Output Budgeting Software– Tarun Das and E.

Sandagdorj
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Output Costing Methodology for Software Selection-

Basic Concepts and Some Advices for Selection

Prof. Tarun Das1 and Mr. E. Sandagdorj2

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1. Output Costing Methodology

Major steps involved in the output costing and output budgeting include the
following:

Step-1: Specification of outputs

Step-2: Identification of costs
Step-3: Define appropriate costing structure
Step 4: Collection of cost data on General Ledger
Step 5: Methodology for assignment of costs to output
Step 6: Classification of costs
Step 7: Assignment of direct costs
Step-8: Allocation of indirect costs
Step-9: Determination of total cost
Step-10: Output budgeting
Step-11: Important considerations and conclusions

Step 1 – Specification of outputs

The first step in any costing exercise is to identify the relevant Cost Objects. A
Cost Object is anything for which a separate measurement of cost is required.
Under output budgeting, the Cost Objects can be a cost centre, an output class,
an output, a sub-output or an activity that an agency is expected to deliver under
the Strategic Business Plan endorsed by the government. These outputs will be
funded by the Government and the Agencies are required to cost these outputs
as a basis for their budget allocation.

Step 2 – Identification of costs

A key step in costing outputs is the identification of the relevant costs incurred;
i.e. the cost of the resources consumed in producing the outputs. The total cost
includes all direct and overhead cash costs and accrued costs for the
period. Direct costs are the cost of resources consumed that can be traced
directly to the Cost Object. Direct costs are generally made up of direct materials
and direct labour. All costs that are not direct costs are overhead/indirect costs.

1
International Strategic Planning Expert.
2
National Strategic Planning Expert.

MOF, Govt. of Mongolia 1 Glocoms Inc. (USA)

 Output Budgeting Software– Tarun Das and E. Sandagdorj
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Initially, an output costing system may be focused only at an output level, which
requires only broad cost assignment and therefore minimizes the complexity of
the costing system. It is likely that at an initial stage, due to lack of adequate
information, none of the activities carried out to produce the outputs is costed.
This may not be very beneficial for internal budgeting and management control.
So, when the system of output costing develops over a few years, a more
detailed costing system on the basis of Activity Based Costing (ABS) may
be developed. Finally, an agency’s costing system must be well documented to
ensure that it can be audited and is robust enough to generate public debate.

Step-3: Define the Required Costing Structure

Whilst there are many different costing methods, all are designed to describe the
two primary functions of cost collection and cost assignment. At the initial stage,
it is better to use a simple model as described below. Over time, the
methodology can be improved and an agency may adopt ABC (Activity Based
Costing) system when required data are available.

Step-4 Cost
accumulation and
General Ledger (GL)
Costing

Prior to the output costing,

agencies collect their
costs under cost centre
codes within the general
ledger. In the Government
sector, this is commonly termed as ‘general ledger costing’. This technique
requires cost data to be collected from source documents and processed through
the accounting system into the general ledger. All costs incurred during a period
are recoded and accumulated against relevant general ledger accounts
according to a cost centre structure defined by the chart of accounts. Depending
on the nature of the item, certain costs may not be able to be posted to a single
account. Accordingly, the cost may be distributed across a number of general
ledger accounts.

MOF, Govt. of Mongolia 2 Glocoms Inc. (USA)

 Output Budgeting Software– Tarun Das and E. Sandagdorj
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Table-1: Allocation of G/L Cost Items to Outputs

G/L Items Cost centers in MOF/ Outputs in MOF

Departments and
Divisions
• Salaries & wages • Economic Policy • Policy advice
• Insurance and • Fiscal Policy • Budget preparation
pension benefits • Treasury • Revenue collection
• Travel and tours • Loan and Aid • Expenditure
• Purchase of Goods • Procurement management
• Transport • Financial sector • Investment planning
• Telecom • Administration • Treasury functions
• Fuel • Accounting • Public debt
• Power • State Secretary management
• Water • Finance Minister • Banking settlement
• Stationary • Government sale
• Software and procurement
• Rental • External assistance
• Maintenance management
• Depreciation • Advice on audit and
• Equipment accounting
• Others • Financial sector
policy & regulation

This is the simplest model where Departments and Divisions are taken as Output
Centres or Cost Centres or Budget Centres or Activity Centres.

Step-5 Methodology for assignment of costs to output

1. First Level Allocation, find appropriate cost drivers to allocate G/L items
to cost centres (which can be output centres or departments or divisions)

2. Second Level Allocation, find appropriate cost drivers to allocate cost

centre items to outputs (which can be broad output groups, sub-outputs or
programs). In this case, for simplicity, cost/output centres are treated as
activity centres.

3. Third Level Allocation, only when the data base is established and the
system develops over the years, have third level allocation i.e. allocate
cost centre items to activities, and then activities to outputs. This is the
final stage of ABC for output budgeting.

MOF, Govt. of Mongolia 3 Glocoms Inc. (USA)

 Output Budgeting Software– Tarun Das and E. Sandagdorj
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Output-1
Cost
Drivers

Output-2

Cost
Centre- Output-3
1

Cost
Drivers

Output-4

Cost
Centre- Output-5
G/L 2
Item
s
Output-6

Cost
Centre-3
Output-7

MOF, Govt. of Mongolia 4 Glocoms Inc. (USA)

 Output Budgeting Software– Tarun Das and E. Sandagdorj
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Step-6 Cost classification

Table-2 Summary of Types of Costs

DIRECT COSTS
Staffing Costs
Base wage or salary Overtime
Allowances Shift loading
Housing Uniforms
Superannuation Travel expenses
Training Protective clothing
Subsidies Air conditioning/water
Workers’ compensation insurance premiums

Other Direct Costs

Consumable supplies
Contractors/consultants
Office equipment expensed on purchase
Purchase of services such as maintenance
The cost of inventory consumed in the course of producing a service

INDIRECT COSTS
Includes corporate services costs

CAPITAL RELATED COSTS

Depreciation
Capital charge (i.e. Opportunity cost of capital)

Taxes, Duties and Fees (Only if Actually Paid)

Local government taxes, duties, fees, royalties etc.

Total Cost

Step 7: Assignment of direct costs

MOF, Govt. of Mongolia 5 Glocoms Inc. (USA)

 Output Budgeting Software– Tarun Das and E. Sandagdorj
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Method (When used) Description Cost Drivers

1. Cost centre attribution Direct costs are allocated Staff working in the cost
(When business units are to the cost centres as they centre
responsible for delivery of are incurred. Example:
one output only) Direct staff cost.
2. Time recording systems Employees record the time Full time equivalent (FTE)
(Useful for assigning direct they spend for the delivery staff
labor and staff cost). of output. Time may be
recorded on hourly, daily,
weekly, monthly or annual
basis.
3.Resource consumption Measure each output’s use Full time equivalent (FTE)
accounting of resources such as staff
(when use of resources is photocopies, computers,
significant) telephones and printers,
goods and other services.
4. Output Accounting Direct costs are allocated Contract Labor engaged in
(Suitable only when there to specific output codes in production of particular
is a relationship between the budgeting body’s goods or services or
outputs and cost centres). General Ledger as they programs.
are incurred.

Step-8: Allocation of indirect costs

• In many cases, resources are consumed by support activities which

cannot be traced directly to outputs.
• These overhead costs must be attributed to the outputs using an
allocation method.
• For example, salaries of DG of a department, salary of state secretary,
salary and other expenses of the Minster’s office, overheads and
maintenance expenditure of the ministry such as cleaning, security, fuel,
energy, water, electricity, sanitation, library, administration and personnel
costs, audit and accounting etc. These costs are allocated across all
departmental outputs according to appropriate cost drivers such as FTE
labor or floor space used.
• When apportioning overhead costs between outputs, an agency may
choose alternative techniques depending on availability of data.

MOF, Govt. of Mongolia 6 Glocoms Inc. (USA)

 Output Budgeting Software– Tarun Das and E. Sandagdorj
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• There are two basic methods:

A. Logical cause-and-effect or cost-driver

• Costs that cannot be traced directly to specific outputs are attributed to
cost pools/centres.
• The total cost in a cost pool/centre is then attributed to outputs based on
the cost-driver that causes the activity to be undertaken.
• Some commonly used cost-drivers are:
1. Floor space
2. Number of staff
3. Number of hours worked
4. Number of transactions processed
5. Number of documents received & dispatched

B. Arbitrary pro-rata.
• This technique attributes costs without determining a clear cause-and-effect
relationship.
• For example, administrative overheads are attributed using the number of
direct labour hours consumed in producing the output.
• Another example, the total cost of computer maintenance can be attributed
equally to all output/ cost centres.

Step-9: Determination of total cost (Fully Distributed Cost)

• Fully Distributed Cost (FDC) takes account of:

1. All direct costs such as labour, materials and premises;
2. Indirect costs (overheads) such as personnel services, IT support,
administration; and
3. Depreciation and capital charge of physical assets utilised.
• The following financial management systems are developed and used to
calculate FDC:
1. Accrual accounting;
2. Output costing; and
3. Asset valuation.

Step-10: Output budgeting = Fully Distributed Cost (FDC)

MOF, Govt. of Mongolia 7 Glocoms Inc. (USA)

 Output Budgeting Software– Tarun Das and E. Sandagdorj
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Direct Costs
Labour
Materials
Services

PLUS
Allocated indirect costs
HR and IT
Administration
Finance

PLUS
Capital Costs
Depreciation
Capital Charge

Step-11: Important considerations for Choice of Output costing Software

1. Present data base for costing, accounting and auditing

2. Present output specifications
3. Present cost specifications
4. Current general capacity and skill in costing, accounting and
auditing with feasible training
5. Existing and future resources in next three years in terms of
technical manpower, financial resources and information
technology
6. Customization and localization of software
7. Cost for well developed software(including costs for customization
and localization) versus cost of software development in the next
three years

MOF, Govt. of Mongolia 8 Glocoms Inc. (USA)

 Output Budgeting Software– Tarun Das and E. Sandagdorj
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Conclusions

Please remember the following advice by ABC Software expert Jim Gurowka3

(a) Avoid purchasing ABC software which is tied exclusively to a specific

consulting firm. It is better to have separate consulting companies and
software companies for advice. Consulting companies should be experts
at consulting, and software firms should be experts at software
development.

(b) Alternatively, there are small software companies, whose products are
relatively specialized or immature, who only sell you their product if you
buy their customization and implementation work. This is a good way for
them to generate large consulting fees, but you have to be concerned
whether you are getting the most cost-effective, or even the best,
solution.

(c) There are integrated software venders who claim to have ABC modules
which will link into other parts of their system and make ABC updates and
reports a simple procedure. The fact of the matter is that ABC data
typically is 15 per cent financial and 85 per cent operational data. Much of
this operational data is traditionally not kept in formal general ledger. ABC
systems are operational modeling tools, not financial analysis tools. Being
linked to the G/L is not a major issue, since financial data is the easiest
data to import into your ABC software.

(d) In order for an integrated system to be effective, all parts of the integrated
system need to be implemented before you can receive the true benefits
of the integration. To get a system completely up and running to its fullest
capacity will normally take a minimum of two to three years.

(e) In summary, the world of ABC software is continually changing and

evolving. Set out your goals and needs early and do your research into all
the different options available. Find the software which supports your
unique requirements. In the end, the software is not the most important
part of your output costing and output budgeting. It is a necessary
requirement but should not overshadow the importance of developing the

3
Jim Gurowka, a former senior financial analyst at Volkswagen Canada, is an
associate of Focused Management Information Inc., of Oakville, Ontario. He specializes
in profit and performance improvement, and the integration of human performance
systems with workplace change projects. These comments are extracts from his paper
on “Activity-based costing software- The market explodes- Here are some of the
features to look for, and some tools to help you evaluate today's ABC software
choices”.

MOF, Govt. of Mongolia 9 Glocoms Inc. (USA)

 Output Budgeting Software– Tarun Das and E. Sandagdorj
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right methodology for output costing and output budgeting and designing
an appropriate costing architecture that meets your goals and needs.

MOF, Govt. of Mongolia 10 Glocoms Inc. (USA)