Stage 2 – Develop charging model

Benefits of cost control

A well-developed charging model enables entities to compare expected expenses and revenues to actual expenses and revenues, to:

• ensure prices charged remain aligned to the policy authority for the level of the price and the requirements of the Charging Framework
• measure and improve efficiency
• minimise the over- and under-recovery of costs of the activity
• manage costs and monitor performance
• justify how prices have been calculated and how they relate to the costs of the activity through appropriate attribution of outputs and subsequent charges
• determine the balance of funding needed, based on the alignment of expenses

A well-developed charging model improves the entity’s understanding of the activity costs (that is, the entity’s cost consciousness). The cost information and control of the charging expenses assists the accountable authority or governing board in meeting their requirements under the PGPA Act to govern their entity in a way that promotes the proper use and management of public resources for which they are responsible (PGPA Act, s.15).

Charging model - Introduction

If, in developing the detail within the charging model, it appears that it would not be practical, effective or efficient to charge as approved by Government in the high-level charging design (that is, the policy objective of the charging will not be achieved), the entity may need to bring the new information for the Government’s decision for the revised approach. Entity staff should consider engaging with Finance to assess whether this may be undertaken through the Budget process. In developing a detailed charging model, entity takes the following steps:

• Step 1 - Identifying outputs and business processes
• Step 2 - Costing the activity - developing cost model
• Step 3 - Pricing the activity - developing pricing model
   

In developing a charging model entity staff break down the activity into distinct outputs (for example, registrations, audits, or the development of standards) and the key business processes that are used to produce those outputs. Techniques for identifying business processes include process modelling, performance measurement and workflow analysis. Staff should monitor and re-examine business processes periodically to ensure that the processes continue to produce outputs efficiently and effectively.

The level to which the activity is broken down (for example, outputs versus business processes) for reporting and costing purposes needs to be proportional to its complexity, materiality and sensitivity. As an example, the following business processes may be involved in the assessment of a permit application (that is, the output of the cost recovered activity):

• receiving an application
• checking the accuracy of information in the application
• assessing the application
• deciding on the application
• notifying the applicant of the decision.

Figure 1: Activity outputs and business processes—concept and example

Once entity staff have broken down the activity into outputs and related business processes, the relevant costs can be identified and attributed to the outputs and processes. The approach used to cost the activity, and the level at which it is costed (for example, activity, output or process), would be proportional to the complexity, materiality and sensitivity of the activity and be based on clear methods for:

• categorising costs into direct and indirect costs
• measuring direct and indirect costs
• attributing costs to the activity processes and outputs.

Entity staff are expected to document the costing methodology and apply it consistently, preferably across all of the entity’s activities.

When relevant, it is a good practice for an entity to benchmark activity costs and processes against similar government activities and/or organisations in Australia or overseas. Benchmarking can be against either the whole activity, or where there is no directly comparable activity against part of the activity (for example, business processes). Benchmarking similar activity's costs may assist an entity in comparing and improving activity efficiency, as well as manage the activity's performance. Benchmarking against the private sector may not always be appropriate, as Commonwealth entities have a range of accountabilities to the public and the Parliament and some charging activities have unique cost drivers.

Assumptions

Assumptions about cost drivers are an important part of costing. They may relate to the expected demand volume of outputs, the cost of resources or other variables that affect financial estimates for the activity. The choice of assumptions depends on the activity; for example, there may be higher costs in registering a new product compared to an established product; or there may be less activity during an economic downturn compared to a period of economic growth.

Furthermore, financial estimates for the activity may be sensitive to changes in the assumptions - the change in the assumed demand value of a variable (for example, the number of products submitted for registration) might not result in a proportional change in the affected financial estimate (for example, registration expenses may rise at a lesser rate due to economies of scale/efficiency gained). Where this is the case, the entity should indicate the level of sensitivity in the CRIS.

Efficient costs

Financial estimates are expected to be based on efficient costs, which are defined as the minimum costs necessary to provide the activity while achieving the policy outcomes and legislative functions of the Government. Efficient costs realisation assist entities in proper use and management of public resources. Efficient costs are particularly important in the context of capital assets. ‘Gold plating’, or installing assets that are unnecessarily large or sophisticated, is an example of inefficient costs that should be avoided.

Types of costing models

There are several options for demonstrating costs. Techniques to identify outputs and business processes include:

• a ‘bottom-up approach’ attributes cost, effort, and resources per unit output to determine the unit cost and then this is aggregate to the policy program level to provide the basis for the activity’s total cost for a year. This process may for some activities involve consideration of the expected annual demand, but may not be relevant for all activities.
• a ‘top down approach’ uses an cost amount and divides it by expected demand ‘down’, to get an average output cost.

The issue of the 'top down approach' is the average cost based on what was spent may not be the minimum efficient cost of doing activity. Entities are encouraged to consider a ‘bottom up approach’ as it enables the price to be based on the minimum efficient cost for delivery of actual activity, not the average cost.

In addition, a ‘top down approach’ does not capture the effort variation between users for the same output or the difference between average expense and actual cost.

Using a ‘bottom up approach’ provides transparency that assists in avoiding:

• cross subsidisation between users
• charging being perceived as taxation (for example, charging an individual more than the cost of the output the individual caused)

The calculation of effort should be based on the typical time of a proficient officer for the delivery of the output, and the resources required to support this effort.

Figure 3 - Cost modelling approaches

Determining the process for each output and appropriately attributing costs enables analysis, benchmarking and demand driven budget estimates. It allows for the development of minimum efficient costs, the demonstration of transparency and accountability, and supports stakeholder engagement, as required in the principles for charging. It also enables entities to inform and affirm the total resourcing and budget forecasts.

Entity should document the data behind the costing methodology and apply it consistently. It is this record of process, effort and cost allocation that allows assurance that costs are efficient and consistent with the charging principles.

Recoverable and non-recoverable costs

When building a cost model, the model must allow an entity to distinguish costs due to effort caused by industry and costs due to effort caused by government (for example, internal reporting or policy development). Then depending on the nature of the activity and the charging approach (non-taxation or taxation), the appropriate cost per output, and total costs can be determined.

Some costs are not appropriate to be charged to the non-government sector, unless the Government decides otherwise. These costs must be funded in another way (for example, Taxation or Budget funded through appropriation). The costs excluded from being recovered via a regulatory charge include:

• activities that do not have policy approval or policy authority to be charged for
• activities incurred from direction by government, for example, a strategic review or relocation of premises
• policy development of new or significant changes to existing activities, including policy development of regulatory standards.
• building the business case for making changes to existing regulatory requirements, introducing new regulatory requirements, or introducing charges for existing regulatory charging activities.
• drafting of legislation or changes to legislation for new or significant changes to existing activities
• development and promulgation of advisory material or educational material not for those being regulated

Figure 4 – Attribution of costs to regulatory (cost recovery) charges

Allocating costs

Once the method and level of costing are decided, then total costs, which generally consist of direct and indirect costs, are allocated to cost objects (for example, activities, outputs or processes):

• direct costs are the costs of effort or resources that directly attribute to the output of a sub-activity or activity with a high degree of accuracy. The allocation of direct costs to sub-activities is relatively straightforward if the entity’s financial system is able to generate relevant information. The most common direct costs are staff salaries (including on-costs, such as training, superannuation and leave) and supplier costs (for example, office supplies and workers compensation premiums). Direct costs may or may not vary.
• indirect costs are those costs that cannot be easily linked to the output of a sub-activity or activity, or costs for which the costs of tracking outweigh the benefits. Indirect costs should be apportioned to a cost object using the entity’s documented internal costing methodology. Common indirect costs include overhead costs such as salaries of staff in corporate (for example, finance, human resources) and technical support (for example, legal) areas, or accommodation costs (for example, rent, maintenance, utilities). The appropriateness of recovering all or some of indirect costs is determined on a case-by-case basis.

Direct and indirect costs can be further detailed, depending on the complexity, materiality and sensitivity of the charging activity. Costs that may need to be identified separately include:

• different categories of capital costs (for example, operation and maintenance, depreciation, capital investment). The appropriateness of recovering all or some of these costs is determined on a case-by-case basis. For example, the Government may make an upfront investment in a capital asset for the activity and recover that investment over an appropriate period, which may be close to the useful life of the capital asset.
• costs split between commercial or resource charges activities and activities funded via other mechanisms (for example, Budget funded), where the same resources are used in their provision (for example, shared capital assets).
• costs incurred by parties other than the responsible entity (for example, an outsourced service provider).

Two main methods are used for apportioning indirect costs:

• traditional based costing (that is, simple cost allocation) typically uses volume-based cost drivers, such as floor space or average staffing levels. This method may not suit a complex charging activity if a volume-based cost driver is not representative of the use of resources in the activity outputs and processes.
• activity-based costing focuses on activity-based cost drivers, which convert indirect costs into direct costs and assign them to a cost object. The use of an activity-based costing method enables more informed analysis of the efficiency of outputs and business processes of the activity.

Figure 5 shows an example of how direct and indirect costs can be attributed to a cost object (for example, an output). The costs of staff, suppliers and capital incurred in producing the output are directly allocated to the cost object. Where the same staff work on more than one output, an appropriate method of apportioning their costs to relevant cost objects is required. Indirect costs (for example, the entity’s overhead supplier and accommodation costs) are apportioned to the cost object using relevant cost drivers.

Figure 5: Allocating and apportioning costs to a cost outputs

Use of estimations and cost drivers

If the costs of producing a specific output vary substantially, a variable fee may be more appropriate. For example, an assessment of a permit application may require specialist advice depending on its complexity, which means that it may be difficult to estimate total assessment costs in advance. In these circumstances, tiered fees (based on different levels of assessment complexity) or input-based fees (based on the number of staff hours) could be used.

When designing a levy, staff should select a relevant cost driver as the basis for the distribution of levy payments among individual levy payers that best reflects their cost contribution. The cost driver should approximate the level of resources used to provide the activity to levy payers. Depending on the activity, this may be done by distributing the levy payments on an equal basis (a flat levy rate). Alternatively, differentiated levy rates could be used to more closely reflect resources used by different groups of levy payers based on their risk, size or other criteria. Complex activities may justify the use of more than one cost driver to determine levy rates. The potential for cross-subsidisation among levy payers may increase if a levy rate does not bear a reasonable relationship to the cost driver of the activity.

Depreciation costs

Depreciation costs is understood as the recovery of the cost of an investment over the useful life of an asset. The depreciation cost is the amount determined following a policy approval for a capital investment by the Government or the Accountable Authority. A schedule of depreciation should be documented to ensure an appropriate amount is recovered each year from the activity or group of activities. For regulatory activity that is charged for, a depreciation schedule should be published in the CRIS to show aggregate asset value, accumulated depreciation and value outstanding, to demonstrate that over recovery is not occurring. Note that when the asset is only supporting a single activity output it is a direct cost and should be treated as such.

The level of the price is driven by the nature of activity and the policy objective.

The design of the price model should be consistent with the Government policy objective for the activity and the high-level charging approach approved as part of policy decision. The price model will also vary depends on the activity type.

All charges should be:

• clear and easy to understand
• closely linked to the specific outputs of the activity
• set to recover the full efficient costs of the specific activity as default
• efficient to determine, collect and enforce
• set to avoid volatility, while still being flexible enough to allow for changes based on fluctuations in demand or costs.

Flexibility of price

Entities should ensure that the price model has appropriate mechanisms in place to ensure that the decision on the price reflects any change in costs, including increases or decreases due to demand, indexation, process changes or technological developments. This review of alignment of price to the decision should occur at least annually and on a shorter time frame where evidence exists that the price may not be reflecting the true cost of the effort.

Balance in price effort

Entities should balance the need for an administratively simple price model against the legal and policy need to closely link the price paid to the cost caused.

• Less frequently changed regulatory (cost recovery) fees or levies generally provide more certainty for both non-government stakeholders and the entity. This makes the charging simpler to administer, but may require stakeholder consultation about the risk of actual prices not aligning to actual costs and careful planning, budgeting and management to ensure final revenues and expenses align over the period.
• A single price point is only appropriate where the effort each individual causes is substantially the same.
• A tiered price model would only be appropriate where it is clear the effort each individual causes can be clearly grouped, with little variation within the grouping and few, irregular or ad hoc instances, where the effort the user causes is between these points.

Entities should consult with Finance on any proposal to use a price model that does not closely align the expected actual costs of an output.

Charging Framework Examples of Pricing Model