Using Activity-Based Costing for Efficiency and Quality

Article excerpt

Applying activity-based costing analysis was a necessary first step in deciding on which services the City of Indianapolis wanted to or should provide to the citizens and in defining core vs. ancillary activities.

When the new mayor of Indianapolis took office in 1992, he was faced with a situation unique to most mayors of large cities: a city with an excellent credit rating and a solid reputation for having its financial house in order. Yet he was amazed at what city officials did not know about their budgets. They knew that the city took in more money than it spent but did not know how much any single activity cost. While the mayor and other city officials could detail how much the city spent on such things as transportation and how much the various department budgets increased annually, they did not know how much it cost the city to fill one pothole or install a traffic signal.

Lack of accurate information about how much it cost to provide specific city services was more than just an inconvenience. Before the city government could begin to consider providing a given service more efficiently, it had to accurately determine the cost of providing that service. Without such information, how could citizens know if they were getting the most out of their tax dollars?

City officials began asking some basic questions that had not been asked nor answered with the current budget and resultant financial reporting process: What does it cost the City of Indianapolis to provide a service? Is the city's cost of providing services competitive in the marketplace? Is there an alternative delivery system that can provide the same service at less cost or at greater value? Is there a cause-and-effect relationship between spending and results? What is the outcome that citizens can expect? How does the city respond to customers needs?

When city officials started calculating how much it cost to pick up a ton of trash, they uncovered surprising information. During the analysis, they found garbage trucks that were out of service for six months because they were being repaired. After inquiring about the situation, they were told only that the cost of running the truck was X dollars, and nobody had ever thought about it before because there was a budget for the garage, there was a budget for the trucks, there was a budget for the gas and there was a budget for the drivers. The components did not come together until people were forced to cost each city service.

ABC for Identifying Costs

To help the city determine the true costs of providing given services, a consultant was engaged to implement an activity-based costing system (ABC). The process was a learning experience for city officials in determining exactly how many and what services were provided by citizens; it also helped identify those services which might be more efficiently provided by different departments. Applying ABC analysis was a necessary first step in deciding on which businesses the city wanted to or should provide to the citizens and in defining core versus ancillary services. It also heightened awareness of costs and the need for greater efficiencies.

ABC is a technique for cost control that assigns costs to products or services based on their consumption of activities. By identifying component cost details, cost impacts and savings from alternative courses of action, the ABC model can be used for comparing delivery costs for the same service in different locations, highlighting areas of efficiency and areas needing improvement. By attaching costs to the performance of specific activities, it can enable city departments to measure the quality, efficiency and effectiveness of the services delivered.

ABC is not new. The concept and system analysis has been in existence for years; however, it is just recently being applied in the governmental environment. The objectives of ABC are to preserve, at a minimum, the present quality and availability of core services but to acknowledge that some of the forces for greater expenditures have not been controlled. …