Indianapolis: Activity-Based Costing of City Services
1- Yes, government should perform a cost analysis before privatization, especially if the government will remain as a participant in the bidding process. The cost analysis will provide the government with cost information for accurately pricing the bid. In case the government is not going to be a participant in the bidding process, the cost estimate will provide the government with an estimate on how much to pay for a service. For example, if the government wants to engage in a firm fixed price contract, a cost analysis will provide an accurate estimate of the cost and government can adjust the estimate for labor contractor rates and profit to price the contract.
2- For pothole filling activity direct labor and materials are relatively easy to trace directly, but it is more difficult to allocate indirect costs to the service. In order to apply ABC in Department of Transportation, reconciling with controller’s records, the team correctly identified in phases 1 and 2 all the basic activities. There were 35 activities, one of them being "pothole patching". The labor hours and direct materials assigned for this activity were easy to be traced so the direct labor and materials were precisely determined in the "Pothole Filling Cost" table.
A few comments about the overhead costs:
The model allocated costs for fixed assets and unused equipment, which is one of the strengths. The model also adjusted the current year capital purchases and added back the depreciation (the consumed portion of the purchase price). We think that was an appropriate decision in order to have a true cost for this activity. The city already had an accounting system to trace the depreciation, and that was an advantage.
It is debatable the decision not to include the headquarters expenses. In fact those costs may vary up or down depending on who does the pothole filling - municipal workers or private contractors. Decision was that...
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