Cost accounting and analysis are important for improving budgeting, performance evaluation, and resource allocation decisions. Spending budgets are basically the aggregation of the allowed costs of producing goods and services in certain quantities. Government officials are urged to make resource allocations on a rational basis; that is, by comparing the costs and benefits of alternatives. This calls for the identification and projection of those alternatives. These and other examples point to the general need for cost information in government. More specifically, since government is supposed to operate on a not-for-profit basis, cost is—or should be—used as a basis to set user fees—and perhaps taxes as well, if possible. Furthermore, government operations should be economical and efficient in order to keep taxes and fees as low as possible.


Cost accounting and analysis are important for improving budgeting, performance evaluation, and resource allocation decisions. Spending budgets are basically the aggregation of the allowed costs of producing goods and services in certain quantities. Government officials are urged to make resource allocations on a rational basis; that is, by comparing the costs and benefits of alternatives. This calls for the identification and projection of those alternatives. These and other examples point to the general need for cost information in government. More specifically, since government is supposed to operate on a not-for-profit basis, cost is—or should be—used as a basis to set user fees—and perhaps taxes as well, if possible. Furthermore, government operations should be economical and efficient in order to keep taxes and fees as low as possible.

The government of the State of São Paulo is implementing a public service cost system (PSCS) to better inform the public about the cost of public services.1 The primary objectives are to generate savings, improve public service efficiency, strengthen budget realism, and increase transparency. It goes beyond the cost system that was implemented at the federal level to calculate cost at the level of programs and budgetary entities. The reason for this is because the State of São Paulo prefers to influence decisions also at the micro level; that is, at the level of activities provided by the cost centers. First, regarding the cost centers, the cost project calculates cost at the level of the direct service provider (e.g., schools, hospitals, and prisons) that is one tier below current budgetary entities. Second, in terms of programs, it calculates cost at the level of service or activity, one level below the program. The rationale is to influence performance at the operational level. The system, therefore, has to provide cost information to the cost center managers, where the services are provided.

International experience has shown that it is very complex to implement cost systems in the public sector. This is because of the complexity of public administration, nonexistence of a standardized and well-tested cost methodology in the public sector, difficulties in motivating policymakers to use cost information in making budget decisions, and the large volume of financial information to be processed. In addition, most public sector information systems are not easily adapted for generating cost information.

To overcome these difficulties, in 2011 the Department of Finance (Secretaria da Fazenda (SEFAZ)) of the State of São Paulo requested the International Monetary Fund (IMF) and the Institute of Economic Research Foundation (Fundação Instituto de Pesquisas Economicas (FIPE)) to provide technical assistance (TA) in cost accounting. The four-year technical assistance project was intended to draw from international experience in cost systems, define cost methodologies and reports, identify financial and nonfinancial information used to calculate cost, provide capacity and training, define a project management framework, and propose an implementation strategy.

During its first stage, the PSCS aimed to calculate costs of public services provided by selected cost centers (e.g., hospitals, schools, and prisons), applying standardized methodology and using existing financial and nonfinancial data and systems. The services initially identified were to be aligned with the activities of the multiyear plan (Plano Plurianual (PPA)). Four entities were selected as pilots: Department of Education (Secretaria de Educação (SEE)), Department of Health (Secretaria da Saúde (SS)), Department of Penitentiary Administration (Secretaría de Administração Penitenciária (SAP)), and the entity responsible for assisting youth in legal custody (Casa Foundation (Fundação Casa)).

The main outcomes of the project would be a conceptual model of the cost system (cost manual, definition of policies and procedures used to calculate costs); design of reports; adjustments of the government financial management information system (Sistema Integrado de Administração Financeira dos Estados e Municípios (SIAFEM)) to generate cost information; alignment of cost services with PPA activities; and capacity building of staff in charge of the PSCS. The first phase of the project was anticipated to be completed in 2015, at which time cost information was expected to be produced automatically by the SIAFEM.

Despite the substantive results having been achieved to date, implementation has not yet been completed. The project has turned out to be more difficult to implement than was initially envisaged. The contributing factors were the complexity of defining the public services to be cost; lack of country experience on which to base the design of the system; initial reluctance to invest the necessary time to prepare field studies and analytical work; significant volume of financial and nonfinancial information to process; coordination of multiple layers of stakeholders; and amount of time required for a consensual methodology and strategy. Future steps include expanding the project to other services, further aligning services and PPA activities; and using cost information to improve budget allocation decisions, performance evaluation, and cost control.

This chapter consists of four major sections. The first section on cost accounting and analysis will explain fundamental cost concepts and will briefly describe some international experiences in applying those concepts. The following two sections will describe the experience of the State of São Paulo in creating a costing system for its public services. The proposed approach will be compared to how it was actually implemented. Finally, an evaluation that was carried out has produced some conclusions and drawn some lessons to improve the practice of cost accounting and analysis in government. As a project that is not yet fully implemented, it is too soon to assess the results achieved in terms of the impact on budgetary and financial systems.

Cost Accounting and Analysis

Fundamental Cost Concepts2

Despite the fact that “a revolution in the practice of cost management” (Cooper and Kaplan, 1999) has taken place, some cost concepts are so fundamental that they have remained in mode. This section introduces some of them, which can be used for costing goods and services produced by government, as well as for planning and control. Since concepts are abstract, numerous examples have been provided to illustrate them. Essentially, since they are derived from the application of economics to real-world situations, there are various cost concepts for different purposes.

Concepts for Costing Goods and Services

Direct costing and full costing are the two basic methods used to calculate the cost of goods and services (cost objects). Direct costing includes only the cost of resources that are easily traceable (attributable) to the outputs, such as raw materials and production workers. Since direct costs are likely to change in response to the volume of output produced, direct costing is also known as variable costing. Efficient production requires support services (overhead), such as maintenance and managerial supervision. These overhead costs are also referred to as indirect cost because they are not easily traceable to individual units of an output. This is why full costing is also known as absorption costing, in which total cost = direct costs + indirect costs.

It is easier to calculate the cost of producing goods than it is the cost of rendering services. Given the tangible nature of goods (e.g., a mobile phone), it is relatively easy to identify and quantify the material inputs used and the labor hours required. The production process tends to be structured, and one is able to visualize the work in progress and, ultimately, the finished goods. Furthermore, what is not sold remains in the finished goods inventory. In contrast, services, such as education and health care, are intangible and cannot be stored in inventories. The service process tends to be less understood and engineered; indeed, to be effective, service has to be flexible and adapted to the needs of the recipient. The server often requires the cooperation (coproduction) of the recipient. Furthermore, in the case of public goods consumed collectively by a community, it is difficult—or not sensible—to divide them in order to set individual fees or taxes that reflect their costs. These complicating factors have to be taken into account when designing cost systems in government.

Unless otherwise specified, the costs discussed in this chapter refer to actual costs—the financial sacrifices made in achieving an objective, such as producing government services. Information on actual costs is sought after because it is considered objective or even true. Actual costs are, however, only as true—or valid—as the cost accounting concepts and procedures that are used. Nevertheless, actual cost information is essential, since it responds to the question of how much it cost. Knowing the actual cost produced by a cost accounting system, however, is only the start. Cost analysis based on the data is required to establish the hidden properties and relationships. For example, an average cost number on its own does not disclose the range or distribution of the underlying cost figures. Furthermore, analysis is often necessary to make raw cost data useful for planning, budgeting, and performance evaluation purposes.

Cost Concepts for Planning and Budgeting

Since planning and budgeting relate to the future, future cost is more relevant than the historical cost that is reported in the financial statements produced by financial accounting systems from past transactions and activities. For example, in the accounts, a piece of equipment may be reported at historical cost, adjusted for depreciation. Its current replacement cost, however—or even better, future replacement cost—is significantly more useful in capital budgeting. A future cost is an estimate, even if the estimate is made by projecting from the current cost or the past cost. For example, the estimation of future labor costs has to take into account such factors as productivity gains or the cost of living adjustments promised in contracts.

One way of estimating future cost is to relate cost to the future level of the activity (cost driver) that will cause cost to rise or fall. In this regard, costs that change in response to the activity level are called variable costs; and those that do not change within a certain range of activity levels are fixed costs. For example, with the number of prisoners considered to be the cost driver of prison costs, food consumption is a variable cost, while utilities (e.g., electricity) represent a fixed cost. Total cost can be estimated by using the following formula: fixed cost + (unit variable cost) x (number of units), or (utilities and other fixed costs) + (food cost/prisoner) x (number of prisoners).

The concept of opportunity cost is applied in decision making. Establishing an opportunity cost entails the selection of an alternative from various available options (e.g., spending more on public safety instead of public education). In that case, the opportunity cost of more public safety is the foregone gain in learning. This simple example shows that while opportunity cost is theoretically sound, it requires imagining the alternative use of resources and speculating the benefits that might be produced. This is difficult to implement in reality. In deference to greater feasibility and objectivity (if not due to lack of imagination), financial accounting remains with actual or historical cost, which economists dismissively refer to as sunk cost.

Good managers are often tempted to make changes in the way services are provided to achieve greater economy or efficiency. For example, in the face of rising labor costs, a municipal government may consider replacing existing garbage trucks with more sophisticated ones, thereby reducing the crew from two persons to one. The more capital-intensive approach would reduce the labor costs associated with the garbage collectors in the sanitation departments. The latter are common costs (i.e., the same regardless of the alternatives) in contrast to the differential costs for equipment and garbage collectors. Only the differential costs and differential benefits—not common costs—should affect the decision outcome. Differential costs, therefore, are sometimes referred to as a relevant cost for decision making.

Barring exceptional circumstances, when changes do take place in government, they are of an incremental nature. Zero-base budgeting that leaves no government activities unexamined is rare; instead, incremental budgeting is practiced far more often. Whereas zero-base budgeting would examine total cost, incremental budgeting focuses on marginal costs; for instance, the cost of adding or dropping a program, or the cost of adding or reducing a certain number of employees. While decision making at the margin is a conservative approach that favors the status quo, it is more efficient and requires less information.

In budgeting—as in performance evaluation (see below)—a very useful concept is standard cost or allowable cost. Budgeting is, in essence, a series of standard cost calculations. Continuing with the earlier example regarding garbage collection, the cost includes labor cost and capital cost. Whereas financial accounting keeps track of actual cost in terms of the amount paid to employees, the determination of standard labor cost necessitates judgments about the desired levels of labor productivity and compensation. In this way, when budgeting is based on standard costs, benchmarks are available for subsequent performance evaluation.

Cost Concepts for Performance Evaluation and Control

When resources are scarce or budgets are tight, managers—on their own initiative or requested by the management—tend to contain cost or even reduce cost. As mentioned by Robinson (2007), using cost information to link funding to results is an essential issue that relates to performance budgeting theory and practice. Robinson continues, “Expenditure prioritization decisions are viewed as a matter of deciding how to allocate money between programs, the starting point is to measure program costs so as to permit a comparison between program costs and benefits.” The issue, however, is which method should be applied to measure program costs to allow a reasonable and expedited comparison.

Cost for performance evaluation can be conducted in three ways. The first method recognizes the tradeoffs between service (in terms of quantity and quality) and costs. The second method of evaluation takes the perspective that lower cost is more favorable than higher cost, recommending cost cutting with little attention to the consequences. The third and more rational approach compares actual costs with standard costs so that significant cost variances are investigated for potential corrective action. The first method makes use of cost analysis; its success, however, relies on operational and financial staff, since the information on quality and quantity is at the operational level. This approach requires in-depth knowledge of the cost composition relating to a particular service, according to a specific quality and quantity. Only the specialists at the operational level would know what impact on the provision of service in terms of quality and quantity would be acceptable. While this approach is recommended, it is difficult to implement in large scale. The second method is rather simplistic and should be avoided, as it tends to sacrifice quality across the board. The third method, within the competency of the finance department, is recommended and is described next.

Total costs are broken down to direct material, direct labor, and overhead costs. Labor cost is simply added for illustration. Total actual labor cost = actual hourly rate x actual number of hours worked; total standard labor costs = standard hourly rate x standard number of hours allowed. The hourly rate standards are usually set by the human resource department for different categories of employees, based on required skills and prevailing market rates, among other factors. Amount of time is allowed on the basis of a combination of objective factors (e.g., work load) and subjective actors (e.g., management expectation of productivity improvement). Therefore, total cost variance = (total actual labor cost) – (standard labor cost). While the total cost variance may be used to evaluate the general manager, it is not appropriate to evaluate the production manager, since he/she could only influence the efficiency of operations. A labor efficiency variance is found, therefore, equal to [(actual hours worked – standard hours allowed) x standard hourly rate]. Applying the same principle of holding managers responsible for their controllable cost, the human resource department is informed of the labor rate variance, which is equal to [(actual rate – standard rate) x actual hours worked].

In addition to responsibility accounting—holding managers accountable—another advantage of this approach is efficiency. That is, a manager’s attention is immediately directed to the discrepancy between what happened and what should have happened. If the variance is significant (i.e., excessively large), the manager is prompted to take remedial action. Obviously, too high an actual cost relative to the allowable amount (unfavorable variance) is undesirable from a financial standpoint, and it should be investigated and corrected; neither is too high a favorable variance—actual cost being low compared to the standard. The manager should examine whether quality is being compromised due to, for example, using less-skilled workers on a lower pay scale and cheaper materials at lower prices. In other words, an effective cost performance evaluation system will allow, or require, managers to use their qualitative judgment to interpret cost data.


In essence, the word “cost,” excluding the adjectives to describe it further, is not useful in practice. Doing so has resulted in a confounding variety of cost concepts. In actual fact, true cost only exists to the extent that (1) a valid cost concept is used and (2) reliable numbers are collected to measure that concept. In theory, the above analysis and examples have shown a variety of cost concepts to enable cost accounting and analysis to meet several purposes. These purposes include scorekeeping, directing management attention to problem areas, and decision making, particularly resource allocation in planning and budgeting.

For basic scorekeeping, the applicable cost concepts are actual costs which are calculated by using financial accounting principles. While generally accepted accounting principles on the accrual basis require full or absorption costing, direct costing is regarded as appropriate for planning and control. In planning and budgeting, the concepts that are useful are future cost, differential cost, marginal cost, and allowable or standard cost. For attention-directing purposes and performance evaluation, standard costs provide the benchmarks for evaluating actual costs, so that significant cost variances are investigated and reduced as appropriate.

International Experiences

Despite claims by politicians and complaints by the public regarding the rising costs of government, there have been relatively few serious and sustained efforts to measure and control government costs. This section reviews some of these efforts.3

Developing Countries

Cost Information System: The Case of Brazil4

In 2010, Brazil implemented cost information to improve budget allocation decisions. Designed and operated by the National Treasury (Secretaria do Tesouro Nacional) in the Ministry of Finance, the system has the capacity to integrate data from several systems (e.g., budgeting, accounting, asset management, purchasing, and payroll) into a single data-base by means of a powerful data warehouse. The central finance agency supplies the data to the operating departments for their own analysis. The system allows managers to produce cost information in terms of budget entities and administrative units and government programs.5 It has the capability to define cost centers and activities at a more detailed level in response to an entity’s unique characteristics and needs. The system can generate cost using the top-down and bottom-up approaches. The latter is used by budget execution units and can incorporate quantitative information about goods and services.

The federal government has developed the Cost Information System that is currently available to all entities at the federal level (Brazil, 2015). The system is based on a business intelligence solution (Data Warehouse) that uses available information from the integrated financial management information system after some adjustments, such as expenditure paid in this year but related to previous years to bring more adequacy to the accruals concept for cost accounting.6 The adjustment methodology used by the federal government also has been adopted in the State of São Paulo. The user of the system can select preformatted reports or construct its own reports. The system is publicly available on the website of the Ministry of Finance, http://www.tesouro.fazenda.gov.br/custos. The system allows the generation of cost reports by budgetary entity, program, economic classification, and activity. The purpose is to improve budget preparation and to control costs. An assessment of the use of the system to improve resource allocation, however, has so far not been done.

Some Brazilian states, such as São Paulo and Rio Grande do Sul, are implementing their own cost systems. The experience in the State of São Paulo is further discussed in detail later in this chapter. The State of Rio Grande do Sul has adopted a similar approach to the federal government: calculating costs at the administrative and programmatic levels (Di Francesco and Barroso, 2014). The system has been implemented in 14 agencies to date, although it is at a very initial stage. The purpose is to influence the budget preparation by making the projections more realistic.

Concern and Theory of Cost: The Case of China

In 2014, the Ministry of Finance of China launched a major initiative to improve the quality of financial management in the public sector. Since this effort is relatively recent, there is no written literature. This initiative reflects the concerns about the inability to accurately account for costs and to effectively control them,7 reflected in a number of publications. Zhou and He (2001) use economic theory to analyze the costs of government without attempting to define or measure such costs. Xu and Zhang (2008) discuss the costs of government operations in the context of improving public management and budgeting, again without addressing definitional and measurement issues. Xia, Zhao, and Xia (2009) collects a group of essays about the need to control excessive administrative costs in the Chinese government due to corruption and waste. These essays report expenditure numbers, again without a serious effort to deal with the technical issues of cost measurement. Despite the efforts already achieved, further refinement to calculate costs is essential.

Developed Countries

Numerous attempts in Australia, Canada, New Zealand,8 the United Kingdom, and the United States have been made to raise awareness about the rising costs of government and to measure those costs. These instances illustrate the stages of developing government cost systems. The contents of each case are briefly described below, details for which are available in an unpublished technical note, entitled “The Nature of Public Services and Implications for Cost Systems,” which has been submitted to the State of São Paulo. The note presents a large number of studies to measure specific service areas, such as elementary and secondary education, health care, penitentiary administration, and social work.9 It also provides citations to the studies mentioned below.

Raising Awareness

The Chartered Institute of Public Finance and Accountancy (CIPFA) issued in 2011 a series of publications, entitled “counting costs” to encourage governments to create a “cost conscious culture” such that “cost considerations automatically feature in everyone’s actions across the organization.” CIPFA was responding to the findings of the UK Audit Commission for local governments that legislators did not have a good understanding of costs. CIPFA emphasized that cost analysis is not an end in itself, but that it is applied to influence decision making. The document, therefore, explains cost concepts and techniques, and endorses six international costing principles, originally intended for business. It also suggests that managers assess their understanding and use of cost information, as well as their relationship with the finance staff.

In 1985, the U.S. General Accounting Office (GAO) released a study, “Managing the Cost of Government: Building an Effective Management Structure,” in support of the Hoover Commission’s accrual budgeting proposal. The GAO raised the concern that the failure to disclose full costs, in fact, resulted from structural deficiencies in current budgeting and accounting systems. The GAO proposed that the federal government measure outputs and inputs, as well as use budgeting and accounting principles that match the delivery of services with the cost of the services.

Costing Services and Activities; Setting Standards

In 1984, the Government Finance Officers Association (GFOA) of the United States and Canada published Costing Government Services: A Guide for Decision Making by Joseph T. Kelley (1984). Kelley used actual cases to illustrate cost analysis to improve the decision making of North American municipal officials in considering new services, setting prices required to recover costs, and determining the amount of subsidies of self-financed municipal services.

A number of U.S. government agencies responded to the GAO’s call to produce the cost information mentioned earlier. In 1990, a GAO survey found 59 cost systems (using the “resource consumption” definition of cost) in five U.S. federal agencies (Department of the Interior; Department of Health and Human Services; General Services Administration; Department of Agriculture; and Department of the Army). The problem of lack of uniformity in concept and practice in cost accounting in American federal agencies was dealt with through laws and regulations in the 1990s. In the early 1990s, the U.S. Congress passed two laws requiring government agencies to produce cost information. To realize the goals of the above legislation, in 1995, the Federal Accounting Standards Advisory Board (FASAB) issued Statement of Federal Financial Accounting Standards Statement No. 4, entitled “Managerial Cost Accounting Standards and Concepts for the Federal Government.” To facilitate the implementation of the above standard, the Joint Financial Management Improvement Program (JFMIP), in 1998, issued “System Requirements for Managerial Cost Accounting.”

Since the U.S. Government carries out so many of its programs and activities through other entities, the Office of Management and Budget (OMB) establishes cost accounting principles and standards to be followed by state and local governments, higher education institutions, and nonprofit organizations. These documents permit contractors and grantors to charge the federal government on the basis of allowable costs and full costs. Allowable costs are those for which the federal government is willing to pay. Many of the cost standards pertain to the allocation of indirect costs to federal contracts and grants.

In Australia’s State of New South Wales, the Office of Financial Management in the Treasury, issued two Policy & Guidelines Papers, “Service Costing in General Government Sector Agencies” and “What You Do and Why: An Agency Guide to Defining Results and Services” (New South Wales Treasury, 2006; 2007). These administrative directives require the identification of results, so that it would be possible to define service costs. In our view, the guidance was not sufficiently operational to be practical, as the guides are concentrated in explaining how to define the chain of outcome/output/activity relationship without being specific about how to calculate the cost of the service itself, leaving to each entity the responsibility to develop its own cost system.

Activity-Based Costing and Accrual Budgeting

The adoption and upgrade of cost information systems in U.S. federal agencies in the last 20 years was influenced by the issuance of the FASAB and JFMIP documents mentioned earlier, as well as by the advent of the activity-based costing (ABC) technique.10 The GAO report to Congress in 2007 noted that “implementation and use vary widely across 10 federal agencies.” In 2009, the Association of Government Accountants carried out a survey of 10 federal entities—mostly components of federal departments—that “had implemented MCA [managerial cost accounting] and were successfully using the information available to program managers” GAO, 2009: 5. Table 6.1 indicates the nature of the cost systems and how cost information was reportedly used.

Table 6.1

Using Managerial Cost Information in U.S. Federal Agencies

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Source: Adapted from Figure 1 of AGA (2009).

In 2004, the GFOA updated its 1984 guide to costing government services. Most of the fundamentals remained unchanged, except for the analysis which became more quantitative and activity-based and was central to the new guide. The guide objectively stated the advantages and disadvantages of ABC. The main advantages were more accurate cost data and a better understanding of activities in terms of value-added and nonvalue-added activities. The key disadvantage was the high cost of obtaining the data. In 1999, the Florida legislature required this state’s departments to report the unit cost of providing services; otherwise, their appropriations would be reduced by 10 percent.

Since the beginning of the 1990s, the United Kingdom has been implementing accrual accounting and budgeting initially in departments and, subsequently, at the whole-of-government level. Departments are required to produce resource accounts.11

In summary, there have been many uncoordinated efforts to find the cost of government services and to develop systems to capture those costs. Following private-sector examples, some governments have begun to use ABC, the literature of which features various initiatives. Due to the lack of accessible public information, however, it is impossible to assess how many of these initiatives began with a bang and ended with a whimper.

Design for the São Paulo Cost System Project

As indicated earlier, the relevance of cost concepts is determined by the purposes of cost accounting and analysis. Similarly, the choice of methodology for the State of São Paulo cost system project was influenced by the goals of finding the costs of services provided by the State. Interviews with senior officials in operating departments and São Paulo’s Department of Finance (Secretaria da Fazenda (SEFAZ) revealed that the main objectives were to improve resource allocation decisions and to control costs. On the basis of these objectives, it was decided that it would be prudent to have an initial pilot project phase to develop and validate the methodology before commencing a full-scale rollout of the system across the entire state government.

The following steps of the pilot project were proposed and accepted by the authorities of the State of São Paulo:

  • 1. Select a small number of pilot departments of diverse characteristics to develop systems and procedures for government-wide application.

  • 2. Undertake field investigations to better understand these pilot departments in terms of their structure, function, and operational characteristics, particularly the services they provide and the resources used to provide those services.

  • 3. Develope a profile of services to the extent of detail sufficient to respond to planning and management needs of these departments.

  • 4. Develope cost accounting modules for these departments.

  • 5. Produce a cost manual on the basis of generalizing the experiences gained in the previous steps, in preparation for state-wide implementation.

  • 6. Prepare cost reports and analyze the cost information produced for presentation to managers, planners, and policymakers.

So far, items 1 to 4 are completed and items 5 and 6 are in process. All steps are expected to be concluded in 2016.

Since a review of the literature had not found precedents of a government cost system project of the scale and depth expected by the authorities of the State of São Paulo, a study was conducted by Chan, Holanda, and Pessoa (2012) to ensure the conceptual soundness of the project. The study analyzed the nature of public services, as discussed in the economics, accounting, and budgeting literatures, and found a considerable gap between theory and the need for practical guidance. Furthermore, the study could not determine precedents for the type of government-wide cost accounting systems envisaged for the State of São Paulo, despite the fact that there were numerous cost studies of specific service areas, including the four areas that had been selected for pilot projects. These service areas were elementary and secondary education, health care services, penitentiary administration, and social services. This knowledge of the “state of the art” made it convincing—even though costing services were technically difficult—that an ever larger challenge would be to develop a system that would encompass these and other services provided by the State. The challenge could be overcome, in part, by developing a cost manual that would set forth uniform definitions, standards, and procedures.

Selection of Pilot Departments

Since the objective of the pilot project was to generate insight to develop a state-wide system, it was essential to select departments that had diverse characteristics. These characteristics included size, significance, organizational complexity, and complexity of service delivery processes. Size could be measured in terms of amount of annual spending, number of clients served, and number of staff members. Larger departments would likely be more significant, but significance could also refer to social impacts and, therefore, political sensitivity. For example, prisons were significant because over-crowding conditions produced unrest by inmates. This led to social pressures on improving prison conditions and debates on whether to build more prisons or outsource their construction and operation. Organizational complexity is, in part, indicated by the number of levels in the organizational hierarchy and the number of reporting relationships. Service complexity is reflected by the extent to which capital equipment is used and the requirement of skilled personnel. The last point was important because the higher the required skill level, the staff (e.g., medical doctors) would have greater professional authority to order resources (and drive up costs). As will be discussed in greater detail, the four pilot departments were Secretary of Health, Secretary of Education, Secretary of Penitentiary Administration, and the Casa Foundation.

Understanding the Production of Services

Since costs arise from using resources to produce and distribute government services to their recipients, it made sense to understand the resource consumption patterns, so that costs could be attributed (attached) to the resource consumed. The production function in microeconomics—expressing outputs as a function of such inputs as capital and labor—was a good starting point, although it was too abstract a function upon which to build an operating information system. Field investigations, therefore, were proposed to better understand these pilot departments in terms of their structure, function, and operational characteristics, particularly the services they delivered and the resources used to provide those services. Caution, nevertheless, should be heeded against pushing the engineering approach to an excessive extent; that is, detailing the service production process to identify activities only to the necessary extent for costing those activities. This advice was based on the awareness that the more detailed the activity specifications, the more finely and arbitrary it would be to allocate costs so as to attribute the costs to those activities. Furthermore, we had to remind project sponsors and participants that the primary goal and output was the cost information of services. Operations research on service produced, while necessary, should be regarded as a means and not an end. Since the economist’s production function could be drilled down to infinitely detailed engineering specifications, this phase of the projection had to be constrained in time and resources so as to leave adequate time and resources for the even more critical cost accounting and analysis phases.

Construction of Service Profiles

At the time of planning the pilot projects, the State of São Paulo was initiating a project at its Secretary of Planning department to change the traditional line-item budgeting to an output-oriented program budgeting system. Since a key objective of the cost system would be to supply data to the budget system, the hope was that the two projects would be synchronized so that there would be synergy between them. That is, the program budget structure would guide the identification of service outputs, and the cost system project would provide the basis for setting standard costs for services. While linking the two projects made sense, it was also risky in that the cost system project would be adversely affected by delays and other unfavorable developments in the program budget project. A contingent plan was to deduce the pilot departments’ service profiles by elaborating their functional classification in a hierarchy of several levels, down to the level where cost data would be produced. For example, elementary and secondary education would consist of regular education, special education, and vocation education. These educational programs would have common, as well as unique, services. This exercise would lead to a profile of services that is sufficiently detailed to give a complete scenario of services provided, although not so detailed as to require arbitrary cost allocations.

Developing Prototype Cost Accounting Modules

A government accounting system includes components such as cost accounting, financial accounting, budgetary accounting, and others. The cost accounting modules for the pilot departments could be developed by using a number of approaches: (i) the service profiles are considered to be the primary database and costs derived from the financial data systems are assigned to these services; (ii) from the financial data systems, total cost data are generated and then allocated to services or other cost objects; and (iii) a commingling of the previous two methods. Since the cost accounting subsystems at the pilot stage are not part of the on-going operating system, they are considered to be prototype modules.

Regardless of the approach taken, it would be necessary to decide on an acceptable definition of cost. Even though financial accounting principles require cost to be measured as full cost, influenced by the thinking of “different cost concepts for different purposes,” the State of São Paulo project had considerable flexibility in choosing applicable cost concepts and related measurement methods to achieve the planning and control objectives. Nevertheless, the introduction of accrual accounting into Brazil had the tendency to at least raise issues with defining cost in terms of cash outlay. It was also clear that, while various definitions of cost could be tried in the pilot project, the alternatives should be narrowed so that the same cost accounting policies and procedures would be adopted in the state-wide implementation.

Furthermore, regardless of the approach taken, it would be necessary to have some degree of integration of financial and nonfinancial data from separate and disparate databases. Financial data would derive from budget execution and financial accounting systems. Nonfinancial data would come from the personnel payroll system and the system for tracking the purchase, requisition, and inventory control of numerous types of materials. If the cost of capital consumption (i.e., depreciation expense) would be included in the calculation of overhead, the fixed asset accounts would be involved as well. Since these data systems were not designed with the calculation of cost of service in mind, considerable adaptation and modification was anticipated. For example, the labor cost of a teacher entails the combination of salaries, bonuses, if any, and fringe benefits such as insurance. Since the essence of the cost system project was to find the cost of service, his or her service could be expressed in terms of number of classes taught, and if the classes had an unequal number of students, some other measures of service might be devised. In general, data dis-aggregation was expected to be a major undertaking.

Finally, the calculation of service costs requires factual knowledge of how resources (and, therefore, their associated costs) are deployed to produce services. Since the production of a particular service (e.g., a surgery) requires personnel with particular skills, and a specific mix of materials in an environment of required equipment, it is often the case that such complex and qualitative information resides in the heads of knowledgeable specialists. The extensive involvement of managers (e.g., chiefs of medical services, school principals, etc.) would be necessary to construct an accurate picture of how resources are utilized and costs are incurred. The solicitation of cooperation of managers, therefore, was included in the project design.

Cost Manual

The design of a government cost system entails the resolution of many conceptual and organizational issues. These issues would undoubtedly be debated and, hopefully, consensus or authoritative decisions are reached. Since the pilot project was launched to generate ideas and experiences, a Cost Manual was proposed to codify the results of the discussion and experimentation process. The Cost Manual would have the following general contents:

  • Goals of the cost system with regard to planning and control

  • Policies:

    • Governance: stakeholders, authority, and responsibility

    • The role of a cost system in the government process

    • Relationship between cost system and other information systems

  • Standards:

    • Cost definitions and concepts

    • Guidance for cost accounting and analysis

    • Use of cost information

  • Procedures:

    • Cost identification, tracing, and allocation

    • IT support for data collection and production of reports

While the experience of individual departments was valuable, it is essential to standardize processes and procedures for state-wide application. The major output of the project, therefore, was the Cost Manual to assist in the establishment of norms. Box 6.1 shows a summary of 10 cost standards, which are elaborated in the Cost Manual.

Preparation and Analysis of Cost Reports

It was intended that the first stage be to calculate the cost of services provided at the cost-center level (e.g., hospitals, schools, prisons). The expectation was for the Cost Manual to guide implementation by means of a standardized methodology throughout the state. This process would involve obtaining data in preexisting corporate information systems to be correlated with data that was specially collected with regard to the services of the pilot departments. Definition of the services needs to be aligned with the services identified in the PPAs in accordance with the new program-based budgeting approach. SEFAZ would be responsible for regulation, supervision, and quality control of the cost data generated, and the project manager would be responsible for validating the data and producing the cost reports. Initially, priority was given to producing quarterly summary reports to support decision making with an emphasis on improving budgetary and financial management.

Definition of Cost Standards

  • Standard 1: Quality of cost information. Cost systems must seek to produce cost information that will be useful, valid, reliable, and cost-effective.

  • Standard 2: Development of cost systems. Cost systems must be developed gradually, taking into account current capacity and possible future expansion.

  • Standard 3: Identification of cost objects. Cost objects selected must have a close relationship to the desired outputs of government activity. Government departments that provide services can serve as cost objects in the initial phase of developing the cost systems for the state government of São Paulo.

  • Standard 4: Criterion for recognition. The recognition criterion used in cost systems must be linked as directly as possible to the expense (despesa), unless intermediate criteria, such as outlays (gastos) are accepted as a transition stage.

  • Standard 5: Full costs, direct costs, and indirect costs. Full costs must be compiled through a technique known as absorption costing, in order to comprehensively understand the implications of the resources employed in creating a public service.

  • Standard 6: Controllability of costs. Cost systems, based on departmentalization, must organize costs in light of their controllability, provided that cost control is part of performance assessment management.

  • Standard 7: Determination of real costs: direct tracing of a cost system must be enable the accumulation and attribution of costs to services. Direct tracing of costs, based on a reliable measurement of resource consumption, is the preferred method to accumulate costs and must be used whenever possible.

  • Standard 8: Determination of real costs: cost assignment. Before a cost assignment decision is taken, the costs and benefits must be compared. Costs should be allocated in accordance with criteria that reflect the relationship of cause and effect between the costs and the cost objects.

  • Standard 9: Standard costs and cost behavior pattern. Program budgeting must be used as the basis for implementing a standard cost system to assess real costs. Budgeted values must be restated as standard costs to analyze cost variances. The cost behavior pattern should also be analyzed in terms of its variability to facilitate forecasting and control.

  • Standard 10: Cost reports. A cost system must extend from the accumulation and analysis of costs through to the production of cost reports. The scope of the cost reports, their level of detail, and their frequency must be based on the responsibility and functions of their intended audience.

Source: Authors’ elaboration.

Implementation of the São Paulo Cost System Project

Developing Consensus on Project Scope

The State of São Paulo is the largest state in Brazil, with a gross domestic product (GDP) in 2011 of approximately US$865 billion (R$1.349 trillion) and a population of 41.4 million people. This corresponds to 31.4 percent of the Brazilian GDP. The state is responsible for providing a significant number of services, such as primary, secondary, and college education; health care; public security; penitentiary services; social assistance; and investment in infrastructure such as roads, local airports, housing, and water and sewage systems. The state budget executed in 2011 was US$85 billion (R$160 billion), of which 92 percent was financed by its own taxes and fees.

The initial stage of the technical assistance project, provided by the IMF and FIPE, was concentrated in the definition of the scope of the project, objectives, and selection of the cost methodology to be applied. In April 2011, SEFAZ organized a workshop to develop consensus on cost methodology. The workshop drew participation from officials from SEFAZ, Department of Planning and Regional Development (Secretaria de Planejamento e Desenvolvimento Regional (SPDR)), Department of Public Management (Secretaria de Gestão Pública (SGP)),12 and the pilot departments of Health, Education, Penitentiary Administration, and the Casa Foundation, with FIPE and IMF as consultants. Representatives of the federal government contributed the experience of implementing the federal cost system.

The workshop mobilized the key stakeholders at the state level, discussed national and international experiences, and built consensus on the objectives and strategy to be pursued. The approach was to build up the strategy collectively, favoring a gradual approach and taking advantage of the efforts and progress already made in compiling financial information. The discussion focused on formulating a proposal that should be useful, feasible, and sufficiently robust and standardized to allow generalizing the cost methodology to all entities of the state. The result of the workshop is summarized below.

In its first stage, the public sector cost system of the State of São Paulo aims to calculate the cost of services provided by cost centers that attend the population directly (hospitals, schools, and prisons, among others), using standardized methodology focused on direct appropriation on cost objects and using data from the existing information systems. Due to the conceptual and operational complexity of the cost system, implementation will be gradual and based on pilot projects. Initially, priority will be given to the production of quarterly reports to support high level decision makers and with emphasis on improving budget and financial management. It is important that the services to be cost are aligned with the activities defined in PPA and the subsequent managing for results framework. The Department of Finance is responsible for regulating, supervising, and providing quality control of the cost information, and the budget execution managers for collecting and validating cost information and producing cost reports.

At the outset, the following criteria were proposed and consensus was sought to determine the success of the cost system project: (i) there would be a good match between cost concepts and methods for the defined purpose of the cost system; (ii) it must be feasible to produce the desired cost information; (iii) the cost information would actually be used by intended users; (iv) the cost information would be found to be useful for intended purposes; and (v) the pilot projects would lead to the development of cost systems in other parts of the government so that the cost system would be sustainable over time. The six steps are described below.

Using Existing Corporate Systems

The cost system made maximum use of the available data in government information systems. After substantive investment, the State of São Paulo implemented various information systems that contain data that were potentially useful in generating cost information (SIAFEM, SIGEO, SIAFIS-ICO, and SIMPA, among others).13 For this reason, financial and nonfinancial data already available were used as much as possible to speed up the production of cost information and to avoid duplicating efforts and wasting of resources. Although the available financial information regarding the stages of budgetary expenditure (commitment, liquidation, and payment) were different from the concept of cost, the project concluded that it would be possible by applying standardized accounting adjustments to transform the budgetary financial data at the verification or liquidation stage to cost information (see Table 6.5 for more details on the adjustments). The current data, however, were not classified by service and cost center. These parameters had to be included in the structure of the chart of accounts (CoA).

Table 6.2

Skills Needed for Implementation of the Cost System

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Source: Authors’ elaboration.
Table 6.3

Budget 2011 of the Pilot Projects

(In Million Reals)

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Source: Budget 2011.

Excluding obligatory transfers to municipalities, debt service, and judicial sentences.

Table 6.4

Cost Model of the Department of Penitentiary Administration

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Source: SEFAZ and SAP.
Table 6.5

Adjustments from Budgetary to Cost Information

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Source: Machado (2005).

Project Structure and Support of Technical Assistance

Considering the complexity and dimension of the cost system, a governance structure articulating different levels of stakeholders was defined. The governance model included several committees at the strategic, tactical, and operational levels. It also defined the roles of key stakeholders in the conceptual and operational support (IMF and FIPE as technical assistance providers) and pilot projects (Figure 6.1).

Figure 6.1
Figure 6.1

Governance Model of São Paulo’s Cost Project

Source: Authors’ elaboration.

The skills needed to implement the cost system were identified. Technical and personal skills were essential for the successful implementation of the cost system (see Table 6.2). SEFAZ allocated full-time financial analysts to the cost project. The IMF allocated one resident advisor for two years and made periodic short-term expert visits to provide guidance to the implementation and conceptualization of the project. FIPE allocated a team of academics and experts on a part-time basis to support the field work and preparation of studies and definitions of the cost system. At the end of 2014, SEFAZ created a formal Cost Division within the Accounting Department and allocated additional financial analysts. The pilot entities also assigned part-time staff in their accounting and financial divisions to work as counterparts of the cost project. At a later stage, staff members from the State of São Paulo IT Company (Empresa de Processamento de Dados do Estado de São Paulo (PRODESP)) in charge of information technology (IT) development were involved during the discussion of the proof of concept of the IT solution.

Relationship of the Cost System with the Program Budgeting System

One of the main characteristics of the State of São Paulo cost system is the link between the cost services and the activities defined in the PPA. This was intended to expand the usefulness of the cost system and provide information for planning, performance evaluation, and budgeting (not only for financial control).

The PPA is the main instrument for medium-term planning. It is structured by programs and provides information, such as (i) entity responsible for the program; (ii) outcomes, outputs, and inputs; (iii) activities; (iv) projects; and (v) programs. Indicators are defined at the program and activity levels. The cost project, however, identified that a uniform understanding of results, objectives, and indicators were not harmoniously applied. The cost project helped to rediscuss the structure of some programs, as was the case of the Department of Penitentiary Administration. Figure 6.2 shows the relationship between cost information and the PPA. Ideally, the services to be cost should be the same as those actitivies of the PPA; however, this was not the case in most of the pilot entities.

Figure 6.2
Figure 6.2

Link Between the Multiyear Plan and the Public Service Cost System

Source: Authors’ elaboration.

Figure 6.3 shows the conceptual model of the cost system. Cost information (X) should be generated by relating financial information with nonfinancial information (number of services). The project defined the cost concepts, based on detailed investigation on available cost literature and studies about the specific reality of each pilot entity. It has also prepared an inventory of the information systems available and the information required to calculate costs.

Figure 6.3
Figure 6.3

Cost System Conceptual Model

Source: Authors’ elaboration.

Four Pilot Case Studies

The selection of pilot projects was based on size, diversity, and availability of cost information. The pilot project budget covered approximately 38 percent of the total budget expenditure of the State of São Paulo in 2011 (Table 6.3).

The first pilot was Casa Foundation because of its previous experience with cost information. It had about 146 units that served approximately 11,000 juvenile offenders and was operated by 13,000 employees. Each youth received five meals a day, education (by the Department of Education), health care (by the Department of Health), counseling, social assistance, housing, and security. Casa Foundation produces information on the running costs of each youth by cost center.

The SEE was the largest employer in the state, with 5,350 schools providing primary, secondary, adult, and youth education for 5.1 million students. While basic information of the characteristics of schools was available, cost information was not.

The SS was the most complex entity of the state, with 3,148 units including 1,199 specialized clinics, 125 specialized hospitals, and 494 general hospitals. The size and complexity of the health sector required long debate on the services to be measured and cost centers to be studied. For example, the list of the national health system included more than three thousand procedures, the number of which was considered impractical to manipulate during the initial stage of the project.

The other pilot selected was SAP because of its similarities with Casa Foundation and, since the penitentiary units and services are very standardized. The SAP was responsible for managing 148 units, including one maximum security unit, 75 prisons, 36 provisional detention centers, 22 resocialization centers, 8 centers for progressive incarceration, and 6 penitentiary hospitals. The SAP provided security services, housing, health care, education, training, rehabilitation, counseling, and legal support to approximately 167,000 inmates who occupied 97,000 available beds. Overcrowding, therefore, needed to be carefully considered when analyzing cost information.

Field Work and Identification of Cost Centers and Services

The first activity was the application of a questionnaire to detail the services provided, map the organization structure, and identify systems and information available. The questionnaire enabled the project team to understand the reality of each organization, with its limitations, traditions, systems, and processes, and learn what information was available and feasible to obtain, as well as how managers made decisions. The FIPE applied the Ishikawa methodology to map the activities grouped in families of services. This analysis of the services led to a set of family of services that better represented most of the activities.

The survey was essential to understand the cost methodologies and information available in the State of São Paulo. It identified cost methods used, information available to support budgeting and planning, and systems used for processing financial and nonfinancial information. The survey also found the types of services provided and goods produced; main clients or customers; and how managers used financial and cost information; as well as the principal difficulties faced in collecting and analyzing cost and financial information. Alternatives were adopted in cases where certain information was not available. The survey was conducted with the idea of having a systematic and standardized approach for application in all the public entities of the State of São Paulo, rather than adopt a methodology that was custom-made for each type of entity.

Table 6.4 shows the cost matrix of the Department of Penitentiary Administration. Level 1 identifies the entity as a whole; Level 2 identifies the cost centers with different characteristics, and Level 3 defines the main services. To avoid excessive detail, the project adopted the concept of families of services (i.e., the most aggregated level of services that represents most of the services provided). In the case of the penitentiary, the main services were security, health care, education and training, food, housing, social assistance, legal assistance, and counseling. In addition to these penitentiary services, a program exists to assist prisoners with their reintegration into society. The administrative cost of SAP, as a whole, was taken into account, although it was not distributed by cost center or service. Figure 6.4 shows the relationship of those services and the PPA program, essential to allow that the cost be aggregated at the program level as well.

Figure 6.4
Figure 6.4

Services Provided by the Department of Penitentiary Administration and Link to Programs at the PPA

Source: SPDR and SAP, PPA 2012/2015.

Another important step was to define the accounting adjustments that were necessary to convert budgetary information into cost information. The SIAFEM system is an accounting system that is capable of integrating budget, financial, and accounting information. It is structured in a way that enables it to identify which classes of the CoA need to be utilized when an expenditure or revenue is inserted. Since cost concepts differ to some extent from budget concepts, some adjustment had to be introduced. Given that the SIAFEM system adopts a modified cash accounting system, some cost concepts, such as depreciation and cost of future liabilities (e.g., pensions and other social benefits), are not covered at this stage. Once accrual accounting is fully implemented, the State of São Paulo will need to revisit this. Table 6.5 schematically describes the main types of adjustments.

Analytical Work to Support the Development of the Cost System

The ambitious proposal to have a standardized cost methodology for the entire public sector required a substantive volume of knowledge and studies to support project decisions. The project developed the documentation detailed in Box 6.2.

Proof of Concept by the IT System

Of note was the specification of the methodology to process available data and transform them into cost data. Figure 6.5 shows a high-level scheme of the proof of concept (POC) adopted in the cost system. The purpose of the POC was to test, in reduced scale, the capacity to identify cost data and automatically calculate it. This was done prior to modifying the current IT systems so as to test the viability of the proposal.

Figure 6.5
Figure 6.5

High-Level Scheme: Proof of Concept

Source: Authors’ elaboration.

Documentation of the Cost System

Working Papers: Purpose of defining the scope of the cost project, adapted to specific systems of and circumstances in the State of São Paulo.

  • Clarification of concepts.

    • Nature of public services and implications to the cost system.

    • Cost concepts and available options and techniques.

    • SIAFEM as a source of cost data: potential and limitations.

  • Foundations for the questionnaire and fieldwork.

    • Conceptual model of the public services cost system: objectives, policies, producer, process and products, what to observe in the field.

    • Guide for carrying out the cost system field study; define questionnaire to be utilized.

Technical Notes: Document existing systems and information available in each pilot project. The final result would determine the cost centers and services.

  • Department of Health: Cost center (hospitals and clinics).

  • Department of Education: Cost center (schools).

  • Department of Penitentiary Administration: Cost center (penitentiaries and prisons).

  • Casa Foundation: Cost center (custody center).

Manual of Cost Accounting Policies and Procedures

  • Cost accounting policies: General principles, list of definitions and concepts, standards.

  • Cost accounting procedures: Overall implementation guide, rules and procedures, considerations relating to the information system.

Proof of concept strategy: High-level functional specifications of the system; high-level architectural document; requirements document (with detail of business rules); main specifications of reports and access controls; screen and report prototypes; information technology implementation strategy.

Cost report templates: Definition of the content of the cost information report.

Note on communication strategy: How to communicate to politicians, managers, and the public, cost information. A careful strategy should be defined to avoid confusion of interpretation when publishing cost reports.

Project management framework: Definition of main stakeholders, roles, and responsibilities.

Capacity building and training strategy: Identification of training needs, definition of training content, and calendar.

Source: Authors’ elaboration.

The SEFAZ performed a proof of concept between November 2013 and June 2014 to validate the feasibility of the cost system on the basis of its existing public financial management systems.14 The proof of concept was carried out by SEFAZ with the participation of FIPE and PRODESP. Its objectives were to (i) develop a prototype of the information system with a limited functional scope and the capacity to process information from the original systems, allocate costs for each cost center and each service, and generate reports using basic filters (time periods, cost centers, and services);15 and (ii) confirm that reports generated by the prototype contain timely, significant, and reliable information that can be used for cost analysis within an adequate processing period and with adequate disaggregation of information.

The scope of the proof of concept was broadened considerably in 2014, at the institutional level as well as regarding the coverage of expenditure items. It included original processes to adjust and allocate costs for each cost center and service, in relation to personnel expenditures and a limited set of remaining expenditures in two SEE regional directorates of education and two SAP penitentiary coordination offices.16 During its implementation, seven hospitals under the Department of Health were added, and the scope was broadened in SEE to include all 95 regional directorates of education, which managed 5,300 educational establishments (schools). The objective was to cover 80 to 85 percent of all costs in each sector, including the costs of personnel, public utilities (water, electricity, and telephony), cleaning services, and services specific to each sector, such as laundry and catering in the health care sector. The FIPE documented the processes and actions performed in the entities, including the parameters used to allocate some expenditures by services, such as the parameters for laundry in hospitals. Figure 6.6 shows the blueprint of the prototype for the cost system.

Figure 6.6
Figure 6.6

It Blueprint of the Prototype for the Cost System

Source: State of São Paulo IT Company (Empresa de Processamento de Dados do Estado de São Paulo (PRODESP)).

Cost Reports and Cost Analysis

The preparation of cost reports and cost analysis are the most incipient activities and need more work to be finalized. The SAP has already initiated a cost study of its operations, but subsequent to completion, the conceptual model of non-financial information, in other words not related to cost information, was produced. Non financial information includes, for example, the number of inmates, number of students and capacity of each school. Classified as cost centers were 147 units (prisons, rehabilitation centers, progression center, provisional detention center, hospitals, and maximum security unit). Initial running costs determined some wastage. The high costs in some units were fixed costs. It was not possible at the time, however, to identify cost by type of service provided (security, food and housing, education, training, legal assistance, and counseling, among others). Available information in SIAFEM has made it possible to obtain data on actual expenditures in each administrative unit, although this could not be characterized as cost information at the time. The reason was the incapacity to attribute administrative costs to the services and determine goods and services consumed.

The common practice of computing average cost carries a risk of misinterpretation. For example, other things being equal, overcrowding in a prison lowers its average cost because of the larger number of inmates to share the same fixed costs. The low average cost might be an indicator of a low quality of service and not of efficiency. A cost report without consideration of the quality of the service provided has serious limitations.

A cost report template was developed (Figure 6.7). The example presents expenses for each prison modality, then decomposes the expenses by specific category of prison—the progression center—and finally decomposes by service. Although the information on expenditure incurred by cost center could be useful for budgetary purposes, it tells little about the cost of services. Cost analysis is intended to answer questions such as: Does the size of prisons influence cost? How does overcrowding impact cost analysis? Is it possible to define a range of cost variation in which the cost of standardized cost centers or service is considered adequate? This is a stage that requires further development.

Figure 6.7
Figure 6.7
Figure 6.7

Example of Cost Reporting of the Department of Penitentiary Administration


Sources: SEFAZ and Yamazaki (2012).

The same is applicable in relation to the use of the cost information in the decision making process. As the reports have not been stabilized and the quality of the information needs some fine tuning, they have not yet been distributed to the main decision makers, such as the State Governor and Secretaries of State. It is expected that by the end of the system implementation period in 2016, periodic information will be produced, influencing the discussion with regard to the efficiency of the cost centers over time, comparison of costs among similar cost centers, and identification of good practices that can be replicated elsewhere.


The four-year experience of constructing a PSCS for the State of São Paulo in Brazil has confirmed earlier expectations about the multifaceted challenges of the project. This chapter concludes by recounting these challenges, which were overcome with varying degrees of success. The conclusion, therefore, focuses on the valuable lessons that international consultants and their clients—as well as other stakeholders—have learned in the process. These lessons provide the basis to offer some recommendations to governments that are interested in undertaking a similar project.

Perhaps the greatest challenge is to build and maintain a coalition of stakeholders. For the secretary of ministry of finance, as host of the cost system, the main stakeholders are the planning and budgeting staff; statelevel policy makers; and heads, general managers, and operating managers of the line departments. All these actors are potential users of cost information, either because their decisions and actions have cost consequences, or they are charged with cost reduction without sacrificing service. Nevertheless, it is not easy to interest policymakers in the consequences of those costs. Similarly, it is not easy to secure the cooperation of managers, as they tend to view cost finding as a prelude to reducing their budgets. Consequently, mobilizing and keeping the interest and support of a core group of stakeholders is critical for the success of a cost system project. In a way, an indicator of success is the extent to which potential users are converted to actual users of cost information.

Highlighting the intersection of the supply and demand for cost information is likely to be another major challenge in designing a PSCS. There are so many cost concepts available to meet almost every conceivable need. Unless the potential users are able to reveal their preferences, the probability of intersection would be low; and especially, the cost system designer has to be very knowledgeable with the decision making and operational environment to offer a reduced set of alternative cost concepts for consideration by potential users. The conclusion is that it would be better to reduce the subjective element by focusing the information rationally required to carry out the responsibilities of a particular organizational role, instead of basing the design of the cost system on the unstable preferences and imperfect knowledge of individual users. After all, over time individuals move in and out of official positions. An institutional information system, therefore, should be anchored on institutional roles.

It is important to note that the lack of sufficient international experience in the implementation of public service cost accounting systems for an entire administration imposed an additional burden to the project. The State of São Paulo had to invest significant effort in research and investigation and develop a complex system, while defining the scope and parameters of the project. For that reason, implementation was very cautious because the government would not be likely to release cost information before being completely confident about its accuracy. The project dedicated a significant amount of time to the knowledge about the specification and to the design and calculation of cost information in a way that could be practical, user friendly, and cost-effective. The project—initially envisaged to be implemented in two years—extended its schedule to four years to accommodate all these circumstances. One positive element was the administrative stability and political support during the period, which facilitated the implementation. This has made it possible for a more flexible calendar of implementation to be provided.

After reflecting on the experiences, the merit of the basic approach adopted by the cost system project in the State of São Paulo is convincing. The approach has six sequential stages, the first of which was the selection of the pilot departments and the second of which provides a conceptual foundation for the subsequent field work and case studies. The third stage requires studies of the service delivery systems so that the cost system will be grounded in the realities of particular organizational settings. To prevent the proliferation of custom-tailored systems producing noncomparable information, a fourth stage produces a manual of cost accounting policies and procedures to generalize the lessons learned from the pilot departments. The fifth stage is the definition of the IT specifications and testing of the solution. The final stage is the systematic production of cost reports and subsequent cost analysis. Professional judgment is required to maintain the delicate balance of uniformity in principle and flexibility in applications.

Finally, preparing, designing, and implementing a PSCS often results in taking more time and resources than initially projected. Since cost is such a commonly used word, the complexity of cost measurement and cost systems is almost invariably underestimated. Furthermore, it is all too tempting to be so fascinated by the details of service delivery that one overlooks the increasingly arbitrary cost allocations needed to attribute costs to activities. Unless one keeps in mind that the objective of a cost system is to find costs and to use cost information to improve resource allocation and decision making, too much time and resources are likely to be consumed in collecting nonfinancial data. It requires an effective project manager to reserve sufficient time and resources to generate cost data to prevent a cost system project from becoming too costly.

The project carried out by the State of São Paulo is a relevant experience to other national and subnational governments, considering the dimension of the state and complexity of the public services provided. The approach adopted and the capacity to achieve the objective of producing cost information—adding a new dimension to the public service—have demonstrated that it is feasible to implement a solution that, albeit demanding in its nature, is less complex than implementing across the board a sophisticated solution such as the ABC methodology that has proved very expensive and difficult to sustain in the public sector.

In terms of the resources invested in the project, SEFAZ created a division with 8 financial analysts, hired consultants from the IMF and FIPE to work on the conceptual design and implementation, and mobilized its IT company (PRODESP) to develop the IT system. The project implementation is expected to take four or five years to complete, since its inception.

The next challenge will be to use the cost information to influence budget allocation and financial decisions, and to be part of the performance evaluation of programs and entities. But this will be addressed by the next stage of the project. The main lessons of the State of São Paulo cost system, therefore, are the following:

  • Keep the scope simple and realistic: The experience has shown that generating additional financial and nonfinancial data in the public sector is challenging. It is important, therefore, to select a cost methodology that preferably adopts a direct allocation of cost to a few simple cost drivers. Number of services should not go beyond a dozen in a specific department.

  • Use available systems and information as much as possible: Prior to investing time and resources in selecting the ideal cost structure, it is important to dedicate time to map and understand the systems and information available. The capacity of line departments to dedicate additional time to further detail and capture financial and nonfinancial information is very limited. The best alternative would be to make small adaptations to the existing system and procedures instead of building specific and dedicated systems.

  • Use pilot projects to study current circumstance and familiarize financial analysts with cost concepts: Using pilot projects will reduce the complexity and facilitate organization and convincing. Comprehensive solutions applicable to all entities in one leap are very risky and expensive. The Secretary of Finance needs to demonstrate capacity to generate results quickly, otherwise there is risk of fatigue and competing priorities will tend to reduce availability of resources.

  • Identify multiple uses and users of the cost information: Cost information should serve multiple purposes and respond to multiple necessities. The approach adopted in the State of São Paulo was successful in defining the public services at a level useful for program managers and planners. It also involved the line departments in the definition of the services and how information would be collected and manipulated.

  • Use a proof of concept phase to test the IT solution before fully developing the IT system: It is important to have a sound conceptual design of the cost system, as well as dedicate time to test the IT solution outside the main financial database as a kind of prototype. It is much easier to make changes and carry out adaptation in small scale at that stage than when an entire database system is already operational.

  • Invest time to understand the needs of the main stakeholders and communicate in a language that is familiar to their interests: Because each sector is different and complex, it is important to invest time to understand the peculiarities and specific needs of each stakeholder. It is important, however, to keep in mind that a system to serve the entire government will have limitations to respond to all needs. It should be clear to the stakeholders, therefore, what a generic system can and will provide. A generic cost system will be able to respond to the needs of high-level authorities (governor, secretaries of departments, and chief executive officers of entities) and, to some extent, to the first line of managers of the main cost centers (hospitals, schools, and prisons); it will not, however, be able to respond to all needs of low-level managers of each individual department.

  • Install upfront a good project structure to manage the cost project: Experience has demonstrated that it is important that the government allocate dedicated people to develop the cost system. It is also important to bring on external advice to learn new ideas and concepts. Finally, a well-structured decision-making process should be defined to separate strategic, tactical, and operational decisions. Considering the size of a cost system, it is important to have a permanent division in the accounting department that is capable of maintaining the cost manual, specifying the cost system, analyzing data, and producing cost information.

  • Take into consideration the political cycle and avoid targeting the implementation of the system during administrative transition: Such a complex project should start at the beginning of a new administration, as the development and implementation is likely to take three to four years. If this time is not available, the designers should target the project in two phases: the first one relating to the definition and design of the system and the second phase to the modifications of the IT system and generation of the cost reports and correspondening cost analysis. Ideally, the permanent production of cost reports should start at the beginning of the fiscal year to benefit from the entire budget execution and avoid distortions of the calculation, since there is a tendency to have some seasonal expenditure that may not be captured if the process starts during the year. This should be accompanied by a good communication strategy, as it will be necessary to explain to internal and external stakeholders what the new cost information entails, since it will be different in format and content from the information provided by other financial and budgetary reports.


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The State of São Paulo is the most developed state in Brazil. It has an economy that is larger than most Latin American countries.


The concepts discussed in this section are detailed and illustrated in Zimmerman (2011), Blocher et al. (2008). Khan (2000), despite the reference to government in its title, presents mostly quantitative techniques and numerical illustrations. Thompson (1999) offers a catalogue of cost concepts and techniques. Ingram (1992) outlines the steps in determining the cost of government services in three stages: identifying cost centers and goals, measuring services, and identifying costs and finding costs.


A more comprehensive review of recent international experiences is available in Chan, Holanda, and Pessoa (2012), which provides detailed citations that have been omitted from this chapter.


An administrative unit is the lowest level of organizational unit for which the budget is allocated during execution. An administrative unit receives its budget from a higher budget unit. A budget unit can be composed of one or more administrative units.


The accounting system in Brazil is a modified cash accounting system with selective use of accruals, such as for inventory purposes. The State of São Paulo is moving gradually to accrual-based accounting as part of a national reform effort, to be completed in 2020. For more details on public accounting reform, see Chapter 5.


Disclosure: One of the authors, James Chan, was appointed Special Advisor to the China Association of Chief Financial Officers, the main organizational vehicle for improving management accounting in China.


New Zealand also has relevant experience, but is not discussed in this chapter. For additional information, see New Zealand (2014).


The note is not published but can be made available by the Author by sending an email to Mario Pessoa at mpessoa@imf.org. The note is in Portuguese.


Instead of pooling all indirect cost, ABC (1) accumulates the costs of indirect resources for each of the activities undertaken to produce a service, and (2) assigns these activity costs to the services in accordance to the amounts of activities required to produce the services.


The United Kingdom no longer uses Public Service Agreements to capture the amounts of services delivered. It is, therefore, difficult to match departmental resource accounts with nonfinancial performance measures. For more details, see Brimson (1998).


In January 2015, SPDR and SGP were merged, creating the Department of Planning and Management (Secretaria de Planejamento e Gestäo (SPG)).


SIAFEM (Sistema Integrado de Administracão Financeira dos Estados e Municipios): main financial management information system; SIGEO (Sistema de Informacões Gerencias da Execução Orçamentéria): data warehouse that allows manipulating SIAFEM information to generate managerial ad hoc reports; SIAFISICO (Sistema Integrado de Informacões Fisico-Financeiras): physical and financial resources management system; SIMPA (Sistema de Monitoramento de Programas e Ações do PPA): a system that provides information on PPA programs and activities.


A proof of concept is an opportunity to demonstrate the capabilities of an IT system on a small scale and in a controlled manner. Developing a proof of concept can help organizations test an IT project’s feasibility without having to incur the full cost of its development.


Filters are used to include various dimensions of data in the reports generated by an information system. The inclusion of a larger number of dimensions in a report increases its processing complexity, while it also requires data to be collected and processed from other information systems for each additional dimension of the report.


In SEE, the areas studied were (i) the North II Regional Education Directorate, covering 70 schools: and (ii) the Regional Education Directorate in Itaquaquecetuba, covering 58 schools. In the case of SAP, the analysis covered (i) the metropolitan region coordination office, with 28 penitentiary units; and (ii) the central region coordination office, with 23 penitentiary units.

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