Best Practices

Measuring the Full Cost of Government Service

Governments should calculate the full cost of the different services that they provide.

Measuring the cost of government services is useful for a variety of purposes, including performance measurement, comparative analysis, grants administration, disaster recovery cost documentation, establishing government charges and fees, and evaluating service delivery alternatives. The cost of these services may be different than those recorded for general purpose external financial reporting. Shared costs should be allocated systematically and rationally, and the method of allocation along with a reference to information on the methodology (calculation details, etc.) should be disclosed.

GFOA recommends that governments calculate the full cost of the various internal services for managerial reporting purposes.

Service Related Decisions. Cost data can be extremely useful in identifying situations where a government should evaluate service delivery alternatives (this would exclude situations where a government is obligated by law or contracted to provide services directly). Cost should not be the sole factor used to determine how a government will provide services. Effectiveness, efficiency, compliance, and other factors are critical components of any service-delivery decision. It is important that full cost data be used appropriately in decision making. GFOA’s best practice on evaluating service delivery alternatives covers such items as distinguishing avoidable costs from unavoidable costs, taking into account the cost of transition in service, flexibility of the agreement, offsetting revenues, communicating to stakeholders, and monitoring expense and performance.

Direct vs. Indirect Costs. The full cost of a service encompasses all direct and indirect costs (both operating and capital) related to that service. Direct costs include the salaries, wages, and benefits of employees while they are exclusively working on the delivery of the service, as well as the materials and supplies, and other associated operating costs such as utilities and rent, training, and travel. Likewise, they include costs that may not be fully funded in the current period such as compensated absences, interest expense, depreciation or a use allowance, and pensions, and other postemployment benefits.

Indirect costs include shared administrative expenses within the work unit and in one or more support functions outside the work unit, the entity-wide indirect costs (e.g., legal, finance, human resources, facilities, maintenance, technology). It is important to include both types of indirect costs. An internal pricing system should include the following steps. (1) identify cost objectives; (2) develop allocation strategy; (3) define level of costing detail; (4) determine cost of service being allocated; and (5) decide basis and responsibility of allocation (see GFOA’s best practice on Indirect Cost Allocation). Care should be taken in recognizing that some indirect costs may not be avoided by eliminating or reducing a particular service.

Other Considerations. Below are general principles that should be observed when determining other cost decisions.

  • Cause-and-effect relationship. Costs should be allocated based on usage or causal factors relating to costs incurred by the service provider. Care must be taken when comparing year-to-year indirect cost allocation if the allocation methodology has intentionally changed or costs have changed dramatically. Significant swings in the results in total and by unit (e.g., department or agency) should be investigated to ensure there is legitimate reason and that no mistake or unintentional allocation has occurred.
  • Benefit received. The basis for allocation should bear a relationship to the benefit the customer receives from the service. It is important to tie the allocation method to the benefit received to avoid pushback from the receivers of the indirect cost.
  • Fairness. The method of cost allocation must be seen as fair and legitimate by the users of the costing system. Any fee should be charged equitably based on use and other considerations. The allocation method used should be as close of a proxy to the underlying cost as possible. Customers and internal users must understand how the costs are calculated and should have a role in determining how the price system will be structured. Allocating shared internal service costs to various government units and services must be completed in a neutral, data-driven manner. Often it is expedient to retain an outside entity to perform an indirect overhead allocation study or similar analysis for this purpose.
  • Legal constraints. State or Provincial laws may place constraints on how charges are developed. For example, if the charge for providing a service exceeds the true cost of the service, it could be construed as a tax under the law. Also, federal regulations on grants may place limits on internal charges against grant programs.
  • Communication between accounting and budgeting. It is essential that accounting and budgeting staff communicate to make sure that accurate figures are used when developing historical and projected costs; and that accurate rates are charged/allocated for service provision, when appropriate. It is also important to know which costs will be allocated for accounting purposes. Governments should calculate the indirect cost rate that will be charged to all departments and other funds.[1]
  • Systems. In conjunction with the communication between accounting and budgeting, clear systems must be in place to allow for the tracking of these costs and be used for decision-making purposes.
  • Cash flow. Determining costs on a cash flow basis is also important, as this will assist the government in determining the relative value of proposed services on a net present value basis. Although return on investment is not a primary driver of determining government services provision, it should be a contributing factor.
  • Duplicate expense reporting. Beware of double-counting in reporting when the costs from the supporting departments are allocated to the operating departments.
  • Federal or other approvals. Some grants require that an entity’s indirect cost report is federally approved. The timing of those approvals should be built into the process to ensure on-time completion of all related tasks.
  • Methods. Some entities have the option of using a de minimis indirect cost rate where eligible for federal grants, if they do not have a negotiated indirect cost rate. A simplified allocation method assumes that all entities receive the benefits of the indirect costs equally. If that is not the case, a multiple step allocation method should be used.

1. Allocating the indirect costs to departments within the fund that generated the indirect costs may be counter-productive for accounting purposes since it has no impact on the fund’s position. However, doing the allocation across all departments, even if the government does not actually charge those departments in the same fund, will assist in ensuring the government will not overcharge other funds for costs beyond their share.


This best practice was previously titled Full Cost Accounting for Government Services

  • Board approval date: Friday, October 1, 2021