Page 108 - DCOM206_COST_ACCOUNTING_II

Unit 5: Differential Costing

Notes
Exhibit 1: Make-Versus-Buy Cost Analysis

It is also important to examine whether the resources (labour, facilities, equipment, and
material) used for the service are formally or informally shared with other government
services. For example, garbage collection crews might assist with snow removal after a
heavy snowfall, or they may help the parks and recreation department clean up after a
summer festival. All of these details must be documented in the contract to arrive at an
accurate cost comparison and to avoid disputes with vendors after the contract is signed.

Step 2: Calculate the in-house costs that would be avoided by outsourcing the service. The
second step is to calculate the total government costs that would be avoided or saved by
outsourcing the service. To determine the costs that would be saved, first itemise the full
cost of the service, including all of the direct and indirect costs. Then, use this list of costs
as the basis from which to determine the specific costs that would be saved if the service
were outsourced. GFOA’s recommended practice on measuring the cost of government
services defines the in-house costs saved by outsourcing as those costs that are either
eliminated immediately or eliminated after a brief transition period. It is important to
remember that many fixed costs—overhead costs in particular—will remain the same
even though the resources behind those costs are not being used.
Cost estimates should be made on a multi-year basis and discounted to a present value. To
ensure that inflation is treated consistently, nominal costs should be used if a nominal
discount rate is used, and real costs should be used if a real discount rate is used.
Step 3: Calculate the total costs of outsourcing. The third step is to calculate the total costs
of outsourcing the service. The costs of outsourcing include the contractor’s bid price, the
government’s contract administration costs, and the government’s transition costs, less
any new revenue generated from outsourcing. These cost estimates should be discounted
to their present value and cover the same period as the cost savings in the previous step.
To be consistent throughout the analysis, only new costs should be counted, not the costs
that would be incurred regardless of who provides the service. For example, if a government
already employs workers to perform contract administration, these costs should not be
included in the analysis as long as they are absorbed by existing employees.
Contd...

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