Determining Highway Maintenance Costs (2011)

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72.1 Introduction The literature review and the discussions with 10 state DOTs conducted in this study provided ideas for a general approach to maintenance full cost determination. Ideas and practices of agencies that had advanced the farthest in implementing comprehensive, integrated cost accounting processes that could support full cost determination were considered. However, also considered were the range of prac- tices in other DOTs and the fact that cost determination processes could be supported with simpler analytic procedures. This chapter outlines a conceptual framework for cost deter- mination to meet these diverse needs and lays the foundation for more-detailed explanations and examples in subsequent chapters of the report. For simplicity throughout this report, references to a maintenance organization, function, program, or activity are intended to refer also to entities that may go by somewhat different names [e.g., (highway) maintenance and opera- tions, (highway) asset maintenance, or (highway) infrastruc- ture maintenance]. 2.2 Definitions General Terms The following definitions will clarify the terms used in developing, explaining, and applying the full cost determina- tion process. While many of these terms have a general manage- ment or financial meaning, definitions will often be narrowed for purposes of this report to address highway maintenance specifically. • Maintenance activity: A specific classification of mainte- nance work or service that is defined in the agency’s main- tenance program and maintenance management system (MMS) and/or financial management system (FMS). The full cost determination process deals with all defined activ- ities that relate to maintenance, regardless of number or detail. Cost data are required and accomplishment units are preferred for each activity to be considered. • Maintenance job: The performance of a maintenance activ- ity at a particular highway location (or length) on a particu- lar day and time. • Cost objective: A financial accounting term defined as “a function, organizational subdivision, contract, grant, or other activity for which cost data are needed and for which costs are incurred” (OMB, 2004). Unless otherwise indi- cated, a “cost objective” will refer in this report primarily to a maintenance job. • Direct costs: Costs “that can be identified specifically with a particular final cost objective” (OMB, 2004). In a road maintenance context, typical direct costs include wages or salaries paid to employees for work performed on a main- tenance job, costs of materials acquired for or consumed on a maintenance job, costs of equipment use on a main- tenance job, and costs of travel to and from a maintenance job. Where maintenance is performed by contract, direct costs refer to contractor payments. • Indirect cost: Costs that are: “a) incurred for a common or joint purpose benefiting more than one cost objective, and b) not readily assignable to the cost objectives specifi- cally benefitted, without effort disproportionate to the results achieved” (OMB, 2004). For example, the guidance, oversight, supervision, and assistance of a district main- tenance office may be said to benefit all maintenance crews and jobs within its jurisdiction, but there is no direct connection or nexus between the district office personnel and each individual maintenance job. A reasonable but efficient method must be found, often informed by judg- ment, to relate district office costs to all the maintenance jobs under its responsibility. • Allocation (also attribution or distribution or assignment): For the purposes of this report, the process of relating indi- rect costs to the maintenance jobs or organizational units C H A P T E R 2 Full Cost Determination Framework

that have benefitted from the expenditures of these indirect costs. For example, the indirect costs of a maintenance dis- trict office need to be related to maintenance jobs and units that benefit from the guidance, oversight, supervision, and assistance of the district office. This relationship is generally analytic (i.e., able to be computed) but is also informed by judgment since the relationship is not immediately obvious (i.e., if it were, the costs might be considered as direct costs). An acceptable relationship is one that is reasonable (i.e., its logic is understandable) and felt to be fair by affected par- ties, but also efficient (i.e., not requiring excessive time and effort that is burdensome relative to the magnitude and importance of the costs being considered). Often an account or pool is created to accumulate indirect costs and allocate them efficiently to the maintenance jobs or organizational units that benefit from the expenditure of these costs. • Base or basis: The analytic quantity by which indirect costs are assigned pro rata to different functions, programs, groups, or activities. Many potential bases are available. For example, indirect costs could be allocated by the rela- tive shares, respectively, of labor costs, total costs, number of employees, or square footage of building space occupied by an organizational unit. • Cost base or cost basis: For purposes of this report, a basis that is expressed in the overall direct cost of maintenance for an activity, function, or program. The overall direct cost of maintenance in this context means the sum of all direct labor, including fringe benefits, equipment, materials, and other expenditures, including contractor payments, to per- form and complete the specified maintenance work. • OMB Circular A-87: A document issued by the Office of Management and Budget (and last revised on May 10, 2004) that establishes principles and standards for treating costs in connection with federal awards, including discussions of direct and indirect costs, and explanations of allowable and unallowable costs. • Indirect cost plan (ICP): For purposes of this study, a docu- ment prepared and submitted by a state DOT and approved by the FHWA, according to requirements of OMB Circular A-87, for use in administering reimbursements of the federal share of costs for federal-aid highway work. • Allowable cost: A direct or indirect cost that is valid to include in requests for federal reimbursement. Govern- ing principles for cost allowability are contained in Attach- ment B of OMB Circular A-87. – At a general level, allowable cost criteria include broad institutional requirements such as to be necessary and rea- sonable for proper and efficient performance and admin- istration of federal-aid monies, to be authorized or not prohibited under state or local laws and regulations, to conform to federal laws and terms and conditions of the award of federal-aid monies, and so forth. – At a detailed level, 43 categories of cost are discussed with explanations of whether or not they are allowable or under what conditions they might be allowable. Ex- amples of cost categories include compensation for per- sonal services of employees; employee morale, health, and welfare; bonding, insurance and indemnification; advisory councils; depreciation and use allowances; idle facilities and idle capacity; interest; meetings and confer- ences; rental costs of buildings; and equipment, training, and travel. – These principles relate to this study in that only allow- able costs may be included in a state’s approved ICP. • Full cost: For purposes of this report, the direct cost plus the indirect cost of a maintenance activity, function, or program. • Full cost determination process: For purposes of this report, the process of determining the full costs of maintenance for an activity, function, or program, whether statewide or by district or other geographical or organizational coverage. Reasonableness in Addressing Indirect Costs As OMB Circular A-87 notes, indirect costs are “incurred for common or joint purposes,” which introduces an ele- ment of judgment in how these costs are allocated across cost objectives. OMB Circular A-87 therefore incorporates rules of reasonableness in dealing with indirect costs by stating the following: “ . . . there is no universal rule for classifying certain costs as either direct or indirect under every accounting system. A cost may be direct with respect to some specific service or function, but indi- rect with respect to the Federal award or other final cost objective. Therefore, it is essential that each item of cost be treated consistently in like circumstances either as a direct or an indirect cost.” One rule of reasonableness is therefore recognition of the latitude and due consideration needed in judging costs as direct or indirect, together with the requirement that these decisions be made in a consistent manner. The practical impli- cation for maintenance cost determination is therefore to examine whether a decision to classify a cost item as direct or indirect can hold up statewide throughout the mainte- nance program. If so, the decision would likely be viewed as consistent treatment, subject to other requirements of allow- able costs. A second rule of reasonableness is the allowance to treat minor items of direct cost “as an indirect cost for reasons of practicality where such accounting treatment for that item . . . is consistently applied . . . ” (OMB, 2004). A petty cash account is a simple example of a potential direct cost that is instead accumulated in an indirect cost pool for subsequent 8

allocation across cost objectives. Care must be taken, how- ever, that similar items are not pooled as indirect costs in some cases but considered as direct costs in others. A third rule of reasonableness is the recognition that a level- of-effort consideration is important in determining whether a cost item is direct or indirect. For example, even if it is the- oretically possible to relate field office supervisory and back- office personnel costs to specific maintenance jobs, the time and paperwork needed to make these connections could be excessive. In this case it is appropriate to treat these office- related costs as indirect costs. Again, the DOT must be con- sistent in this decision across all similar field office expenses. Issues in Defining and Applying Indirect Costs Even with the allowable reasonable practices described above, it may not always be possible to distinguish clearly between direct and indirect costs among DOTs and other transportation agencies nationwide. One reason is the differ- ent interpretations, judgments, practices, procedures, and maintenance activity definitions that have evolved in individ- ual agencies. Another is the situation recognized in OMB Cir- cular A-87 that even within a single agency, certain costs may be viewed as direct in some contexts but as indirect in others. The combination of these two effects may lead to differences and ambiguities, as illustrated in the following examples: • Assume two large states in which DOTs manage highway maintenance costs. From time to time, maintenance crews in each state must travel long distances to remote work sites to perform a number of jobs involving different main- tenance activities. One DOT accumulates these long-distance travel ex- penses within an indirect cost pool, consistent with the fact that each travel expense serves multiple cost objectives (maintenance jobs). The long-distance travel cost pool is distributed periodically across all maintenance activities in proportion to their cumulative direct costs. The approach is felt to be simple and fair, since over time the likelihood is that most or all activities will have been performed at these remote sites, at about the same frequency with which they occur elsewhere throughout the state. Another DOT, by contrast, has programmed its MMS to recognize long-distance travel costs when they occur and to distribute them to each activity that was performed in pro- portion to its total labor, material, and equipment costs. This approach treats these long-distance travel costs as direct costs (i.e., although the costs apply to more than cost objective and therefore serve a joint purpose, they can fairly be assigned to each maintenance job without dispropor- tionate effort). The second DOT also regards this approach to be simple and fair. The result is two different perspectives on the treatment of long-distance travel expenses as a direct or an indirect cost. Both are likely to yield reasonable and fair results so long as the assumptions on which each analysis is based are realistic. • One agency accumulates its planning, legal, and research expenditures within three indirect cost pools, each of which is allocated across other agency functions (e.g., design, con- struction, maintenance, safety) on some basis. Another agency accumulates these expenditures within a more detailed set of accounts in which each planning, research, or legal expense is related to a specific project, job, or func- tion wherever possible. Only those expenses that cannot be explicitly related to an individual cost objective are accu- mulated in a general account (e.g., the costs to prepare a general guidance document or an annual report). The plan- ning, legal, and research expenditures that are related to spe- cific cost objectives (projects, jobs, or functions) take on the character of direct costs; only those remaining expenditures in the general accounts are allocated as indirect costs. The two agencies thus differ in their perspectives on the degree to which their planning, legal, and research expenditures are treated as direct costs versus indirect costs. • An agency typically regards the expenditures related to cen- tral office functions (e.g., the office of the chief executive, planning, human resources, and information technology) as indirect costs to be allocated among the direct costs of field-oriented functions such as design, construction, maintenance, safety, environmental mitigation, and traffic services. However, the agency’s legal office not only serves the field-oriented functions (e.g., in lawsuits involving construction projects, maintenance services, road traffic safety issues, and disputes regarding environmental miti- gation) but also addresses the legal matters involving the central office functions listed above (e.g., suits citing the department’s leadership team, legal challenges involving human resources or information technology, and disputes involving the agency’s long-range plan). Assume that legal office expenditures are to be distributed as indirect costs among all of these other functions, based on each func- tion’s relative share of professional labor costs annually. Within this limited context, the costs of professional labor in each of these functions—both central office as well as field-oriented units—might be regarded as direct costs, with the indirect costs of the legal office being distributed in proportion to each function’s relative share of these pro- fessional direct costs. Thus, the agency’s perspective on whether to regard central-office costs as direct or indirect depends on the context within which these costs are being analyzed. 9

These types of issues are resolved in this study in a con- sistent, understandable way by adopting concepts explained in the following two sections: 1. Additional nomenclature that distinguishes the different types of costs that are important to cost determination without using the terms “direct costs” and “indirect costs.” 2. A hierarchy of cost attribution that helps guide managers in handling different types of costs for purposes of cost deter- mination, without explicit resort to direct or indirect costs. Nomenclature for Cost Determination The following terms are used in this report to provide gen- eral guidance and avoid ambiguities due to possibly different interpretations of direct costs and indirect costs among agen- cies or within a single agency in different contexts. The notion of line costs and support costs is often evident in agencies’ analyses of their full costs, even though they do not use these particular terms. It is understood that agencies must continue to use “direct costs” and “indirect costs” as part of the financial accounting and management and in connection with the indi- rect cost plans. Furthermore, “line costs” and “support costs” are not to be taken as synonymous with “direct costs” and “indirect costs,” respectively. It is entirely possible that line costs, for example, will include a combination of direct costs and indirect costs, and that support costs will likewise include a mix of direct costs and indirect costs. • Line costs: The labor (including fringe benefits), equip- ment, material, and other (LEMO) costs to perform actual maintenance work (i.e., line activities) on highway assets or to provide maintenance services to the public. For example, pavement patching, mowing, snow and ice control, repair of pavement markings, traffic sign and signal repairs, litter pickup, rest area maintenance, and incident response. • Program support costs: The subset of support costs that is closely associated with the maintenance function and program. Program support costs can be divided into two types. The first type supports all line activities, such as the costs associated with the headquarters- and district-level maintenance organization, office supplies, office facilities, and utilities. The second type supports only a subset of line activities, for example, the fence inspection support activ- ity supports the fence installation and repair line activities. • Enterprise support costs: Other expenditures of the trans- portation agency that can reasonably and fairly be allocated to highway maintenance. For example, a portion of the costs of agency executive management, human resources, finance and accounting, information technology, planning and research, and legal counsel. These definitions provide a general guide to the nomencla- ture used in this report. Recognizing different practices among agencies in both maintenance management and financial accounting, the categorization of costs between line and sup- port varies by agency, as does the further division of support costs between program support and enterprise support. The subsequent discussion in this section, the example in Chap- ter 3, and the documented calculations in the attachment will show, however, that minor differences in how costs are cate- gorized will not significantly affect the result of the full cost determination process. Rather, it is much more important to identify all relevant costs completely and to perform a fair and reasonable allocation to maintenance. If cost identification and allocation are done properly, the result will be a reliable indication of full maintenance costs. Decision Structure for Cost Attribution This section builds on an approach developed by Texas DOT to guide the treatment of costs. The approach has been adapted and modified to relate to highway maintenance specifically and to use the cost determination nomenclature introduced in this project, with examples added by the authors. The resulting guidance is provided in Table 2.1. The value of this guidance for cost determination is that it focuses on a systematic approach to relating all agency costs to a particular cost objective—in this case, maintenance jobs (although it applies equally to maintenance activities)— without resorting to using terms such as “direct costs” or “indirect costs.” Rather, it essentially attempts to define how closely a particular agency cost relates to performing and completing one or more maintenance jobs or if there is a fair, reasonable, and practical method to attribute all or part of a given cost to these maintenance jobs. If there is a relationship or nexus between the cost and maintenance jobs, the guidance recommends allocating a fair, reasonable share of the cost in a practical, efficient way. If not, the cost is regarded as relating to other agency line functions and can be excluded from the maintenance cost determination process. 2.3 Building the Full Cost Determination Process This section explains how the cost determination process is built for a highway maintenance program. The explanation is given in bottom-up order since line costs—the primary con- stituent of MMS calculations and reports—provide a familiar point of departure for DOT maintenance managers. Once line costs are established, the explanation broadens and proceeds up the cost structure hierarchy to program support costs and enterprise support costs. This explanation is given in a logical, step-by-step fashion to facilitate understanding of the com- position and the treatment of each category of cost. Figure 2.1 10

11 Consider Different Types of Agency Expenses Action to Handle This Type of Expense with Respect to Maintenance Example(s) of This Type of Maintenance-Related Expense Consider potential maintenance-related expenses reported from various activities and locations, and analyze them in the following way: 1. Is the expense reasonably attributable to a single maintenance job? (If yes, see columns to right). (If yes from left column) Charge the expense to the individual maintenance job. Labor, equipment, and material charges reported for an individual maintenance job. If answer to above is no, consider the following: 2. Is the expense reasonably attributable to more than one maintenance job? (If yes, see columns to right). (If yes from left column) Subjectively prorate the expense among individual maintenance jobs. Significant travel costs to one or more remote sites requiring multiple maintenance jobs: distribute travel expenses among these jobs [e.g., equally (if jobs are roughly of same scale) or in proportion to some basis (e.g., relative total cost of each job)]. If answer to above is no, consider the following: 3. Is the expense reasonably attributable to a maintenance program service center or clearing account? (If yes, see columns to right). (If yes from left column) Charge to the maintenance program service center or clearing account for subsequent distribution to maintenance line costs or other service centers/accounts as appropriate. A. Costs of district or field offices: maintenance personnel, office facility, utilities and services, equipment, materials and supplies, and other operating expenses. B. Costs of a sign fabrication shop. If answer to above is no, do the following: 4. Consider the expense an enterprise support cost for distribution across agency line functions or other service centers/accounts as appropriate (see columns to right). Charge the expense to the appropriate enterprise support cost account. Allocate a fair share of each cost account to maintenance line costs. A. A share of costs associated with the executive office. B. A share of costs of central agency functions (e.g., payroll, legal, accounting, human resources, planning, research). Note: This guidance is adapted from a more general accounting approach developed by the Texas DOT. The approach has been modified to focus on maintenance expenses and Project 14-18 cost determination nomenclature. Maintenance-related examples in the right-hand column have been added by the report authors. Table 2.1. Hierarchy of decisions on cost attribution. Figure 2.1. State DOT maintenance activity full cost context.

illustrates how the three categories of cost included in the full cost determination process relate to each other as well as to other agency expenditures. The following descriptions should help explain how the complete set of line and support costs are identified and allocated to maintenance. Line Maintenance Costs Line maintenance costs are the costs of accomplishing actual work or services through line maintenance activities. The bulk of activity-related costs in an MMS report are typically line costs. Line costs comprise costs related to labor, equipment, material, and other (including payments to contractors). • Labor costs: The sum of agency payments to (or on behalf of) employees for performing maintenance jobs. These pay- ments encompass compensation (wages, salaries, tempo- rary or part-time payments, etc.), any overtime for hourly employees, Social Security and Medicare payments, and applicable fringe benefits (e.g., vacation, sick time, other leave, health and other insurance premiums, and retire- ment fund contributions). All of the DOTs interviewed in this study included travel time as a legitimate part of activ- ity labor costs. Labor costs for crews brought in to supple- ment state DOT workers (but excluding contractors) also should be incorporated in the totals (e.g., costs of convict/ inmate/correctional department labor and costs of any agency personnel from outside the maintenance organiza- tion assigned to work on a maintenance activity). While volunteer programs such as Adopt-a-Highway may not entail identifiable labor costs, it is useful to document the use of such programs for particular maintenance activities as a matter of record and to help establish the context within which the cost determination process is applied. The insertion of an equivalent agency labor cost for work accomplished by volunteers is not needed unless this equivalent cost is judged be a significant percentage of the maintenance program or it is felt that a placeholder cost should be estimated for other reasons. • Equipment costs: The total equipment charges incurred in performing maintenance jobs, whether for agency-owned equipment or use of equipment owned by other entities. Typically these charges are structured as rental rates for each class of equipment. Some agencies have further organ- ized these rates to support an enterprise-fund operation, in which the equipment function is financially self-supporting. In these cases the rental rates may be set for each individual piece of equipment to cover the respective costs of depreci- ation of the initial purchase price, fuel and other operating expenses, routine equipment maintenance, and repairs and overhauls through an estimated service life. For purposes of full cost determination, if any of these sources of cost have been excluded for the rental rate (e.g., depreciation or shop overhead), it is important to determine how signifi- cant these excluded cost elements are and, if they are sig- nificant, to ensure that the costs are picked up fully and correctly in either the maintenance program or the enter- prise support categories. • Material costs: The total charges for materials and supplies in performing maintenance jobs. These charges can be for consumption of materials that are maintained in agency inventories or stockpiles, the use of materials fabricated in agency shops, or materials purchased specifically from outside vendors to complete a particular maintenance job. The costs to be applied within the cost determination pro- cess should be the costs of materials actually used in main- tenance jobs and not the overall cost of bulk purchases. Agencies may use unit material prices that are determined by their stockpile management or inventory stores manage- ment programs, where available, or other methods consis- tent with their financial accounting and maintenance man- agement practices, so long as these reflect the raw material costs themselves. Additional costs such as overhead for inventory stores/stockpile operation and management should be treated as support costs, not line costs. • Other costs: Total charges for other items associated with maintenance jobs that do not fit into the labor, equipment, or material categories. For example, utility charges, private equipment rental (i.e., not part of the agency fleet), and the sum of payments made to contractors to complete maintenance jobs in cases where maintenance activities are delivered through a combination of agency and con- tractor resources. These jobs, which may be bid for work on individual activities, for multiple activities within a given geographic area, or for multiple activities for a given length of highway route, must be within the scope of the routine maintenance program as the agency defines it and not within other programs (e.g., construction or capital preservation). A challenge that many agencies may face in treating con- tract costs within a cost determination process is to iden- tify the maintenance units of accomplishment that relate to contract expenditures for each maintenance activity. Ideally, total units of accomplishment would be calculated before the contract is awarded rather than leaving the cal- culation as an afterthought that later becomes difficult to complete in a timely way. Accomplishment data enable contract costs to be combined with the costs of state-force maintenance work in calculating an overall unit cost for each activity, thus satisfying the principle of considering the complete set of costs. Some agencies also have raised the issue of the timing of contract payments as a potential issue (i.e., situations where payment of the entire contract amount occurs at one time even though services are deliv- ered incrementally over a period of time). In fact, this issue 12

should not affect cost determination if all work performed and payments expended occur within the same fiscal year. In this case, the date of posting of the charge is immaterial since it is recommended that cost determination be applied based on data for a completed fiscal year. If there are signifi- cant misalignments between work performance and con- tract payments across two or more fiscal years, adjustments to posted charges can be made to bring work accomplish- ment and payment to contractors into better alignment within each fiscal year. Information on maintenance line costs is typically avail- able from an agency’s MMS and potentially its financial man- agement system. Steps in preparing this information for the cost determination process are as follows: • Identify which activities are properly considered as line cost items (i.e., they involve the performance of actual work or services to the public that are the intended outcomes of the agency’s maintenance program). Other activities (e.g., train- ing, maintenance management, building and yard mainte- nance) should be included with program support costs. • Develop a good understanding of the relationship between costs reported in the MMS and maintenance costs reported in the financial accounting system. – Agencies that have a well-integrated system architecture and a financial system that tracks specific maintenance activities should consider using the financial system data for cost determination. An important prerequisite for this decision is that financial system totals for the maintenance program be close to, and preferably match exactly, the corresponding MMS totals. If this is not the case, a reconciliation and adjustment review should be done to bring the respective totals closer together. Typical reasons for such differences include variations between the two systems in how individual costs are recorded, inclusion of projects for which judgments differ on whether they are part of the agency’s routine maintenance program, and errors by agency personnel in reporting work (and whether the MMS and the finan- cial system have isolated and corrected these errors). Once adjustments have been identified and agreed to, the financial system data can be used in further calculations. – If the financial system does not break down maintenance expenditures by activity, a hybrid approach should be investigated in which the financial system provides esti- mates of overall line costs and the MMS is used to dis- aggregate these costs by line activity. A prerequisite is to reconcile differences between financial and MMS data before proceeding. The objective is to identify the full, complete set of line maintenance costs as closely as possi- ble with a reasonable level of effort. Estimates are appro- priate when needed; it is more important to account for all likely sources of line costs in a realistic way than to spend excessive time determining every cost to the penny. – If the financial system does not address line mainte- nance costs directly (e.g., it includes only a line item for “maintenance labor” that encompasses both line and support costs), the MMS should then be used as the pri- mary source of line-cost data by activity. Regarding this example, however, it would be advisable—once main- tenance program costs also are computed—to compare total estimated maintenance line labor plus mainte- nance program support labor costs from the MMS and other sources to the total “maintenance labor” item in the financial system to determine adjustments needed. – In all of these and subsequent calculations, it is recom- mended that all analyses that are based on historical cost data be conducted using fiscal year-end financial and MMS reports. The reason is that the data for such reports are typically adjusted to close out calculations for the fis- cal year (some agencies employ a “13th-month adjust- ment,” while others perform an adjustment based on adding costs from the prior year’s closing month and dropping costs from the just-completed year’s closing month). Furthermore, all month-to-month reconcilia- tions of indirect costs are cleared, ensuring that indirect costs in the accounting system are treated such that they are closed out with, ideally, no gains or losses in actual versus estimated items. • Using the guidelines above, establish the maintenance line costs by activity. Maintenance Program Support Costs Transportation agency maintenance organizations perform a variety of planning, management, research, and other func- tions that support the line activities. These functions occur at several organizational levels encompassing headquarters and district and field offices. The maintenance program support cost category accumulates the costs of these maintenance- related support functions. The types of costs to be included in this category include the following: • Program management and field supervision: Costs asso- ciated with the staff responsible for managing the mainte- nance program, including the state maintenance engineer; district/regional managers; and area/shed/foreman-level managers, supervisors, and roving patrols. Only the time used for general management functions is included here, not any time spent directly supervising line activities. • Program administration: Costs associated with office personnel, equipment, and supplies at the several levels of maintenance management above. 13

• Buildings, facilities, and grounds: Costs associated with buildings, facilities, and grounds occupied by maintenance personnel and items used by the maintenance function. These costs include building leasing, rental, or deprecia- tion; grounds maintenance; utilities; and communications (e.g., costs of radio system operation). • Training: Costs incurred by attendance of maintenance personnel at training, and the costs to prepare and provide training sessions and materials. • Material stores/inventory operation: Costs associated with operating the agency’s maintenance inventory, stores, and stockpiles. • Fabrication shops and laboratories: Costs associated with agency shops that fabricate items for use by mainte- nance forces (e.g., signs), and laboratories whose work in research and testing supports line maintenance activities (e.g., a materials laboratory supporting pavement and pave- ment marking maintenance activities). Agencies recognize and deal with maintenance program support costs in several ways: • Maintenance activities capturing program support: A number of agencies interviewed in this study identify pro- gram support activities explicitly within their maintenance activity structure. Common examples include maintenance training; handling and management of material stockpiles; buildings and yard maintenance; and general support activ- ities identified within particular categories or groups of maintenance activity (e.g., pavement/road surface, bridge and structures, roadside, traffic operations). • Cost center/clearing accounts: Agencies also may establish program cost centers or clearing accounts where charges associated with maintenance program support are accrued for later allocation to maintenance line activities or poten- tially other functions. • Inclusion within broader enterprise support: Some agencies include costs associated with maintenance pro- gram management as part of agency-wide management, particularly for items like district-level and headquarters management. Within cost determination, the maintenance component of these costs must be identified and accumu- lated for allocation to maintenance line activities. Regardless of which method(s) are used by an agency, the cost determination process calls for (1) identification of the complete set of maintenance program support costs, and (2) decisions on how to allocate these costs to maintenance line items or other functions/accounts as appropriate. Inter- views with several DOTs conducted in this study indicate that a variety of allocation approaches are used. These approaches range from very straightforward development of a single program functional rate that is applied to all line maintenance activity costs (e.g., Caltrans), to more complex allocations where certain program support costs are allocated to the sub- set of line activities that benefit from those costs. There also are allocation procedures that impose an intermediate step before extending to line maintenance activities. For example, Texas DOT does not allocate the costs of its sign fabrication shop directly to signage-related maintenance activities. Rather, it allocates the fabrication shop direct and indirect costs to its materials and supplies inventory-management cost account. These costs are then passed on to those maintenance line ac- tivities that use signs by including the costs in the amount charged for each sign by the materials and supplies inventory system. All of these examples point to the need for mainte- nance managers to coordinate with financial accounting man- agers in ensuring that the cost determination procedures are consistent with, and supported by, applicable calculations in the agency’s financial management accounting system. It is important to consider the guidance in OMB Circu- lar A-87 regarding reasonable levels of effort in identifying and treating cost items when considering how to allocate pro- gram support costs. For example, while it may be theoreti- cally possible to allocate the costs of each individual training session to a particular set of line activities, it is not clear that the benefit gained by this exercise will warrant the time and effort required. The preferable approach is to pool all train- ing costs and allocate them across all maintenance activities using a suitable base (e.g., total expenditures or total labor costs) according to agency practice. In this context, the agency’s treatment of maintenance training costs should be consistent with its treatment of training costs for its personnel in other functions. As a general rule, many maintenance program support items will be allocated completely (i.e., 100%) to maintenance line activities or a subset of those activities. Some agencies con- sider certain program support items essentially as direct costs because of their close relationship to the performance of main- tenance work. Even where program support costs are con- sidered as indirect costs, they are often allocated 100% to the maintenance function because the cost determination result will differ only a small amount from the case where they would have been considered direct costs. As stated earlier, determin- ing the complete set of maintenance line and support costs and the appropriate methods of allocating support costs to line costs are more important than whether individual costs are classified as “support” or “line.” Exceptions to this 100% guideline are (1) where maintenance program support costs are shared with other agency functions (e.g., materials labo- ratory services are used by the construction program as well as the maintenance program, in which case these costs may be better treated as enterprise support costs), and (2) in situations such as those described for the Texas DOT sign shop above, 14

in which program support costs are allocated to another cost account (materials-and-stores inventory) rather than to main- tenance line activities directly. Enterprise Support Costs Highway maintenance is one of a number of programs and functions that are managed by a typical transportation agency. In the same way that a maintenance program comprises line and support activities, the operations of a transportation agency comprise line and support programs and cost items. Typical agency line programs include construction, mainte- nance, safety, environmental protection/mitigation, and other investment and operations categories of work across different modes. These programs are supported by a number of enter- prise support functions that typically include the following: • Agency executive management; • Planning, programming, and research; • Financial accounting, budgeting, payroll, and procurement; • Legal and audit divisions; • Human resources; • Information technology; • Central office buildings, facilities, and grounds, including utilities and communications services; • Shops, laboratories, and other support functions and cost items that have not already been included in the program support category; and • Support of the DOT provided by external agencies (e.g., the state attorney general’s office or the state auditor’s office). As with the program support costs, the key objectives regard- ing enterprise support costs are (1) to identify the complete set of enterprise support costs, and (2) to allocate an appropriate share of these enterprise support costs to maintenance line costs to complete the cost determination process. As with program support costs, current agency practices on how to compute this allocation vary from a straightforward division of total enterprise support costs by total line program costs to produce a single percentage rate allocation across all line programs (e.g., Caltrans), to more complex calculations that consider different enterprise initiatives and different categories of line programs, projects, and activities (e.g., Florida DOT). Those agencies that have developed a financial management system that is consistent with their approved indirect cost plan may define the enterprise support costs within a number of indi- rect cost pools. For each indirect cost pool, the plan identifies which of the other indirect cost pools and direct program pools (i.e., the line programs/functions) should bear a share of its costs and what should be the basis of this allocation. Typical bases of indirect cost allocation are total expenditures or total employee counts for each line program/function, respectively. It is important to seek complete cost coverage while avoid- ing double-counting when compiling enterprise support costs. For example, in cases where agencies include all vehicle-related expenditures in developing equipment rental rates, the enter- prise support costs should not include any equipment-related expenditures. However, in cases where certain vehicle expen- ditures are excluded from the equipment rental rate calcu- lation, the enterprise support category should include an equipment component that covers these costs. Expressing Cost Determination Results When all applicable support costs have been allocated to maintenance line costs, the cost determination process can be completed. The recommendation from this study is that results be expressed as the full unit costs of each maintenance activity. A unit cost result is superior to an overhead percent- age or other method of expressing full costs. In fact, DOTs that were interviewed for case study development and that have well-developed financial accounting methods to support full cost determination strongly discourage the use of overhead percentages for the following reasons: • A maintenance overhead percentage (indirect cost divided by direct cost) depends on the cost basis used. For example, an overhead rate on the basis of total direct costs (e.g., the sum of labor, equipment, and material costs for mainte- nance) will differ from one based on direct maintenance labor costs alone. Comparisons of overhead rates, say, between the public and the private sector may thus be mis- leading if different cost bases are used by the respective parties. • A maintenance overhead percentage depends on exter- nal factors that are unrelated to maintenance. For exam- ple, agencies with large highway construction programs, where the annual construction budget is a relatively large portion of total agency budget, will exhibit relatively low maintenance overhead rates. This occurs because the dis- tribution of indirect costs among programs is driven by their respective direct cost bases—assume them to be equal to the total direct expenditures for each program. A large construction program will thus attract a large percentage of enterprise-level indirect costs, depressing the overhead percentages computed for all nonconstruction programs, including maintenance. • Variability in maintenance overhead rates (e.g., between districts in a state DOT) may be misconstrued as indicat- ing variations in maintenance efficiency. Maintenance overhead rates are sensitive to the volume of work in other programs such as construction, as noted above, which in turn may be driven by differences in factors such as traffic volume/composition and degree of urbanization. If districts 15

vary in the relative volume of their construction work, and if the unit cost of construction in each district is fur- ther influenced by local factors such as geography, climate, traffic, and degree of urbanization, it is easy to see that the observed variability in maintenance overhead rates may have nothing to do with relative maintenance effi- ciency. Additional influences such as the geographic size of a district and the density of the road network may have similar distorting effects. • Results expressed as overhead rates are more sensitive to the categorization of costs as direct or indirect than are results in terms of full unit costs. The problem arises because this categorization can be subjective, with variability in re- sults among agencies—a fact recognized in OMB Circular A-87. This issue is highly unlikely to affect costs that are referred to as line costs in the recommended process, but it can occur with respect to support costs, particularly the pro- gram support costs. Given uncertainty in what costs are con- sidered direct versus indirect, the ratio of indirect to direct maintenance costs—the maintenance overhead rate—may vary solely due to how costs have been categorized and not to meaningful distinctions in how maintenance has been performed. • Results expressed as unit costs are less prone to categoriza- tion problems. The reason is that regardless of how program support costs might be categorized as direct or indirect, these costs tend to be 100% attributable to maintenance line costs or a subset thereof. For example, it would be reasonable to distribute the support costs related to a district maintenance office to all maintenance activity line costs on a prorated basis. Program support costs related to sign fabrication, however, would be reasonable to distribute to sign-related activity line costs, again on a prorated basis. In each of these cases, the attribution of program support costs remains com- pletely within the sphere of maintenance line costs. There- fore, regardless of how one might categorize them as direct or indirect, these program support costs are fully captured within the total unit maintenance costs that result from the cost determination process. 2.4 Tenets of Full Cost Determination Several tenets that have guided the development of this cost determination process were listed in Chapter 1. The items below elaborate on each tenet and provide its rationale and implications for study findings and recommendations in later sections. 1. The recommended full cost determination process should build on the existing management practices, procedures, data, and systems typically found within state DOTs. Among these capabilities are maintenance management systems; financial management and accounting systems; pro- cedures and/or systems for payroll, equipment management, materials-and-stores/inventory management, and maintenance contract management; and approved indirect cost plans ac- cording to FHWA requirements for federal-aid reimburse- ment, based on OMB Circular A-87. The recommended cost determination approach can be structured to be consistent with an agency’s cost data and computational methods such as those included in its maintenance and other applicable management systems and to conform to the general princi- ples, methods, and assumptions in its approved indirect cost plan. The guidelines and examples in Chapter 3 and the at- tachment identify the types of data needed from these systems and explain the computations involved. Case studies devel- oped for several DOTs illustrate applications of the method- ology under different conditions and assumptions. Where certain systems or data are not available, the descriptions in Chapter 3 identify options for obtaining information from other sources and estimating or approximating values. 2. The focus of the process is state departments of trans- portation; however, it may be useful to any transportation agency with a maintenance program. Identifying state DOTs as the target of this research estab- lishes an explicit context for designing an effective mainte- nance cost determination process. Key factors defining this context are as follows: • Capabilities in planning, tracking, and managing agency functions such as highway maintenance, financial account- ing, equipment and material usage, and other functions described below. These management capabilities play key roles in developing and supporting a viable cost determi- nation process. Moreover, personnel in these disciplines— particularly in maintenance management and financial accounting management—need to work cooperatively in conducting analyses and reconciling cost data. • A funding environment that includes federal-aid program requirements governing reimbursement of applicable highway-related expenditures, including indirect costs. Admittedly, many routine maintenance activities and main- tenance work on non-federal-aid highways are not directly affected by these FHWA provisions. However, agency proce- dures and data needed to conform to FHWA requirements for federal-aid program reimbursements—including an indirect cost plan approved by the FHWA—can assist greatly in developing and implementing a maintenance cost deter- mination process, particularly if DOT cost analyses and reporting are comprehensive and disciplined. This study has adopted the model comprising typical state DOT management capabilities, interdisciplinary collabora- 16

tion in analyzing agency costs, and joint state DOT–FHWA program funding as the context for designing and developing a maintenance cost determination process. Chapter 3 and the at- tachment provide guidelines with several examples of how the cost determination process can be applied to state DOTs with different characteristics and situations. Other transportation agencies also may find the cost determination process to be helpful if they also are trying to estimate the full costs of main- tenance. They would, of course, need to adjust and compen- sate for differences in their own operating context, whether in the availability of management tools and data or in the documentation of their own direct and indirect cost analyses. 3. The focus of the process is highway maintenance pro- grams; however, the basic principles of full cost determi- nation may be applied to any of an agency’s line programs. Highway maintenance is the focus of this cost determination study. The main objectives of the research were to develop a process for determining the full cost associated with per- forming highway maintenance and to document its appli- cation using a number of real-world examples. However, the principles and fundamental procedures in cost determi- nation are general in scope and can be applied conceptually to any program or transportation mode once appropriate adjustments are made for the different activities and cost elements involved. The generality of the approach strength- ens the rationale that if a department is considering out- sourcing road maintenance services, it should commit the resources needed to conduct cost determination compre- hensively but efficiently. 4. The recommended full cost determination process should encompass all activities performed by an agency’s maintenance organization and program. The general approach to assigning full maintenance costs by activity is fundamentally the same across all line activities. Straightforward procedures also are available for support activities. There are variations in the details of specific activ- ities, but these do not fundamentally affect the methodology involved. For example, if a materials laboratory supports maintenance work in pavement repair and pavement mark- ings, those activities may bear a share of the cost of the labo- ratory. Similarly, the costs of a sign fabrication shop may be borne by activities related to signage, and the costs of salt sheds may be attributed to winter maintenance activities. Once these distributions have been calculated and assigned properly, the distribution of other program support costs to individual activities can be done on a prorated basis. 5. Maintenance activity full cost results should be ex- pressed as either total or unit cost rather than overhead percentages. This tenet is important because the purpose, analytic basis, and results of a cost determination process are sometimes misunderstood, with the potential for misuse. Expressing the full costs of a maintenance activity as a computed unit cost provides the most correct and reliable metric. For a given activity, the numerator of the unit cost is the sum of all line and support costs attributable to that activity; the denom- inator is the accomplishment unit assigned to that activity in the maintenance management system (e.g., area of pave- ment, length of guardrail, acres of mowable grass). Only those activities that have defined, physical measures of accom- plishment can have these unit cost results. Expressing results as overhead percentages is unreliable and potentially mis- leading and is therefore discouraged because such percent- ages depend on several factors having nothing to do with the efficiency of agency maintenance. 6. The results of the full cost determination process apply to each agency individually; comparisons of full costs between agencies are not meaningful for several reasons, and should be avoided. The logic and implications of this tenet are similar to those of the previous one. Comparisons among peers based on over- head percentages are inappropriate for all the reasons discussed previously. Even comparisons based on unit costs may not be meaningful because of effects similar to those already discussed as well as differences in items such as program structure (i.e., the number of maintenance activities and how they are de- fined) and the overall size of the maintenance program as com- pared with that of construction and other programs. These dif- ferences can affect the values of line costs and the distribution of prorated support costs, complicating comparisons with other agencies. Comparisons with private-sector costs should, therefore, be done on the basis of the existing agency mainte- nance activity specification, units of accomplishment, level of service achieved, and the associated full unit costs. In addition, if agency full costs are derived from a review of past expendi- tures, appropriate consideration for inflation must be incorpo- rated into the comparison. 7. The recommended full cost determination process should ensure complete coverage of an agency’s expenditures, with no overlaps, duplicates, or gaps. The cost determination process must account for all rel- evant line and support (or direct and indirect) costs so that they can be part of the calculation, even if values and percent- age distributions must be estimated. Overlapping or dupli- cated costs lead to double-counting and must be avoided. Gaps or incomplete tallies of relevant costs likewise must be corrected to prevent distorted results. Care in assembling cost data according to the categories recommended in this report 17

(i.e., line costs, program support costs, and enterprise support costs) will help eliminate these errors. Some examples follow: • Check the totals of corresponding line and support items be- tween the MMS and the financial system to ensure that they are reasonably close or that variances can be accounted for. Differences may be due to errors in data reporting, varying cost calculations and analyses between the two systems, use of different sets of data implied by queries of the two systems (e.g., number and location of personnel identified as belong- ing to the maintenance organization), or other factors. Un- derstanding the reasons for these differences can help deter- mine exactly what costs have or have not been considered. • Since agency practices differ on what cost items to include in equipment rental rates, these costs need to be understood within each agency to avoid gaps or overlapping costs. For example, if agency equipment rental rates include depreci- ation, and other identified costs include equipment capi- tal purchases, this is a cost overlap. Removal of one of these overlapping categories of cost before proceeding with the analysis is necessary. • Similar categories of costs should be scrutinized to ensure that they do not duplicate one another. For example, a materials research lab may be included as either a program- support cost (if it serves primarily maintenance) or an enterprise-support cost (if it supports functions besides maintenance, such as construction, safety, and traffic operations). There also may be a general research expen- diture item in enterprise support costs, representing a broad set of sponsored research projects, studies, and re- ports on behalf of the agency. Determining whether the research lab costs are included in the research item and, if so, eliminating the duplication by removing the redun- dant costs, would be necessary. 8. A practical and consistent full cost determination process is more useful than one that is complex and variable, even if the latter delivers greater accuracy in some cases. Nowhere is there a requirement that estimates of the full costs of highway maintenance must be accurate to the penny. However, a rule of reason should apply in arriving at realistic but sensible treatments of costs using calculations that are practical and efficient. Agencies having well-developed, well- integrated management systems for maintenance and finan- cial accounting can and in fact do come close (if not exactly) on cost totals. In other situations, estimates of costs are per- missible so long as they are realistic. Moreover, distributions of indirect costs necessarily involve subjective judgments, a fact recognized in OMB Circular A-87. Guidelines in OMB Circular A-87 further emphasize the importance of consistency in treating similar types of costs in a similar way. Consistency applies in a number of ways within cost determination (e.g., in how costs are categorized; in the programs, functions, or activ- ities to which they are assigned or distributed; and in the analytic bases by which they are distributed). 9. Agency application of the full cost determination process will benefit significantly from the collaboration of main- tenance with other units within the DOT. At a minimum, a team involving representatives of main- tenance and financial accounting is needed to ensure that costs are fully identified; that the cost determination com- putations are consistent as much as possible with general agency accounting practices, including the approved indi- rect cost plan; and that the needed computations can be done correctly and efficiently. Other groups may be needed to check on details and to provide cost-related information in particular instances. These units may include, for example, equipment management, materials-and-stores-inventory/ stockpile management, payroll, and other functions classified as support (e.g., information technology, research, training). The effort needed to account for the contributions of these support units to the cost analysis may be minimized by basing analyses on completed fiscal year data. 10. Utilization of year-end reports and data simplifies the full cost determination process and reduces the chances of errors and inconsistencies. Agencies routinely close out fiscal years by completing ad- justments to reported costs, reconciling cost variances, and closing indirect cost accounts to zero out inadvertent gains or losses due to differences in estimated versus actual monthly totals. It therefore makes sense to base a cost determination study on the most recent fiscal year-end results, when cost tal- lies are complete and correct, rather than to try to conduct the analysis mid-year. Using year-end results ensures complete and consistent data across all agency units and largely elimi- nates the need to deal with cost reconciliations, revenue-to- cost adjustments, and direct versus indirect cost flows within individual support functions (e.g., materials and stores, sign fabrication shops, central office functions) and enterprise funds where they exist (e.g., in equipment management). 11. The full cost determination process will provide only one input to an agency’s decision making regarding maintenance delivery. The focuses of this research effort are maintenance cost de- termination and the process of identifying the full costs of agency highway maintenance. The project does not deal with contractors’ costs to provide highway maintenance, nor does it address cost comparisons between public- and private-sector delivery of maintenance services. The study’s recommenda- tions do not attempt to provide guidance in making main- 18

tenance contracting decisions. The project does not address other factors and criteria that may enter a contracting deci- sion such as legislative requirements for outsourcing, limits on agency staffing levels, and need for specialized labor skills and other resources. 12. The full cost determination process should incorporate general principles of good analytic technique, including transparency and repeatability. Cost determination is a wide-ranging analytic process that involves agency-wide cost data and several stages of cost dis- tribution and summation. Good practices that have been identified for analytic techniques in general apply here as well, including • Transparency: The ease of understanding the basic calcu- lations and assumptions involved and the specific assump- tions, adjustments, or exceptions that have been made in particular years. • Replicability: The principle that reasonable, knowledge- able people, presented with the same data, assumptions, and objectives, could perform the analysis and arrive at the same result. • Repeatability: Application of tried-and-true management systems, data sources, and other analytic tools such that the same data, when subjected to repeated analyses, yield the same results. Satisfying these principles of good practice suggests that cost determination be supported by the appropriate resources and capabilities: • Designation of a team with the appropriate knowledge, experience, and analytic resources to organize and con- duct the cost determination process when needed. Experts from financial management and maintenance management should form the core of this team. • The performing of key computations by recognized agency management systems (particularly in financial account- ing management and maintenance management) that demonstrate verifiable performance in terms of accuracy, consistency, and data integrity. Resorting to informal spread- sheets and back-of-the-envelope calculations for other than simple analyses/summaries is discouraged. Where supple- mentary calculations are needed (e.g., in spreadsheets or custom programs), they should at a minimum be verified by other team members. If they are a significant part of the process, the tools should be formalized within agency prac- tice (i.e., as named procedures with identified responsibilities for custody, system maintenance and support, and periodic upgrades assigned to a specific agency unit). • Documentation of the cost determination procedure iden- tifies general procedures and sources of data, underlying assumptions (e.g., cost items to be treated as line, program support, or enterprise support), bases to be used in cost attribution/allocation, and special notes. A general docu- ment with annual supplements (e.g., similar to program- ming and budgeting instructions issued annually/biennially by agencies) should be considered. • A library of useful references such as annual maintenance and financial reports, the indirect cost plan, and the gen- eral and annual documentation recommended previously should be maintained. • Archiving procedures and identified repositories to maintain cost determination records, reports, and other documents should be established. 13. Performing full cost calculations requires care and at- tention to detail; however, the data and tools needed to do it can and have been assembled successfully by state DOTs. Appendix A of the attachment illustrates the application of the recommended cost determination process to DOTs of varying characteristics with different maintenance programs. Some of these computations are relatively straightforward, while others are more detailed and sophisticated, taking full advantage of the capabilities of the agency’s financial account- ing system and maintenance management system. One of these agencies (Texas DOT) applies a state-of-the-art approach char- acterized by the following properties: • Full cost coverage, encompassing all agency programs, accounts, and cost centers, with a scope extending depart- ment wide. • Cost elements organized in a way that supports full cost determination, including explicit representation of high- way maintenance activities within the financial accounting system. • Fully integrated management systems—including the finan- cial accounting system, maintenance management system, payroll system, equipment management system, and system for managing materials-and-stores inventories and stock- piles—in which the cost elements are unified and communi- cated among all systems using a common language. • A defined and clear cost analysis methodology that is docu- mented within, and consistent with, the agency’s approved indirect cost plan. • Complete, up-to-date cost data available for the most recent completed fiscal year, and accomplishment data for the set of key activities performed by state employees as well as private-sector contractors. 19