Best Practices When considering an internal service pricing system, governments should identify goals of internal service pricing; develop allocation strategy; define level of costing detail; determine cost of service; decide basis of allocation; and consider potential drawbacks.Internal services are those responsibilities a government provides to support its own internal operations. Common examples of internal services include information technology, payroll, motor pool, budgeting, legal, accounting, and human resources. Certain management objectives are served by creating a system to assign prices for the use of these internal services, which are then assessed to the departments that use the services. However, there is a cost to develop and maintain internal pricing systems. Governments must weigh the benefits of an internal services costing system against the cost and complexity of system design choices. Please note that this best practice is intended to apply to internal service charges regardless of whether it is accounted for in an internal service fund or as a general fund overhead allocation. GFOA recommends that governments follow these steps when considering an internal service pricing system:
Identify goals of internal service pricing. As a first step, GFOA recommends that governments identify the goals they hope to achieve through a pricing system for internal services. The goals will guide the design of the system. Potential goals for a pricing system include:
Develop allocation strategy. After the goals have been identified, the organization must decide which internal services will be priced and allocated to user departments. To make this decision, it may be useful to differentiate between market services and those that have more of a policy or regulatory character.
Define level of costing detail. Governments need to determine the level of detail associated with costing services.
Determine cost of service. With the internal services identified at either a high or low level of detail, the next step is to determine the cost of the service. The elements of the cost that should be considered include:
Decide basis of allocation. With cost of the service decided, the bases for allocating costs from the internal service to customers must be decided. Table 1 provides examples of internal services and cost allocation bases. Below are general principles that should be observed when determining bases.
A government might also consider the accounting mechanism for the internal charge. An internal service fund provides the most detailed accounting, but also entails the most administrative effort. If the goals of the internal charge are modest (e.g., not charging back to federal grants, full cost recovery is not a goal), then it may be easier to simply recognize the charge as a general revenue in the general fund (or some other fund as may be appropriate to the circumstances). Governments should also regularly review their internal charge rates against actual experience for appropriate adjustments. Governments should also develop guidelines to determine what will happen to excess funds should an internal charge generate cost recovery proceeds in excess of actual costs. Consider potential drawbacks of internal costing systems. Finally, governments should be aware of the drawbacks of internal costing systems below and should consider mitigating strategies.
Notes: 1 However, it should be noted that comparing internal charges to a potential external service providers proposed fee cannot be the basis for a sound outsourcing decision because the external providers proposed cost must be compared to the internal costs the government will avoid (i.e., no longer have to incur) by using the external provider (known as avoidable costs). For example, there may be overhead costs included in an internal charge that will not be eliminated (avoided) by using an external provider. 2 If used, the interest rate should be consistent with any governing laws/regulations. 3 For example, single step allocations are the least complex, but is less precise, while reciprocal allocations are more precise, but much more complex. For a complete explanation of these methods please consult. R. Gregory Michel. Cost Analysis and Activity-Based Costing for Government. (Chicago, Illinois: GFOA) 2004 4 For example, the customer may provide value back to the internal service in some way that justifies a lower charge. 5 IT governance systems are on example of a means for giving customer departments input into rate modeling decisions. See GFOAs publication IT Budgeting and Decision Making (2009) 6 For example, the Federal Office of Management and Budget circular A-87 outlines standards for determining costs which can be charged to Federal grants and reimbursement contracts.
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