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7 CHAPTER 2 Full Cost Determination Framework 2.1 Introduction ities that relate to maintenance, regardless of number or detail. Cost data are required and accomplishment units The literature review and the discussions with 10 state are preferred for each activity to be considered. DOTs conducted in this study provided ideas for a general Maintenance job: The performance of a maintenance activ- approach to maintenance full cost determination. Ideas ity at a particular highway location (or length) on a particu- and practices of agencies that had advanced the farthest in lar day and time. implementing comprehensive, integrated cost accounting Cost objective: A financial accounting term defined as "a processes that could support full cost determination were function, organizational subdivision, contract, grant, or considered. However, also considered were the range of prac- other activity for which cost data are needed and for which tices in other DOTs and the fact that cost determination costs are incurred" (OMB, 2004). Unless otherwise indi- processes could be supported with simpler analytic procedures. cated, a "cost objective" will refer in this report primarily This chapter outlines a conceptual framework for cost deter- to a maintenance job. mination to meet these diverse needs and lays the foundation Direct costs: Costs "that can be identified specifically with for more-detailed explanations and examples in subsequent a particular final cost objective" (OMB, 2004). In a road chapters of the report. maintenance context, typical direct costs include wages or For simplicity throughout this report, references to a salaries paid to employees for work performed on a main- maintenance organization, function, program, or activity tenance job, costs of materials acquired for or consumed are intended to refer also to entities that may go by somewhat on a maintenance job, costs of equipment use on a main- different names [e.g., (highway) maintenance and opera- tenance job, and costs of travel to and from a maintenance tions, (highway) asset maintenance, or (highway) infrastruc- job. Where maintenance is performed by contract, direct ture maintenance]. costs refer to contractor payments. Indirect cost: Costs that are: "a) incurred for a common or 2.2 Definitions joint purpose benefiting more than one cost objective, and b) not readily assignable to the cost objectives specifi- General Terms cally benefitted, without effort disproportionate to the The following definitions will clarify the terms used in results achieved" (OMB, 2004). For example, the guidance, developing, explaining, and applying the full cost determina- oversight, supervision, and assistance of a district main- tion process. While many of these terms have a general manage- tenance office may be said to benefit all maintenance crews ment or financial meaning, definitions will often be narrowed and jobs within its jurisdiction, but there is no direct for purposes of this report to address highway maintenance connection or nexus between the district office personnel specifically. and each individual maintenance job. A reasonable but efficient method must be found, often informed by judg- Maintenance activity: A specific classification of mainte- ment, to relate district office costs to all the maintenance nance work or service that is defined in the agency's main- jobs under its responsibility. tenance program and maintenance management system Allocation (also attribution or distribution or assignment): (MMS) and/or financial management system (FMS). The For the purposes of this report, the process of relating indi- full cost determination process deals with all defined activ- rect costs to the maintenance jobs or organizational units

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

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