5 Operating instructions: Cost accounting policy parameters

5.1  Disclosing cost accounting policies

The Act requires departments to:

• identify in the Estimates and other supporting documents the expenses (or forecast expenses) to be incurred for each class of outputs to be supplied by the department (sections 14(1)(a) and 15(1)(c));
• identify in the Statement of Forecast Service Performance the proposed output expenses to be incurred for each class of outputs (section 41(1)(e)(iii)) prepared as part of information on the future operating intentions of the department; and
• compare in the Statement of Service Performance actual output expenses incurred with the output expenses that were forecast in the Statement of Forecast Service Performance (section 45A(c)(ii)) prepared as part of the annual report of the department.

The accuracy and reliability of output expenses are determined by the cost accounting policies that each department has followed. If users of financial reports are to understand output expenses fully, financial reports must inform users of those policies, any changes to them, and what effects those changes of policy have had.

Departments must include a clear and concise statement of cost accounting policies in external financial reports.

The objective of disclosing cost accounting policies is to provide users of financial reports with sufficient information to:

• understand the significance of the output cost information;
• be confident that the information is reliable, relevant and not misleading; and
• determine whether the report is comparable with those of other periods and other departments.

The statement of cost accounting policies in external financial reports must disclose:

• all the significant cost accounting policies used in estimating, accumulating and reporting output costs; and
• any material changes to those policies.

The disclosure must comprise:

• a statement specifying the criteria for distinguishing between direct and indirect costs;
• a statement about the methods of attributing direct costs;
• a statement about the bases for allocating indirect costs; and
• a statement of any changes in cost accounting policies since the date of the last external financial report or, if there have been no changes, a statement to that effect. If the changes made materially affect the cost of individual outputs, there must be full disclosure of:
  • the nature of the changes;
  • the reasons for the changes; and
  • the effect of the changes on individual outputs.

Departments supplying contestable outputs may apply to the Treasury for a modified disclosure.

5.2   Documenting cost accounting policies

Chief Executives must ensure that cost accounting practices are formalised and properly documented, and sufficiently detailed to enable him or her to:

• satisfy his or her obligations under the State Sector Act 1988 and the Public Finance Act 1989;
• satisfy the management information requirements of Chief Executives and departmental managers; and
• achieve the standard required to:
  • satisfy the scrutiny of the Audit Office; and
  • enable the Treasury to assure the Minister of Finance that the output cost information is reliable.

To satisfy these requirements, it would generally be expected that the cost accounting system should be able to produce a reliable average and marginal cost-per-unit of standardised goods and services that are regularly delivered by the department.

When documenting departmental cost accounting policies, the format and level of detail are left to the discretion of each Chief Executive, but the documented cost accounting policies must cover the:

• methods of classifying direct and indirect costs;
• methods of attributing direct costs;
• bases for allocating indirect costs;
• procedures for updating cost accounting policies; and
• procedures for self-reviewing cost accounting systems.

Cost accounting is a formal discipline. Structures and procedures must be followed if information is to be credible and transparent. A proper documentation of this process will include definitions, rules and procedures, and ensure that:

• agreement on major definitions is formalised;
• practices are applied correctly and consistently;
• knowledge can be reliably transferred; and
• audit trails are provided.

5.3  Classifying direct and indirect costs

There are many ways of classifying costs that have proven useful for various purposes. For the purposes of output costing, output purchase contracting and output reporting, cost classification must focus on assigning costs to outputs. This involves the cost accounting policy of distinguishing between direct and indirect costs.

Where costs are treated sometimes as direct, and sometimes as indirect, departments must set out the criteria and circumstances that govern the distinction.

Departments must establish a written policy about how direct and indirect costs are to be distinguished for the purpose of assigning costs to outputs. The criteria used to classify costs as direct or indirect must be based on whether the cost can be causally linked and assigned to an output in an economically feasible manner.

To increase the accuracy and reliability of output costing, departments must review and formalise their definition of direct costs. They must not adopt the convenient approach of grouping direct costs into an indirect cost pool, and then allocating the whole by calling it overheads.

Departments may decide how detailed the classification of costs ought to be, but must disclose separately how each major cost grouping was classified.