to do with the cost (direct and time-period indirect) of each customer-citizen of the specific Division The sequence of this method is quite simple. Every • The employees of whole Division are 7and 2 of department provides some services. Thus, in order to them study for the Revenues and Payment make a cost analysis of each department, it is needed to Department estimate the cost of each activity and convey it to the • The weekly working timetable is 35 h while for the services provided or the customers served. year is 1,820 h (52 weeks) The outcome of this process is the cost analysis of • The actual daily working timetable is 7.5 h which all activities, services and departments. This analysis is means 37.5 h week−1. The researchers decided to forwarded to the Head Administrator for decision consider as a weekly working timetable the 35 h making. and NOT the 37.5 h, to integrate the annual vacation period of the employees of the Division Implementation of activity-based costing: • The actual daily working timetable was figured through personal interviews Analysis of the division of economic services of: The • The direct cost consists of only the employees’ prefecture of Grevena. The mission of the Division of salaries Economic Services is the reassurance of the necessary • The indirect cost includes the depreciation of the resources and revenues for the Prefecture, the record, fixed assets (PCs, office machines and the development and the protection of the assets of the furniture)and is spread to the employees according Prefecture, the payment of the cheques, the creation of to how these assets are used the next year’s budget and the creation of the statement of accounts and balance sheet. Table 1: Annual statement of accounts of 2007 for division of The specific division consists of the following economic services (in euro) departments: Division Prefecture Categories Account total (€) total (€) • Budget Department 1. Employees’ Salaries 149,471.28 3,636,509.77 2. Telecommunication 2,700.00 38,400.00 • Revenues and Payment Department expenses • Assets and Procurement Department 3. Water-supply-irrigation 50.00 1,420.00 • Expenses Audit Department expenses 4. Lighting expenses 3,100.00 63,046.00 • Secretarial Department 5. Cleanness expenses 2,500.00 126,900.00 6. Expenses for supply of 1,700.00 22,091.00 Resources analysis: The Annual Statement of stationery Accounts is the official source of information regarding 7. Expenses for the supply 1,200.00 5,467.00 financial data of the Prefecture. These figures are the of books, periodicals number of the employees, their salaries, the operational and newspapers 8. Expenses for the supply 320.00 17,330.00 expenses of the department and the fixed assets with of detergents their depreciation. 9. Expenses for heating 4,500.00 93,350.00 The real Annual Statement of Accounts (only the 10. Expenses for operational 700.00 18,580.00 expenses) for 2007 is as follows. supplies 11. Expenses for the supply 240.00 4,415.00 Table 1 shows concisely all the expenses for the of personal heating Division of Economic Services. It is thought to be devises useful to include the total expenses of the Prefecture at 12. Depreciation of 5,550,35 - the same table, in order to have a figure of how much in fixed assets Total 172,031.63 4.027.508.77 percentage are the expenses of the specific division to 379 J. Social Sci., 6 (3): 376-382, 2010 The Table 2 applies these steps, meaning that they • The miscellaneous cost includes the telecommunication expenses, the water-supply show the activities of the department, the weekly and irrigation expenses, the lighting expenses, the yearly working timetable, total costs of salaries and the cleanness expenses, the expenses for supply of spread of this cost to all activities of the Revenues and stationery, the expenses for the supply of books, Payment Department. periodicals and newspapers, the expenses for the Table 3 and 4 are similar showing the activities of supply of detergents, the expenses for heating, the each employee that works in the Revenues and Payment expenses for operational supplies and the expenses Department (there are only 2 employees). Table 3 and 4 for the supply of personal heating devises. These also show the hours that each employee spends per expenses are spread to the 7 employees equally week or year on each activity. The columns mentioning • The number of customers served in 2007 was 2,956 the salaries and other expenses are calculated as the • The salary figures are real following example. • The expenses figures are real Employee No. 1 gets €21,538.50 per year and he is • Depreciation of the fixed assets has been calculated occupied on three activities spending 1,612 h year−1 only for the research and according to the Greek (1,300 h for the first activity). Dividing his salary to the Accounting Standards working hours (€21,538.50/1,612 = €13.36), the hourly • In 2007, there were 2,286 checks (bank notes) paid, cost is calculated. Then, multiplying the hours used for 519 times that employees collected revenues for his main activity by the hourly cost (€13.36 * 1,300 = the Prefecture and 1,019 accounting records of all €17,369.76), the cost for his main activity (cash a the transaction cheque) is figured. Having in mind the previous tables, there is a working time “gap” between the hours that The aim is to connect the theoretical methodology (as shown in the previous chapter) with the practical actually the two employees have worked and the implementation. Thus, the next step is to define the cost limitation mentioned (35 h week−1). This gap can be drivers and to connect the cost to the activities. explained by secondary activities performed not shown in the Activity Map of the Internal Office. These RESULTS activities are discovered after the personal interviews of the employees. Such activities are the filing of the At this part of the research the cost analysis of the department starts with the following step. papers and the public relations. Table 2: Implementation of activity-based costing i. Defining the activities of the department and the employees that study in order these activities to be performed ii. Calculating the cost that each activity carries. iii. Setting the weekly working timetable that each employee spends for each activity iv. Measuring the cost of each activity depending on the working h that each employee needs for each activity v. All the above steps calculate the cost of salaries for each employee vi. Allocating the cost of each employee to the department that is engaged and to the activities that performs. There may be 2 or more employees for one activity executed vii. Transferring the total cost of each activity to the cost-objects affected viii. Concluding with the total cost of the cost objects. Table 3: Employee No. 1 of the revenues and payment department Hourly occupation Hourly occupation Activity per year per week Cash a cheque (payment) 1,300 25 Revenues collection accounting 208 4 Record of all transactions 104 2 Total 1,612 31 Employee salary (€) 17,369.76 2,779.16 1,3.58 21,538.50 Depreciation cost (€) 714.52 114.32 57.16 886.00 Miscellaneous cost (€) 1,959.68 313.55 156.77 2,430.00 Table 4: Employee No. 2 of the revenues and payment department Hourly occupation Hourly occupation Activity per year per week Cash a cheque (payment) 1,040 20 Total 1,040 20 Employ EE salary (€) 23,873.50 23,873.50 Depreciation cost (€) 775.50 775.50 Miscellaneous US cost (€) 2,430.00 2,430.00 380 J. Social Sci., 6 (3): 376-382, 2010 Table 5: Costing the revenues and payment department Activity Cash a cheque (payment) Revenues collection Accounting record of all transactions Total Hourly occupation Hourly occupation per year per week 2,340 45 208 4 104 2 2,652 51 No. of personnel 2 1 1 Fixed assets Office (2), Table of reception (1) Bookcase (2), Chair (2) Drawer (4), Chair for public (6), Bookshelf (1), PC (2) Printer (3), Printer for checks (1), Fax (1) Telephone (2) Table (1), Table of reception (1) Bookcase (1), Chair (1) Drawer (2), Chair for public (3), PC (1) Printer (1), Check printer (1), Telephone (1) Table (1), Table of reception (1) Bookcase (1), Chair (1) Drawer (2), Chair for public (3), PC (1) Printer (1), Check printer (1), Telephone (1) Direct Indirect cost (€) cost (€) 41,243.26 1,490.02 Miscellaneous Annual Annual cost cost (€) cost (€) per activity (€) 4,3.68 47,122.96 20.61 2,779.16 114.32 313.55 3,207.08 6.18 1,3.58 57.16 156.77 1,603.51 1.57 45,412.00 1,661.50 4,860.00 51,933.50 Table 6: Total cost of the division of economic services Departments Budget Department Compilation or alteration of budget Compilation of balance-sheet and statement of profit/loss accounts Auditing of all supporting documents for expenses and emission of payment cheques Accounting record of all transactions Total Revenues and Payment Department Cash a cheque (payment) Collecting the revenues Accounting record of all transactions Total Assets and Procurement Department Compilation and observation of the program for the supply of materials or other asset for the prefecture’s needs Public competitions for nominating a supplier Total Expenses Audit Department Audit of the expenses, settlement of expenses, emission Hourly occupation per year 104 52 3,120 104 3,380 2,340 208 104 2,652 1,560 208 1,768 1,560 No. of employees 1 1 2 1 2 1 1 1 1 1 Annual cost (€) 1,691.08 845.56 45,214.79 1,323.20 49,074.63 47,122.96 3,207.08 1,603.51 51,933.50 19,981.10 2,6.15 22,5.25 24,471.15 Quantity of activities Annual cost per performed activity performed (€) 8 1 5,231 5,231 2,286 519 1,019 - 6 2,088 211.38 845.56 8. 0.25 20.61 6.18 1.57 - 444.03 11.72 The Table 5 shows the full cost analysis of the activities and the department. Furthermore, the same steps have been followed for the other departments of the Division of Economic Services. The Table 6 is a combined table of the cost estimation results of the whole division. DISCUSSION Table 7 shows a result of €58.19 that each customer cost to the specific division of Prefecture of Grevena. This outcome is according to the new cost estimation model. If we used Table 1 (Annual Statement of Accounts) and divided that to the customers served in 2007 (€172,031.63/2,956 = €58.197), the result would be the same and that method is the traditional costing. The main difference between traditional and Activity-Based Costing is shown in the Table 3-7. Table 3-7 analyze the Division of Economic Services in many levels. It is crucial to argue that traditional cost accounting does not give information regarding the reasons of cost created. Thus, Activity-Based Costing works complementary providing detailed cost information to administration for further analysis and proper decision making. 381 J. Social Sci., 6 (3): 376-382, 2010 Table 7: Total annual cost per customer No. of Total cost per Cost per customer Department employees department (€) per department (€) Budget Department 2 49,074.63 16.60 Revenues and 2 51,933.50 17.57 Payment Department Assets and Procurement 1 22,5.25 7.66 Department Expenses Audit 1 25,286.85 8.55 Department Secretarial Department 1 23,091.35 7.81 Total 72,031.58 58.19 CONCLUSION The main purpose of this article was to present the basic principles and procedures of Activity-Based Costing and to examine whether the implementation of this method is possible to a Public Sector Organization. From all the above, the key characteristics of the new method are shown with great detail, along with the capabilities to provide information regarding the cost estimation, so that can be easily used by the administration for identifying the bottlenecks. Especially, Table 3 and 4 of the employees of the Revenues and Payment Department, where the performance of the two employees can be increased and this is obvious to the managers. Furthermore, through this analysis Prefecture of Grevena can extend the method implementation to all its Divisions, targeting to create a full image of the cost of the Prefecture and to apply corrective actions (Activity-Based Management). The data tables created were given to administration, although the actions to be taken are not an area for Activity-Based Costing but for its improvement method Activity-Based Management. The outcome was for a confidential report to be written and sent to the Greek Ministry of Home Department. If the Prefecture was a private company many changes could be made, such as minimizing the working “gap” of the specific employees by creating new services for customers, or, by letting go one of them, but as a Public Sector organization the “Chairman” is the Minister and politics did not let him make any changes. Finally, this research can be used as a pilot in any attempt of implementing Activity-Based Costing in Public Sector. The use of this method with the cooperation of new technologies and new methods of management, can resolve all the deficiencies of Public Sector, so as citizens and companies will be better served. REFERENCES Brimson, J.A. and J. Antos, 1994. Activity-Based Management for Service Industries, Government Entities and Non-Profit Organizations. 1st Edn., John Wiley and Sons, Inc. New York, ISBN: 10: 047101351X, pp: 3. Evans, P. and S. Bellamy, 1995. Performance evaluation in the Australian public sector; the role of management and cost accounting control systems. 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