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The House Cut: Understanding Cost Allocation and User Fees

Presentation to the Louisiana Government Finance Officers Association

bySherra Montz, Sr. Consultant, MGT of America

Bret Schlyer, Sr. Consultant, MGT of America

October 6, 2011

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Cost Allocation is a comprehensive distribution of agency-wide administrative costs to all departments that benefit or receive benefits. Costs of central service departments such as General Administration, Human Resources , Payroll , and Purchasing are distributed to all departments that benefit from their services by unique, fair, and equitable allocation bases.

What is Cost Allocation?

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Definitions

PlanA document which identifies the equitable distribution of central service administration and support costs to benefiting entities.

Central ServicesCentral costs which are incurred for a common or joint purpose benefiting more than one cost objective, and not readily assignable to entities specifically benefited, without effort disproportionate to results achieved.

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Why Do Cost Allocation?

Revenue– General fund cost recovery– Matching federal funds– Offsetting federal audit findings

Management Information– Full program cost identification– Resource utilization analysis

Taxpayer Fairness– Elimination of subsidies where appropriate

•Federal & State Funded Programs•Special Revenue Funds•Capital Project Funds•Enterprise Funds•Internal Service Funds•User Fees

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Types of Plans Prepared

Federal 2 CFR 225 (OMB A-87) Plan– In accordance with Federal cost recovery principles– In accordance with GAAP– Cost recovery on Federal and State programs– Applicable to Government Agencies– Schools use A-21, Non Profits use A-122

GAAP (Full Cost) Plan– In accordance with GAAP– Cost recovery on non-Federal/State programs

Enterprise funds Internal Service Funds User Fee charges

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Cost Allocation Plan

Federal (A-87) Approval– CAP must be prepared annually– Only required to submit to State/Federal

cognizant agency for approval if requested.– No official approval required– Must maintain CAP and supporting

documentation for audit

GAAP (Full Cost) Plan– Approval Not Required

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Allocable Central Services

Mayor and Council City Manager Information Tech City Attorney Budget and

Research Internal Audit Human Resources Finance

Building Maintenance Community Relations Intergovernmental Relations Asset Management Non-Departmental Costs Building Use/Depreciation Equipment Use/Depreciation More…

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Basic A-87 Cost Allowability Guidelines

Necessary and reasonable Allocable Authorized under state or local laws Not otherwise restricted by statute All activities charged uniformly Consistent treatment In accordance with GAAP Not included as a cost of another Federal award Net of all applicable credits Adequately documented

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Common A-87 Unallowable Costs

Lobbying Advertising (except for hiring) and public relations Contingencies/reserves Investment management Idle facilities Self-assessed taxes Capital Outlays

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Unallowable Central Services in an OMB A-87 Plan

General government - Mayor/Council– May be portions allowable

City/Parish Clerk Revenue and Taxation - tax collection services Intergovernmental Relations Community Relations Public Information Office Departmental administrative cost centers*

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Plan Methods

Simplified Method– Easy, but imprecise for most organizations– Assumes uniform central service support to all

departments– Susceptible to audit exceptions by Federal cognizant

agencies Multiple Allocation Base Method

– Complex, but accurate (double step-down)– Reflects differences in central services provided to

departments

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Plan Development Tasks

Review and analyze City/Parish organization structure

Identify central service departments Obtain and analyze detail financial data Reconcile detail financial data to CAFR

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Plan Development Tasks (Continued)

Interview Central Service Department Staff– Identify activities performed– Identify department/entities served by each

activity– Identify staff and operating for each activity– Identify an appropriate allocation base

(statistic) for each activityEquitableAvailable

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Plan Development Tasks (Continued)

Obtain allocation base data (statistics) Enter/Import data into CAP software

– Central service expenditures– Activity allocation bases

Process calculations Review for accuracy/reasonableness Develop summary schedules Complete Plan

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Reviewing a Cost Allocation Plan: Cost Plans should be a “Road Map” of Costs: Where they came from; how they are being distributed; results of distribution

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Reviewing a Cost Allocation Plan

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Reviewing a Cost Allocation Plan

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Reviewing a Cost Allocation Plan

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Reviewing a Cost Allocation Plan

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Reviewing a Cost Allocation Plan

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Who Prepares Cost Allocation Plans?

Cost Allocation Plans (CAPs) are prepared by:

•Professional firms specializing in CAP preparation

•In-house employee of governmental entity

•Not at all

•Often requires special software

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•Over/under identifying allocable central service costs•Under identification is more common

•Plan structure doesn’t match organization structure•Plan structure stagnates over time•Methodology established years ago, not updated to match changes in organizational service delivery

•Information Technology & Purchasing•Utilizing estimates in expenditure distributions or allocation statistics•Charging Full Cost Allocation Plan results (instead of A-87) to a department with federal funds (they can’t pass them on)•Missed opportunities in application of results

Common CAP Pitfalls

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•MGT has found that a majority of the CAPs prepared in-house or by consultants that have not conducted departmental interviews on a regular basis have unidentified allocable costs, and plan structures that don’t match the actual organization

•Lower recoveries•Increased audit risk

•Example City, Massachusetts – In-house full cost plan designed in late-1990’s. In 2000, employee benefits were moved out of individual department budgets, and into their own fund.• Methodology was never updated to capture the benefits• Over $1 million dollars of un-reimbursed costs as a result

Common CAP Pitfalls

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Creating Indirect Cost Rates

Indirect Cost Rate ProposalThe document required by OMB A-87 to be prepared by a governmental unit or subdivision thereof to substantiate its request for the establishment of an indirect cost rate.

Indirect Cost RateA device for determining in a reasonable manner the proportion of indirect costs each program should bear. It is the ratio (expressed as a percentage) of the indirect costs to a direct cost base.

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Indirect Cost Rates

Approval– Rates must be prepared annually– Only required to submit to State/Federal

cognizant agency for approval if requested.– No official approval required– Must maintain supporting documentation for audit

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Indirect Cost Rates

Components needed to calculate an indirect cost rate– Indirect costs

From cost allocation plan

– Rate base Salaries & Wages Total Direct Modified Costs

– Divide the rate base by the indirect costs to determine indirect rate (percentage)

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Indirect Cost Rates

Application of Rates– Rate is a maximum– Not required to charge all federal programs– Not required to charge same rate but can not exceed

approved or maximum rate– Typically must be included in award budget to be

reimbursed– Changes based on City/Parish fiscal year, not Federal

fiscal year– Applied and claimed as direct costs are incurred and

reported

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Applications & Extensions of Full Cost Allocation Plans

Full Cost Plans are not restricted by A-87, reflect total operating costs

– Can be based on budgeted costs– Can utilize estimates– More accurate reflection of total cost of operation

Management Information– Full program cost identification– Unit cost information to compare with market for outsourcing

decisions (must also evaluate fixed vs variable costs)– Resource utilization analysis

Recovery of costs from Enterprise/Utility funds Use in costs calculated for User Fees

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User Fees

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User Fees Defined

User fees are charges for the cost of goods or services provided directly to the user rather than the general taxpayer.

– When local governments impose taxes, there is typically no direct relationship between the amount paid for government services and the benefit received by an individual taxpayer.

– With a user fee there is a reasonable connection between the activity or service and the benefit received by the individual paying a fee.

– Local governments impose user or regulatory fees to pay for the cost of providing a service or regulating an activity.

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Reasons for User Fees

Tax Relief– Relieves pressure on tax based revenues,

particularly in the General Fund.Equity

– Matches cost recovery with service users (pay for what you get)

Efficiency– Encourages more prudent use of the service

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Reasons for User Fees

Services provided for a specific individual or group should not be paid from general taxes

Services provided to non-residents should not be paid from general taxes

Beneficiaries of a service should pay for the service

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TAXES

Service can be withheld ifbeneficiaries refuse to pay

Use of service is mandatory

Utilization is difficult to measure

Service cannot be withheld ifbeneficiaries refuse to pay

Benefits the community

Utilization can be measured

Use of service is discretionary

Benefits specific individuals or groups

USER FEES

Unable to impact usage of service

Private sector unlikely toprovide similar services

Same level of service is availableto all users

Private sector mayprovide the service

Selective level of service for usersbased on ability or desire to pay

Able to ration or balance usage of service

Comparison of Taxes and User Fees

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Components of User Fees

Direct Costs– Salaries, Benefits, direct Operating Expenses

Indirect Costs– Departmental Overhead– City/Parish-wide Overhead

Other Costs– Cross over support costs– Multiple departments directly involved in single service

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Calculating Full Cost

1. Direct costsA. Salaries and Benefits

Who provides the activity or service? How long does it take? How many are provided?

B. Services and Supplies Directly identified or Allocated proportionately

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Calculating Full Cost

2. Indirect costs A. City/Parish-wide

Full Cost Allocation Plan

B. Department admin

C. Crossover support

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Example – Use Permit1A+1B+2A+2B+2C = Full Costs

Direct – Salaries & Benefits $ 17,500Direct – Services & Supplies $ 5,000Admin & Indirect $ 10,000

Full Cost – Annual $ 32,500 (100 per yr)

Full Cost – Per Unit $ 325

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Labor Rate Service Hours

Available hours (100%) 2080 Less non service hours (20%)

– Paid Holiday (80)– Personal Leave/Vacation (176)– Training (40)– Administrative (120)

Service Hours (80%) 1664 Using service hours instead of available hours

makes sure your rates reflect your cost, not the employees rate of pay

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Application of Full Cost Productive Hourly Rate

Determine How Much Time is Spent of Each Activity?

ACTIVITY HOURS

Intake 0.50Interagency Review 3.50Staff Report 4.00Plan. Comm. Prop. 3.00Filing/Archiving 1.50Data Review 2.50Plan Check/Inspection 12.00 Subtotal 27.00

Blended Hour Rate 95.75$ (Hour rate indiv. calc.)Fee @ Full cost 2,585.25$

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User Fee Pricing Decisions

WhoBenefits

Public

Mostly taxes& some fees

Youth sports

Private

Private / Public

Public / Private

Type ofService

Individual benefit only

Primarily the individualwith some community-

wide benefits

Primarily the individualwith some community

benefits

Community Police patrol services

ExampleServices

Mostly fees& some taxes

100% fees

100% taxes

Tax vs. FeesPolicy

Development services

Code enforcementservices

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The Acid Test - Implementation

There is no Free Lunch. Services that are subsidized means less funding for other services

The Sin is not in Knowingly Subsidizing a Service: The Sin is Unknowingly Subsidizing a Service

Designed Subsidization can be an Effective Tool in Community Enhancement

Work with Stakeholders for Conceptual Understanding

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Questions Contact Information

– Sherra Montz – smontz@mgtamer.com– Phone: (504) 482-7280

– Bret Schlyer – bschlyer@mgtamer.com– Phone: (316) 214-3163

Conclusion