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Statement #4/Managerial Cost Accounting Concepts and Standards for the Federal Government Executive Office of the President Office of Management and Budget "Managerial Cost Accounting Concepts and Standards for the Federal Government" Statement of Federal Financial Accounting Standards Number 4 July 31, 1995 ****************************************************** TABLE OF CONTNETS EXECUTIVE SUMMARY (paragraphs 1-12) INTRODUCTION (paragraphs 13-30) Background Users of Federal Government Cost Information Objectives Terminology Materiality Effective Date PURPOSES OF USING COST INFORMATION Budgeting and Cost Control Performance Measurement Determining Reimbursements and Setting Fees and Prices Program Evaluations Economic Choice Decisions (paragraphs 31-40) MANAGERIAL COST ACCOUNTING CONCEPTS (paragraphs 41-66) MANAGERIAL COST ACCOUNTING STANDARDS Requirement for Cost Accounting (paragraphs 67-162) (paragraphs 67-76) Responsibility Segments Full Cost (paragraphs 77-88) (paragraphs 89-104) Inter-Entity Costs (paragraphs 105-115) Costing Methodology (paragraphs 116-162) APPENDIX A: Basis for Conclusions (paragraphs 163-270) APPENDIX B: Glossary ******************************************************* EXECUTIVE SUMMARY 1. The managerial cost accounting concepts and standards contained in this statement are aimed at providing reliable and timely information on the full cost of federal programs, their activities, and outputs. The cost information can be used by the Congress and federal executives in making decisions about allocating federal resources, authorizing and modifying programs, and evaluating program performance. The cost information can also be used by program managers in making managerial decisions to improve operating economy and efficiency. 2. The concepts of managerial cost accounting contained in this statement describe the relationship among cost accounting, financial reporting, and budgeting. The five standards set forth the fundamental elements of managerial cost accounting: (1) accumulating and reporting costs of activities on a regular basis for management information purposes, (2) establishing responsibility segments to match costs with outputs, (3) determining full costs of government goods and services, (4) recognizing the costs of goods and services provided among federal entities, and (5) using appropriate costing methodologies to accumulate and assign costs to outputs. 3. These standards are based on sound cost accounting concepts and are broad enough to allow maximum flexibility for agency managers to develop costing methods that are best suited to their operational environment. Also, the managerial cost accounting standards and practices will evolve and improve as agencies gain experience in using them. The following is a summary of the concepts and standards contained in this statement: Managerial Cost Accounting Concepts 4. Managerial cost accounting should be a fundamental part of the financial management system and, to the extent practicable, should be integrated with other parts of the system. Managerial costing should use a basis of accounting, recognition, and measurement appropriate for the intended purpose. Cost information developed for different purposes should be drawn from a common data source, and output reports should be reconcilable to each other. Managerial Cost Accounting Standards Requirement for cost accounting 5. Each reporting entity should accumulate and report the costs of its activities on a regular basis for management information purposes. Costs may be accumulated either through the use of cost accounting systems or through the use of cost finding techniques. Responsibility segments 6. Management of each reporting entity should define and establish responsibility segments. Managerial cost accounting should be performed to measure and report the costs of each segment's outputs. Special cost studies, if necessary, should be performed to determine the costs of outputs. Full cost 7. Reporting entities should report the full costs of outputs in general purpose financial reports. The full cost of an output produced by a responsibility segment is the sum of (1) the costs of resources consumed by the segment that directly or indirectly contribute to the output, and (2) the costs of identifiable supporting services provided by other responsibility segments within the reporting entity, and by other reporting entities. Inter-entity costs 8. Each entity's full cost should incorporate the full cost of goods and services that it receives from other entities. The entity providing the goods or services has the responsibility to provide the receiving entity with information on the full cost of such goods or services either through billing or other advice. 9. Recognition of inter-entity costs that are not fully reimbursed is limited to material items that (1) are significant to the receiving entity, (2) form an integral or necessary part of the receiving entity's output, and (3) can be identified or matched to the receiving entity with reasonable precision. Broad and general support services provided by an entity to all or most other entities generally should not be recognized unless such services form a vital and integral part of the operations or output of the receiving entity. Costing methodology 10. Costs of resources consumed by responsibility segments should be accumulated by type of resource. Outputs produced by responsibility segments should be accumulated and, if practicable, measured in units. The full costs of resources that directly or indirectly contribute to the production of outputs should be assigned to outputs through costing methodologies or cost finding techniques that are most appropriate to the segment's operating environment and should be followed consistently. 11. The cost assignments should be performed using the following methods listed in the order of preference: (a) directly tracing costs wherever feasible and economically practicable, (b) assigning costs on a causeand-effect basis, or (c) allocating costs on a reasonable and consistent basis. 12. These accounting standards need not be applied to items that are qualitatively and quantitatively immaterial. The Board recommends that the managerial accounting standards of this Statement become effective for fiscal periods beginning after September 30, 1996. Earlier implementation is encouraged. *************************************************** INTRODUCTION Background 13. Reliable information on the costs of federal programs and activities is crucial for effective management of government operations. In Statement of Federal Financial Accounting Concepts (SFFAC) No. 1, Objectives of Federal Financial Reporting, issued in 1993, it is stated that the objectives of federal financial reporting are to provide useful information to assist internal and external users in assessing the budget integrity, operating performance, stewardship, and systems and control of the federal government.[Footnote 1] [Footnote 1: Statement of Federal Financial Accounting Concepts No. 1, "Objectives of Federal Financial Reporting" (September 2, 1993), pars. 110 and 111, pages 34-35.] 14. Managerial cost accounting is especially important for fulfilling the objective of assessing operating performance. In relation to that objective, it is stated in SFFAC No. 1 that federal financial reporting should provide information that helps users to determine: -- Costs of specific programs and activities and the composition of, and changes in, those costs; -- Efforts and accomplishments associated with federal programs and their changes over time and in relation to costs; and -- Efficiency and effectiveness of the government's management of its assets and liabilities.[Footnote 2] [Footnote 2: Ibid., pars. 126-130, pages 39-40.] 15. It is further stated in SFFAC No. 1 that "The topics of costs and performance measurement are related because it is by associating cost with activities or cost objectives that accounting can make much of its contribution to reporting on performance."[Footnote 3] "Cost" is the monetary value of resources used or sacrificed or liabilities incurred to achieve an objective, such as to acquire or produce a good or to perform an activity or service. Costs incurred may benefit current and future periods. In financial accounting and reporting, the costs that apply to an entity's operations for the current accounting period are recognized as expenses of that period. [Footnote 3: Ibid., par. 192, page 63.] 16. The Chief Financial Officers Act of 1990 includes among the functions of chief financial officers "the development and reporting of cost information" and "the systematic measurement of performance."[Footnote 4] In July 1993, Congress passed the Government Performance and Results Act (GPRA) which mandates performance measurement by federal agencies.[Footnote 5] In September 1993, in his report to the President on the National Performance Review (NPR), Vice President Al Gore recommended an action which required the Federal Accounting Standards Advisory Board to issue a set of cost accounting standards for all federal activities.[Footnote 6] Those standards will provide a method for identifying the unit cost of all government activities. [Footnote 4: 104 Stat. 2938 (See particularly 31 U.S.C. sec 902).] [Footnote 5: 107 Stat. 285 (See particularly, 31 U.S.C. sections 1101, 1105, 1115, 1116-1119, 9703, 9704).] [Footnote 6: Vice President Al Gore, "Creating A Government That Works Better & Costs Less," Accompanying Report of the National Performance Review (September 1993), p. 59.] 17. In early 1994, the Federal Accounting Standards Advisory Board (the Board) convened an advisory group to help develop standards for managerial cost accounting in the federal government. The group included members from government, business, and academe. Their views and proposals have been considered by the Board, and their work contributed greatly in developing this document. Users of Federal Cost Information 18. The cost of government is a concern to the public as well as to the federal government itself. Most government service efforts and accomplishments cannot be measured in financial terms alone. Unlike private business, there is no "bottom line" or profit index to help measure public sector performance. However, government service efforts and accomplishments can be evaluated using both financial and non-financial measures, and "cost" is an important financial measure for government programs. Internal and external federal information users identified below will find these standards helpful in assessing operating performance, stewardship, systems, and control of the federal government. 19. Government managers are the primary users of cost information. They are responsible for carrying out program objectives with resources entrusted to them. Reliable and timely cost information helps them ensure that resources are spent to achieve expected results and outputs, and alerts them to waste and inefficiency. 20. Congress and federal executives, including the President, make policy decisions on program priorities and allocate resources among programs. These officials need cost information to compare alternative courses of action and to make program authorization decisions by assessing costs and benefits. They also need cost information to evaluate program performance. 21. Citizens, including news media and interest groups, are concerned with the costs and results of federal programs that affect their interests. They need program cost information to judge whether resources are allocated to programs rationally and if the programs operate efficiently and effectively. Objectives 22. The managerial cost accounting concepts and standards presented here are intended for all the user groups identified above. These standards are aimed at achieving three general objectives: -- Provide program managers [Footnote 7] with relevant and reliable information relating costs to outputs and activities. Based on this information, program managers can respond to inquiries about the costs of the activities they manage. The cost information will assist them in improving operational economy and efficiency; [Footnote 7: Statement of Federal Financial Accounting Concepts No.1, "Objectives of Financial Reporting," defined "Program managers" as individuals who manage federal programs, and stated that "Their concerns include operating plans, program operations, and budget execution." SFFAC No. 1, par. 85, page 29. ] -- Provide relevant and reliable cost information to assist the Congress and executives in making decisions about allocating federal resources, authorizing and modifying programs, and evaluating program performance; and -- Ensure consistency between costs reported in general purpose financial reports and costs reported to program managers. This includes standardizing terminology for managerial cost accounting to improve communication among federal organizations and users of cost information. Scope of Standards 23. This statement contains managerial cost concepts and five standards for the federal government. The five standards address the following topics: (1) Requirement for cost accounting, (2) Responsibility segments, (3) Full cost, (4) Inter-entity costs, and (5) Costing methodology. The essence of each standard is briefly stated in a box followed by detailed explanations. However, both the words in the boxes and the entire text of explanations constitute the requirements of the standards. 24. These standards are based on sound cost accounting concepts and allow sufficient flexibility for agencies to develop managerial cost accounting practices that are suited to their specific operating environments. Also, it is expected that cost accounting standards and practices will evolve and improve as agencies gain experience in using them. 25. Other Statements of Federal Financial Accounting Standards (SFFAS) address recognition and measurement of assets and liabilities. For additional guidance, readers should consult: SFFAS No. 1, Accounting for Selected Assets and Liabilities; SFFAS No. 2, Accounting for Direct Loans and Loan Guarantees; and SFFAS No. 3, Accounting for Inventory and Related Property. The Board is working on and will soon complete other recognition and measurement projects related to revenues, liabilities, property, plant, and equipment, and other elements of financial statements.[Footnote 8] [Footnote 8: See FASAB Exposure Drafts, "Accounting for Liabilities of the Federal Government" (November 7, 1994); "Accounting for Property, Plant, and Equipment" (February 28, 1995); and "Revenue and Other Financing Sources" (Pending).] Terminology 26. Managerial cost accounting information, to be useful, must rely on consistent and uniform terminology for concepts, practices, and techniques. Consistent and uniform use of terminology can help avoid confusion and miscommunication among organizations and individuals. 27. As a start toward developing consistent managerial cost accounting terminology within the federal government, this statement includes a glossary of basic cost accounting terms.