Archived - Guidelines on Costing

These guidelines are intended to inform discussions about costing and to facilitate collaboration by all parties involved throughout the costing process.

The Guidelines explain the fundamentals of costing, describe common applications of costing in government, and outline key principles and practices. They provide general guidance that includes a seven-step approach to costing that departments are encouraged to use. The Guidelines also provide links to specific guidance on costing-related matters, such as the attestation provided by chief financial officers (CFOs) for Cabinet submissions.

The following are the common applications of costing in government.

Level-of-service decisions

When deciding what level of service to provide, decision makers can use costing to help identify which costs will change if the level of service changes and which costs will not change. For example, a decision to provide a lower level of service may reduce salary and other operating costs.

Decisions about offering a new service or program

When deciding whether to offer a new service or program, decision makers can use costing to help identify new costs but also existing costs that could change. For example, offering a new service might increase costs for internal services such as communications or legal services; it might also affect the cost of services provided without charge by other government departments.

Cost-benefit decisions

When deciding between two courses of action (e.g., upgrade an existing computer or acquire a new one), costing can be used to support a cost-benefit analysis for each.

Capital investment decisions

When making decisions relating to the building, betterment or acquisition of capital assets, decision makers can use costing to help identify and estimate planning, acquisition, maintenance, operating, and disposal costs. For specific guidance on capital investment decisions, refer to the Guideline on Cost Estimation for Capital Asset Acquisitions .

Legislative or policy change

When considering a proposed change in legislation or policy, decision makers are provided with a costing analysis of the proposal to assist them in understanding the scope and financial impact of the change and to ensure adequate resources are available to implement and sustain the change.

Cost-recovery decisions

When deciding how much to charge for a product or service in order to cover all or part of the cost of delivering it, decision makers can use costing to help identify all of the relevant costs and then determine the full cost of delivery.

Decisions about reorganizations

When making decisions about interdepartmental reorganizations or about establishing a new organization, decision makers can use costing to help make sure that all parties involved understand all the cost implications and to ensure that the resulting reference levels will be appropriate.

"Make-or-buy" decisions

When a department is deciding whether to "make" a product or service or whether to "buy" it—in other words, to develop a product or deliver a service itself or to have another department or organization (e.g., a private company) do so—decision makers can use costing to determine both the one-time and the ongoing costs of each option.

Everyone who is involved in a costing exercise should have a basic understanding of the following principles.

Costing requires consultation and judgment.

Changes to a program usually affect more than one organizational unit in a department and can affect other departments, so costing cannot be done in isolation. It requires consultation–sometimes, extensive consultation.

Before starting a costing exercise, managers should consult their department's CFO organization. The CFO organization can provide advice on costing and help ensure a balance between the level of effort required to produce the cost information and the value of the information to the decision maker.

Costing must be done for a specific purpose.

Cost information must be compiled to serve a specific purpose. Before starting a costing exercise, the parties involved must agree on why the exercise is being conducted (i.e., the purpose it will serve and what decision the cost information will inform); different purposes require different information.

Costing should be done consistently for costing exercises that have the same purpose.

If the circumstances are similar and the cost information will serve the same purpose, costing should be done consistently so that the resulting information will be comparable.

Costs do not always vary in proportion to changes in the level of activity.

Costs can be affected by changes in the level of activity in three main ways:

1. Costs can change in proportion to changes in the level of activity (variable costs).
2. Costs can remain constant regardless of changes in the level of activity (fixed costs).
3. Costs can remain constant within a particular range of activity but change when the level of activity passes a specific amount (step-variable costs).

Data used in a costing exercise must be of high quality.

The quality of the data used in a costing exercise directly affects the quality of the information that decision makers receive. Data must be reasonable, consistent, defensible, reconcilable and current. The CFO organization can recommend appropriate data sources based on the purpose of the costing exercise and on the available data.

The benefits of cost information must be balanced against the cost of producing it.

When developing a costing methodology, departments must strive to balance elements such as level of detail, timeliness, accuracy and complexity with the cost of producing the cost information. Departments' costing practices must meet their needs, but the practices must also be sustainable. The investment made to produce cost information should not exceed the benefits the information provides.

This toolkit sets out a seven-step approach to costing, and provides templates and checklists to help you apply the approach.

The approach can be adapted to the diverse mandates and operating environments found in government. If you use it consistently, you will be able to provide high-quality cost information to managers.

In addition to using a consistent approach to costing, you are encouraged to use national or international standards where appropriate to improve the comparative value of cost information (e.g., standards related to work-breakdown and cost-breakdown structures).

Seven Steps to Costing

This toolkit breaks the costing process down into the following seven steps, which are explained in detail in the rest of Section 5:

1. Determine the purpose of the costing exercise. (i.e., What decision will the cost information be used to support?)
2. Define the cost objects. (e.g., Are you costing an activity, an output or a service?)
3. Determine the cost base. (e.g., Will you use historical expenditure information for an existing service as the basis for estimating the cost of a new service that is similar, assuming the same costs are relevant?)
4. Classify the costs by whether they are directly or indirectly related to the cost objects. (e.g., The salary of a service centre employee is directly related to the cost of delivering the service. The cost of heating and cooling the building in which the service centre is located is indirectly related to the cost of delivering the service.)
5. Attribute costs to the cost objects. (e.g., attributing a cost that is indirectly related to the cost object requires an understanding of how the cost will change in relation to changes in the cost object. For example, the cost of heating and cooling a service centre might change if the number of staff is doubled, but it will not change if staff increases by one or two people.)
6. Validate and confirm the results of the costing exercise.
7. Get sign-off on the results of the costing exercise from the appropriate authorities.
   

Step 1 – Determine the purpose of the costing exercise

Unless you know how the information will be used and why, you will not be able to determine the scope of the exercise and what costs are relevant. For example, are you trying to calculate the cost of procuring a particular asset; or are you trying to calculate the cost of owning the asset over its entire life-cycle?

The following are three common purposes for which cost information is produced:

1. To determine resource allocations

Decision makers will use the information to set resource levels for a new program or initiative, to fund an increase in the level of service, to estimate savings that will result from discontinuing an activity, to fund a system change, or to determine what costs should be recovered through a fee.

2. To decide on a program delivery option

Decision makers will use the information to help them decide between alternatives.

3. To measure and evaluate performance

Decision makers will use the information to assess performance.

You need to understand the purpose of the costing exercise because how the information will be used and whether it is intended to meet ad hoc or ongoing requirements influences the rest of the steps in the costing process.

Responsibilities

Managers at all levels are responsible for assisting with the development of the cost information that is used to support decisions. Managers are also responsible for understanding how their decisions affect their departments' overall costs.

During this step, the CFO organization ensures that all stakeholders have a common understanding of the purpose that the cost information is intended to serve, and that the cost information produced will meet any applicable central agency requirement. The CFO organization also assesses the feasibility of producing the required cost information. This assessment includes reviewing data sources, and if no data exist, determining how to collect the necessary data.

Purpose Statement

Once you have determined the purpose of the costing exercise, draft a purpose statement that includes the following information:

• The decision the cost information will support;
• The overarching assumptions that have been made;
• The information that is required to support the decision and the source(s) of data that will be used;
• The time period that will be covered; and
• How often the information will be produced.

Once the purpose statement has been drafted, the end-user of the information should review and approve it.

If the purpose changes later in the costing process, all steps completed up to that point must be revisited.

Common Purposes

This is a list of the common purposes that cost information serves in government and may help you draft a purpose statement. The list is not comprehensive.

Resource allocation

• New program
  • Start-up
  • Ongoing operation
• Changes to existing program
  • One-time costs
  • Demand
  • Service standards
• Capital investment
  • Life-cycle costs
  • One-time costs
• Cost reduction
  • Reduced services
  • Reduced overhead
  • Discontinuance
  • Other cost reduction
• Cost avoidance
  • Reducing future costs
• Reallocations
  • Current year
  • Future years

Performance measurement

• Cost efficiency
  
  • Cost per output
• Cost effectiveness
  • Cost per outcome
• Benchmarking
  • Cost of identical entity
  • Cost of similar entity

Program delivery options

• In-house vs. outsourced
• Collaborative and shared services
• Discontinuance
  • One-time costs
  • Costs that remain

Cost recovery

• Full cost
• Incremental cost

Purpose Checklist

1. What management decisions will the cost information support?
2. What business issues triggered the need for the cost information?
3. Did you consider any central agency, legislative or policy requirements that could affect the purpose of the costing exercise? If so, describe them. If not, why not?
4. Who are the stakeholders in the costing exercise? Did you consult them in drafting the purpose statement? If not, why not?
5. Will the initiative that is being costed affect any other departments? If so, have they been consulted?
6. What time period will the costing exercise cover?
7. What assumptions were made in defining the purpose of the costing exercise? Are they documented in the purpose statement, along with the supporting rationale?
8. What type of cost information is required (e.g., incremental costs, full costs or both)?
9. Is the cost information needed to meet a one-time or a recurring requirement? If it is needed to meet a recurring requirement, specify the frequency.
10. Have the end-users of the information confirmed their agreement with the purpose?
11. Have you documented the purpose statement?

Step 2 – Define the cost objects

A cost object is anything that needs to be costed. For example, it can be an activity, a product, a service or program outcome.

A costing exercise can have more than one cost object. For example, if the purpose of a costing exercise is to compare the cost of the internal services consumed by each of a department's six program branches, there will be six cost objects.

The cost objects for a costing exercise must align with the purpose you identified in Step 1: they must serve the purpose.

Cost objects can include the following:

• Organization (e.g., a department and its units);
• Programs (e.g., business lines);
• Processes (e.g., activities);
• Horizontal initiatives;
• Internal services (e.g., finance and human resources);
• Locations (e.g., headquarters and other offices housing departmental operations);
• Infrastructure (e.g., buildings and systems); and
• Outputs (e.g., services).

Responsibility

Program managers have the most knowledge about their programs, so they need to work with the CFO organization to make sure that cost objects are defined appropriately.

Common Cost Objects

This is a list of the common cost objects. The list is not comprehensive, and terminology varies from department to department.

• Organization
  • Department
  • Branch
  • Directorate
• Internal services
  • Management and oversight services
  • Communications services
  • Legal services
  • Human resources management services
  • Financial management services
  • Information management services
  • Information technology services
  • Real property services
  • Materiel services
  • Acquisition services
• Location
  • Region
  • Headquarters
• Program
  • Business line
  • Service
  • Client
  • Project
  • Activity
• Performance measurement unit
  
  • Output
  • Immediate outcome
  • Intermediate outcome
  • Strategic (final) outcome
• Process
  • Activity
  • Task
  • Departmental process
  • Interdepartmental process
    

Checklist for Defining Cost Objects

1. Did you consult the users of the cost information when you were defining the cost objects?
2. Did you review the documents that were used when defining the purpose (e.g., program alignment architecture, Report on Plans and Priorities, user fee information, audit reports, public accounts)?
3. Do the cost objects fully align with the defined purpose?
4. Have internal and external stakeholders confirmed the cost objects?
5. Have you documented the cost objects?
6. When the cost object is an activity or service, are the proposed start and end dates for the activity or service reflected in the purpose statement?

Step 3 – Determine the cost base

In this step, you identify all of the costs that are relevant to the purpose and the cost objects. Relevant costs could be in the program manager's budget (e.g., salaries and supplies) or in other managers' budgets (e.g., internal services such as finance, human resources and contracting).

The relevance of a cost depends on the purpose of the costing exercise. In other words, relevance depends on what the information will be used for. For example, the cost information will be used to determine how much costs will increase if the number of clients increases, but if the cost of services provided without charge by other government departments (OGDs) does not change, these costs would not be relevant. If, however, the information will be used to determine the government's annual cost of providing a program to the public, the cost of services provided without charge by OGDs could be relevant.

Consultation is essential to make sure that you have identified all the relevant costs and that you have used the most appropriate sources of data as the cost base. The types of data that could be used as a cost base include current-year expenditures, historical expenditures, budgets, multi-year average expenditures, estimates, forecasts, or standard costs. Ideally, the purpose statement will already specify the sources. Each source must be chosen objectively, and the rationale for the choice must be documented if it is not already explained in the purpose statement.

Responsibilities

CFO organization, program, and internal services staff share responsibility for determining the cost base. You may also need to consult other stakeholders, particularly in the case of joint and horizontal initiatives.

Program managers, play an important role in any costing exercise because their knowledge of the program is essential.

For any given cost purpose, you should develop supporting spreadsheets to capture and calculate the relevant cost information.

Cost Base Checklist

1. What data is being used and why?
   • Expenditure data: Does your department's existing financial coding allow you to extract the expenditure data that is relevant? If so, did you use a single field or a combination of fields in the coding block to extract the data? If not, how will you obtain the necessary information?
   • Standard costs: How were they developed and have they been updated within the last two years? If not, why not? Does management approve standard costs?
   • Estimated and forecasted costs: Have you documented the estimating or forecasting technique and your assumptions? Did senior management and other relevant stakeholders validate your assumptions?
2. Did you consult with the program managers and the internal services managers? Have you considered all departmental operating costs, including the relevant internal services costs?
3. Have you considered all costs that are charged to statutory votes or centrally managed funds such as employee benefits?
4. Have you considered amortization costs?
5. If you are costing a joint or horizontal initiative, did you consult with partner departments? Did you take their costs into consideration? If not, why not?
6. If you are costing a service that is provided under a revolving fund, did you include interest on the drawdown as a cost?
7. Did the end-user of the cost information review and endorse the cost base?
8. Have you documented all aspects of the cost base?
   

Step 4 – Classify the costs

Once you have determined the relevant costs, you have to classify them as either direct costs or indirect costs, based on how they relate to a cost object.

Costs are considered direct when they are incurred solely to support the cost object. For example, if the cost object is an activity, the salaries of employees who work full time on carrying out that activity are classified as direct costs.

Costs are considered indirect when they are incurred to support more than one cost object, not solely the object that is being costed. For example, the deputy head has a role in managing all activities of the department; the cost of the deputy head's office is therefore an indirect cost.

The figure below illustrates the concept of cost classification.

Responsibilities

The responsibility for classifying costs rests primarily with the department's CFO organization, with assistance from program and internal services managers.

Cost Classification Template

Purpose:

Object:

Assumptions:

Cost Classification Checklist

1. Have you classified all relevant costs as either direct or indirect?
2. When classifying costs, did you consult the managers who are responsible for them? If not, why not?
3. Did you use financial systems data to help you classify costs or confirm classifications? If not, why not?
4. Have stakeholders confirmed your classification of the costs? If not, why not?
5. Have you documented your cost classification process, including any assumptions you made?
   

Step 5 – Attribute costs to the cost objects

Attributing costs is the process of identifying the appropriate amount of each relevant cost to include when determining the cost of an object such as a service.

The way you attribute costs varies based on the purpose. For example, if the purpose is to calculate the full cost of a government program outcome, you need to attribute a portion of internal services program costs to the outcome, in addition to the direct costs of the program that produces the outcome.

The way you attribute costs also varies based on how you classified the costs in Step 4—as direct costs or indirect costs.

Direct costs

In the case of a direct cost, attribute the full amount of it to the cost object. For example, if the cost object is a particular service delivered to Canadians, the salaries of employees who deliver that service are a direct cost of the service, so you would attribute the full amount of those salaries to the cost object.

Indirect costs

In the case of an indirect cost, attribute a portion of it to the cost object using a general basis of attribution. For example, you could use the percentage of the total departmental budget that is allocated to a unit as a basis for attributing indirect costs to the services provided by that unit.

The costs of internal services (e.g., legal services) are normally indirect costs. However, consult with the internal service managers to determine whether any of their services are provided solely to support the cost object and could therefore be attributed directly. For example, if the cost object is a particular service delivered to Canadians and a situation arises in the delivery of the service that ultimately results in a court case, you would attribute the costs of the legal services associated with the case directly to that service. Whenever possible, identify costs that are incurred solely to support the cost object and attribute them directly because it will make the resulting information more precise.

Cost pools

When you are doing attributions, one efficient approach is to use cost pools—groupings of homogeneous or like costs. Costs are considered like each other when they vary for similar reasons and at similar rates relative to the cost object. If you determine that certain costs are homogeneous, you could group them together as a cost pool and attribute them in the same way. For example, if you determine that human resources, security, and facilities management costs are like costs, you could attribute them as a pool. Cost pools are particularly useful when attributing significant numbers of low-dollar amounts.

Result

At the end of Step 5, you will have created a document that describes the way you attributed each cost (i.e., using direct or general attributions). It also describes any cost pools you have created and the way you attributed each one.

Responsibility

The CFO organization is responsible for determining the most appropriate approach to attribute costs in consultation with program, and internal services managers.

Program and internal service managers have the most knowledge of programs and what drives costs, so they are in the best position to know whether an attribution is reasonable.

Cost Attribution Checklist

1. Have you attributed all of the direct and indirect program costs to each cost object?
2. Did you identify costs that can be attributed directly to the cost objects in consultation with the program and internal services managers? If so, did you attribute them to the cost objects and exclude them from the costs to be attributed using another basis of attribution?
3. For the remaining costs, did you consult the program and internal services managers to determine the extent to which there is a causal relationship between the costs and the cost object?
4. For indirect costs that have no causal relationship with the cost object, did you attribute them using a reasonable basis, such as the number of FTEs, salary budget, or operating budget?
5. Did you check whether some or all of the costs were homogeneous and could be pooled before you attributed them to the cost objects?
6. In deciding on an attribution methodology, did you take into account the time, resources and level of precision required against the benefits to be derived from the information to ensure that there was a balance?
7. Have you documented your cost attribution process, assumptions and data sources?

Step 6 – Validate and confirm the results

This is when you review the calculations with the appropriate managers.

Verify the calculations; make sure that the assumptions, methodologies, reconciliations and documentation are complete, accurate and reasonable; and confirm that the results meet the purpose defined in Step 1.

Once the results are deemed mathematically sound, the department should confirm with the end-user that the results meet the needs, as defined in Step 1.

Responsibilities

Responsibility for validating the data sources, assumptions, methodology and calculations rests with the CFO organization.

Responsibility for confirming that the costing information satisfies the purpose identified in Step 1 rests with both the CFO organization and program management. In the case of horizontal or joint initiatives, other stakeholders may also have some responsibility for confirming that the results meet the purpose.

In complex or highly sensitive costing exercises, the CFO organization or senior management may choose to contract a qualified, neutral third party to validate the results of the exercise.

Validation and Confirmation Checklist

1. Review the calculations.
   1. Review the customized spreadsheets and the costing software and other methods you used.
   2. Make sure that all the headings and data (cost objects, cost base, cost pools, and related volumes) were accurately entered into the spreadsheet or software program.
2. Have you included footnotes where needed?
3. Are the formulas correct?
4. Have you performed all the relevant calculations?
5. Did you review the first five steps to ensure that they were done properly?
6. Did you ensure that the results are reasonable by comparing them with the financial reports for the time period covered by the costing exercise?
7. Have you collected all the necessary financial information from the appropriate sources?
8. Have you checked the mathematical accuracy of your calculations?
9. Have you collected the appropriate non-financial information from the appropriate sources? Have you described those data and their sources?
10. Have you documented all consultations with stakeholders (internal and external) and senior management and the confirmation that the results of the costing exercise respond to the purpose statement?

Step 7– Get sign-off from the appropriate authorities

Departments are expected to have an internal sign-off process for all costing exercises to ensure adequate consultation, quality assurance, internal control, and accountability. The sign-off process should involve the CFO organization, the end-user of the cost information, and all other significant stakeholders.

When internal sign-off on a costing exercise is needed for a memorandum to Cabinet or for a Treasury Board submission, the CFO must complete the attestation letter described in the Guideline on Chief Financial Officer Attestation for Cabinet Submissions . Section 4.1 of that guideline describes the six assertions that CFOs must consider before attesting to a submission. Two of the assertions are relevant to cost estimates. For Assertion 1, the CFO must assess the reasonableness of assumptions that were used in developing the cost estimate. For Assertion 2, the CFO must ensure that risks have been assessed and that the cost estimate was adjusted appropriately. The subjects of risk, sensitivity analysis and contingency are covered in the Guideline on Cost Estimation for Capital Asset Acquisitions .

Responsibility

The CFO is responsible for confirming the quality, completeness and reasonableness of the cost information that was prepared.

CFO Sign-off Template

This template indicates the minimum requirement for an internal CFO sign-off.

Summary of the seven steps

Application of the seven steps to costing

The following is an example of how to apply the seven-step approach.

Background: A department that has service centres across the country has established that demand in a particular region is sufficient to warrant setting up a new service centre. The deputy minister (DM) has asked how much it will cost.

Step 1 – Determine the purpose of the costing exercise

• The purpose of the exercise is to determine the cost of opening a new regional service centre.

Step 2 – Define the cost objects

• The cost object is the new service centre.

Step 3 – Determine the cost base

• Financial officers from the CFO organization consult with the program manager and with managers from the internal services branch about the start-up and ongoing needs of the new service centre.
• They determine that the following costs are relevant to the cost object:
  • Salaries and salary-related costs, including annual training for on-site staff;
  • Equipment and supplies used by on-site staff (e.g., computers and office supplies);
  • Accommodation costs (e.g., rental fees for space);
  • The incremental costs to headquarters and to regional program management of providing direction and guidance to staff at the new centre and of monitoring their performance; and
  • The incremental internal services costs of supporting the new service centre.

Step 4 – Classify the costs

• Direct costs: The costs directly related to setting up the new service centre (e.g., the salaries of the people that will staff the centre)
• Indirect costs: All costs not directly related to setting up the service centre (e.g., relevant program management and internal service costs that will be incurred at headquarters)

Step 5 – Attribute the costs to the cost objects

• The department already has a number of service centres, and they already have a methodology for attributing costs to a service centre. In order to be consistent and to have comparable information, the program manager and the CFO organization agreed to use the same attribution methodology for the new service centre.

Step 6 – Validate and confirm the results

The CFO organization, in consultation with internal services, program management and other stakeholders, does the following:

• Summarizes all information at the level of detail required and performs reconciliations with source data;
• Completes the necessary calculations and reviews them for accuracy;
• Reviews the results, assumptions, and methodologies to ensure they are reasonable; and
• Confirms with the DM's office that the cost information meets the DM's needs.

Step 7 – Get sign-off from the appropriate authorities

Get sign-off at the appropriate levels to indicate that the department's internal procedures, checklists and templates were used.