Academic journal article Management Accounting Quarterly

Activity-Based Costing for State and Local Governments

Academic journal article Management Accounting Quarterly

Activity-Based Costing for State and Local Governments

Article excerpt


State and local governments have a common goal: to provide products and services to their taxpaying constituents at the lowest possible cost. Many governments, however, are not perceived to be particularly efficient in realizing this goal. To illustrate, Jonathan Walters quoted Anne Kinney, who was director of the budget office for the city of Milwaukee: "...there is pressure on virtually all governments to cut costs and hold the line or even cut taxes. To do that in the best way, you have to develop good cost information. Otherwise you might just decide to cut services rather than figure out a way to deliver those services more efficiently." (1)

Traditionally, state and local governments have practiced cost control by simply aggregating costs for the units within a governmental body and comparing the total costs of these units from period to period. Overhead costs that applied to multiple units were normally allocated to the units based on arbitrary measurements that are common to all units, such as square feet occupied or direct labor costs. A more sophisticated costing system, called activity-based costing (ABC), has emerged in for-profit business environments but has been used little in government accounting.

In this article, we explain the ABC system and advance its application to state and local governmental entities. We also highlight the benefits of using ABC for state and local governments.


The primary objective of an ABC system is to improve the accuracy of product and service costs. The result is that more meaningful input for management decision models is available. In ABC, costs of activities are connected to the primary drivers of those activities. To clarify, in an ABC system where the objective is to assign overhead to units of products or services, the "activities" that cause resources to be consumed (overhead costs to be incurred) are identified first. Next, overhead costs are assigned to each of the activities in accordance with the resources consumed by each. Then, overhead rates are determined for each activity or group of activities when activities and their costs can be pooled. These rates ultimately are used to assign the activity costs (overhead) to the products or services that consume the activities.

ABC addresses the real possibility that a portion of overhead is not driven by volume or a volume-related variable. Volume-based measurements are used predominately in traditional, non-ABC systems to determine overhead rates and to assign overhead costs to products and services. ABC recognizes that activities and their costs can be driven by either volume-related or nonvolume-related variables. As a result, both types of drivers are used, as appropriate, to determine overhead rates. The expectation is that the overhead costs assigned to products and services will be more representative of the actual overhead consumed. The benefits of ABC for product and service costing are certainly applicable in determining the costs of the departments or other units within an entity when enhanced accuracy is desired. This and other aspects of ABC that provide costing advantages for state and local governments are discussed and illustrated below.


Katherine Barrett and Richard Greene indicated that "Governments are finally beginning to figure out how to develop solid figures for the cost of the services they provide." (2) They say that cities like Washington, D.C., and Dallas have taken strides to improve cost information. For example, Washington, D.C., determined the cost of issuing individual checks, while Dallas "has been a leader in the use of cost accounting in areas where it charges fees for services or considers outsourcing." Also, state governments in Utah and Iowa have demonstrated the usefulness of activity-based costing. In Texas, a number of state agencies have embarked on pilot projects involving ABC, including the General Services Commission, the Water Development Board, the Workforce Commission, the Office of the State Comptroller, and the Departments of Economic Development and Transportation. …

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