Estimation of cost causality has always been an important part of the accountant’s work. This includes the identification, classification and estimation of factors causing a change in the total cost of a related cost object. In the recent literature these factors are called cost drivers. Different approaches and conceptual frameworks for understanding cost causality are found in the economics, strategy and accounting literature. This paper examines different cost driver approaches in a public sector setting. The study is based on data from primary and secondary schools in the four largest cities in Norway. The findings show that a strategic management accounting approach provides a framework for selecting a broader set of explanatory variables than the traditional cost estimation literature. This set includes product attributes, institutional factors and government policy as cost drivers in the public sector.
Cost causality has always been a major theme in management accounting, both as
a guideline for the allocation of cost to different cost objects and as a base for the
design of responsibility accounting systems (Shillinglaw, 1989). Insight into the factors
causing a change in total cost is also important for estimation, planning, performance
measurement and decision making in the public sector. Changes in policy may cause
changes in total cost and an important part of the accountant’s work is to estimate the
effect of discretionary decisions. This also relates to the role played by the budget in
the public sector, both as a tool for allocating resources and as a tool for measuring
performance. The introduction of more formula funding systems in the budget processincreases the importance of knowing how and why different factors change total cost.
Structural differences in factors changing the total budget and factors changing total
cost might encourage exploration of these differences (Bjørnenak and Pettersen, 1999).
Knowledge of cost causality is also important for performance measurement in the
public sector. Budget variances may be analysed using this knowledge and exogenous
factors may be separated from endogenous factors to explain, for example, a budget
deficit (or surplus).
The recent introduction of Activity Based Costing (ABC) has increased the focus
on factors causing cost, partly by naming them cost drivers. The rhetoric of ABC is
heavily based on the failure of traditional systems to represent cost causality in their
allocation of costs (see e.g. Cooper, 1988). The ‘modern’ approach to the allocation
problem is to identify and use cost drivers (e.g. Cooper and Kaplan, 1988). Although
the original ABC articles written by Cooper and Kaplan did not include any definitions,
a cost driver may be interpreted as any factor that causes change in the total cost of a
related cost object. This very broad definition is now commonly used in textbooks (e.g.
Horngen et al., 1997). However, the more recent ABC literature stresses the difference
between consumption and spending, i.e. cost driver being a factor causing a change in
the consumption of resources. This consumption may or may not cause a change in
total spending (Cooper and Kaplan, 1992). From this perspective a cost driver may beinterpreted as a factor causing workload and not necessarily a change in the total cost
(Innes and Mitchell, 1992).
Cost causality also relates to the estimation of cost functions by using econometric
analysis. This may be called an econometrics or economist’s approach to the cost driver
concept, although the term cost driver is seldom used:
In general estimation literature, these explanatory variables are called independent variables.
Recent jargon in accounting, marketing, and management literature calls them cost drivers.
This is a little too trendy for our taste.
Demski (1997), p. 9.
Some studies integrate ABC terms and the economist’s approach by using, for
example, regression analysis to estimate the effect of different cost drivers (Foster
and Gupta, 1990; Banker and Johnston, 1993). This approach to estimate local linear
approximations to underlying cost functions is fully consistent with the traditional cost
estimation literature (Demski, 1997).
Another approach to the cost driver concept is found in the strategy literature. In
fact, Porter’s (1985) definition of 10 structural cost drivers might have begun the
spread of the cost driver concept in the literature. This set of cost drivers is further
developed in the strategic management accounting literature (Riley, 1987; Shank andGovindarajan, 1993) where cost drivers are divided into groups. Structural cost drivers
are factors that affect the underlying economic structure of the organization, such
as scale, scope, experience, complexity or technology. The other group of drivers,
executional cost drivers, focuses on how the activities are executed. This group includes
continuous improvements, total quality management (TQM), capacity utilization,
production layout, linkages and product configuration.
Another branch of the SMA literature focuses on product attributes as cost drivers
(e.g. Bromwich, 1990). This approach is based on the work of Lancaster (1966), which
states:The attributes are not only creating value by offering service potential for the
customer, but different product attributes may also cause differences in cost. Thus
analysing differences in attributes may be a way of understanding differences in costs.
In this paper four approaches are used to identify and analyse cost differences. These
are:
1. A regression analysis
2. An activity analysis
3. A structural cost driver analysis
4. A product attribute analysis
The purpose of this study is to use these perspectives to understand how the cost driver
concept may be applied in a public sector setting. Most of the empirical literature on
cost drivers, especially in the ABC and SMA literature, is based on studies of private
sector implementations. An important difference in the public sector setting is the use of
budgets to allocate resources to services. The increased use of explicit funding formulae
seems to be a key part of the New Public Sector (Edwards et al., 1995; Mayston, 1998).Understanding the way resources are allocated through the budget may also be a key
to understand differences in resource consumption. Studying the budget process may
be a way to identify independent variables. Thus, the formulae funding approach may
be a supplement to the other four approaches. However, the importance of the budget
formulae will of course depend on whether and to what extent budget variances occur
and are allowed.
This paper focuses on cost differences in Norwegian schools. Based on data from
all primary and secondary schools in the four largest cities, the paper addresses the
following research questions:
• What is causing cost differences between different schools and cities?
• How do the four alternative approaches differ as frameworks for modelling the
causal factors?
• What are the implications of different perspectives on the design of cost management
systems in the public sector?
The findings of this study show that the cost driver concept, although ambiguous, may
be a tool for understanding cost causality in schools. The different aspects may also
contribute differently. The economist’s approach may identify underlying subjective
factors at a level of statistical significance. The activity analysis provides disaggregated
data to better understand differences in the use of resources. Benchmarking the cost
of activities in the public sector may be used both for performance measurement and
to identify and adopt better ways to organize and execute activities. However, the most
important aspect of these two approaches may be the development of knowledge that
can be used in the structural cost driver analysis and product attribute approach.
Traditional cost analysis focuses on ‘direct’ cost drivers, i.e. factors that cause a direct
change in total cost. Typical examples are number of schools, number of classes and
volumes of different categories of pupils. This perspective is illustrated in Figure 2.
Both the regression analysis and the activity analysis are based on this perspective.
The structural cost driver approach and the product attribute approach are not in
conflict with the traditional perspective. Number of classes and schools are still the
important direct drivers. However it opens up a broader perspective on cost differences.Firstly, cost differences may be seen as product attribute differences. This is important
because it emphasizes the lack of valuation of the product attributes which is commonly
found in the public sector. The other difference is the search for underlying explanatory
variables, such as differences in institutional cost drivers, differences in discretionary
policy or in the way activities are performed. This complexity of causal factors is often
ignored in the management accounting literature. A model based on the SMA literature
is shown in Figure 3.
The cost structure of schools is complex, including a lot of different causal relations.
Understanding this complexity may be an important tool for policy makers. The SMA
framework highlights the importance of differences in product attributes, and the
fact that unit cost should not be benchmarked without taking differences in product
attributes into account. It also highlights the fact that those structural decisions (i.e.
number and location of schools) and exogenous institutional factors (teachers’ contracts
and government regulations) are often more important explanations for cost differences
than factors controlled by the school. This should be taken into account when a control
system is designed in the public sector.
Although the SMA framework is the one with the largest private sector bias it is
also found to be the one with the biggest potential for exploring the cost structure.The identification and quantification of strategic cost drivers along with the costing
of product attributes may be a fruitful ways of highlighting public choice problems. It
also enriches the work of management accountants in the public sector, which may be
valued per se.
