2015 Public Financial Publications, Inc.

An Analysis of the Purposes of Cost

Accounting in Large U.S. Cities
ZACHARY T. MOHR

Research on U.S. government cost accounting has received little attention in recent
years. This article analyzes four of the main reasons why large cities use cost
accounting: performance management, grant overhead recovery, rate setting, and
cost management to reduce scal stress. Using a cross section of 81 cities with
populations over 100,000 people, it nds that cost allocation plans are correlated with
lower fund balances and are positively correlated with enterprise expenditures. These
correlations suggest that the use of cost accounting is related to scal stress and rate
setting. Research limitations and policy implications are addressed

INTRODUCTION
Why governments use cost accounting is a question that is of the utmost importance in the current
climate of scal stress, and it is especially timely for local governments such as cities that cannot
devolve responsibility for services to lower levels of government. In the past, cost accounting
was seen to be an important tool for dealing with scal stress (Levine 1985; Coe and OSullivan
1993). It is the tool that bridges the gap from the prospective policy of the budget to strategic
decision making about what types of services and management are the most cost effective. It
further has the benet of being useful for setting adequate rates for services that are provided via
user charges, providing accurate information that puts performance into perspective, and allows
overhead for grants to be collected.1 In spite of these purposes for cost accounting, there is little
empirical research on why United States (U.S.) local governments use cost accounting.
In fact, there is very little research at all on cost accounting in U.S. government, which makes the
question of why local governments use cost accounting an important topic. This analysis reviews
the main reasons for cost accounting in the literature, which includes performance management,
rate setting, recovering grant overhead, and cost management due to scal stress. It then tests these
Department of Political Science and Public Administration, University of North Carolina Charlotte, Charlotte, NC.
He can be reached at zmohr@uncc.edu.
1. Elsewhere, I have referred to these four purposes as rate setting, performance netting, grant getting, and blood
letting (targeted cost management). This is a mnemonic that I have found useful for remembering these four primary
purposes.

Mohr / An Analysis of the Purposes of Cost Accounting

95

purposes on a cross section of 81 U.S. cities

with populations over 100,000 people. The
results show that scal stress and rate setting
are signicantly correlated with a citys use
of a cost accounting plan. Performance
measurement and grant activity did not
have signicant relationships to the use of
a cost allocation plan in local governments,
which means that there is more to be learned
about cost accounting in U.S. local governments. While the limitations of the present
research are acknowledged, this research
may provide a useful foundation for future
research on government cost accounting.

APPLICATIONS FOR PRACTICE

 Cost accounting is not used solely for grant
overhead cost recovery. This analysis suggests
that cost accounting is related with cost
recovery of enterprise funds and a government's fund balance.
 Cost accounting has important policy implications and the type of cost accounting that is used
may be related to the purposes of cost
accounting.
 Cost accounting may also be used with
performance management and to understand
the costs of collaboration.
 A list of additional reading on cost accounting
is provided in the appendix that can provide
more technical details of various types of cost
accounting. Cost accounting is NOT just ABC.

LITERATURE REVIEW
Recently, authors have expressed renewed interest in cost accounting but have suggested that
practical knowledge of it is limited (Williams 2003; Rivenbark 2005). The review of the
literature suggests that there are four primary reasons that local governments use cost accounting,
and the literature on businesss use of cost accounting suggests that there are a variety of
contextual factors that would also affect the utilization of cost accounting. These literatures
provide the basis on which to examine why governments use cost accounting.
Before the reasons why a local government would use cost accounting are discussed, it is
useful to review what cost accounting is and what it is not for this paper. Cost accounting may
refer to two distinct activities for a government. The rst type of cost accounting may refer to cost
accounting for contracts. This type of cost accounting for the federal government is associated
with the Cost Accounting Standards Board (CASB) and the Federal Acquisition Regulations
(FAR). This type of cost accounting is part of the contract process and often uses indirect cost
rates to allocate some share of the indirect costs of project toward the reimbursement for the
overall project. Local governments also use contract cost accounting for construction projects
and other large procurement purposes. The second type of cost accounting is a system for how the
indirect cost rates are determined and is developed to allocate the indirect costs of government
down to service producing departments. This system of allocation is known as a cost allocation
plan and it can be used for a wide variety of purposes that will be outlined in the following
subsections of the literature review.
The key purpose of the cost allocation plan is to allocate, or distribute, the costs that are not
directly associated with the production of the service so that the government has a better estimate
of the cost of producing the service.2 The direct costs are those costs that can be tied directly to the
2. Cost accounting or cost accounting plans can be used by any organization that produces multiple goods or
services; see especially Kaplan and Atkinson 1998 and Kaplan and Cooper 1998 on this point.

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service through the accounting system. The indirect costs are the other costs that are needed for
production but that are accounted for separately. Common indirect costs are things like general
administration, human resources, information technology, accounting, etc. These are resources
to the organization that are consumed as the government produces goods and services but that are
not clearly tied to the production of the service. The way that the government ties the indirect
costs to the direct cost is called the allocation basis or cost driver. There are many more concepts
that require explanation to have a thorough understanding of cost accounting and cost allocation
plans. However, there are many excellent textbooks that describe cost accounting in public and
private organizations, and the purpose of the present research is to look at the factors that are
related to the use of cost accounting in cities and not how it is done. Interested readers are referred
to the textbooks and professional manuscripts included in the appendix for further discussion of
the many aspects of cost accounting that need to be considered when developing an appropriate
cost allocation plan or system. Furthermore, additional considerations and avenues for research
are discussed in the Policy Implications section.
Is Performance Correlated With the Use of a Cost Allocation Plan?
Renewed interest in cost accounting in U.S. governments comes from a camp of scholars not
directly concerned with budgets and nancial management, per se, but with government
performance writ large (Williams 2003; Melkers 2003; Rivenbark 2005, Premchand 2006).
Modern conceptions of performance are concerned with shifting attention from outputs to
outcomes, and one of the most important outcomes is the cost-effectiveness of public programs
(Hatry 2006; Hatry and Harry 2010). Studies largely nd that cost-effectiveness or efciency
measures are one of the least reported types of performance measurements (Julnes and Holzer
2001; Ho and Ni 2005), which some authors suggest is because cost data is not sufciently
comparable (Ammons and Carter 2000). Cost accounting improves the measurement of
efciency by including all of the organizational costs used to produce the service, including both
direct and indirect costs.
Cost accounting is critical to benchmarking because it accounts for all levels of resources when
comparing the results of different cities services (Ammons and Carter 2000; Rivenbark 2000;
Ammons and Rivenbark 2008). It is misleading to compare the outcomes of a city department to a
similar department in another city if the departments do not have equal levels of resources. Cost
accounting allows for this comparison by including indirect costs such as employee benets,
capitalization costs, and indirect resources such as human resource and information technology
support. While the need to account for the cross functional costs that go into services is well
developed in the performance management literature, with the exception of the North Carolina
benchmarking project, there is little evidence that cost accounting is a standardized practice for
local governments for performance measurement or otherwise (Rivenbark 2005).
In spite of assessments that cost accounting is not well developed in local governments for
performance uses, performance is an important trend in public nancial management (Melkers
and Willoughby 1998; Berman and Wang 2000; Ho 2011). It should be expected that as local
governments further use performance measurement that they will seek out ways to more

Mohr / An Analysis of the Purposes of Cost Accounting

97

accurately measure the costs of their services. Therefore, it is expected that those governments
that report performance for their departments and services will have a positive correlation with a
cost allocation plan.
Is Rate Setting Correlated With the Use of a Cost Allocation Plan?
The original use of cost accounting was to set rates for activities such as the railways and textile
factories. Being able to recover the full costs of production is a key to protability for any
business. Because governments do not primarily rely upon markets for the resources to sustain
themselves, cost accounting may not be as critical for government entities. However, as local
governments have responded to scal stress over the last quarter of a century, they have relied
more upon user charges to fund many services (Jung and Bae 2011, Sun and Jung 2012). While
the literature on user charges assumes that we know the full (and correct) cost of the services, one
of the original reasons for advanced cost accounting methods, such as activity based costing
(ABC), was that cost accounting in the 1980s was not sufcient to provide accurate costs in the
face of global competition (Johnson and Kaplan 1987; Kaplan 1988). ABC was criticized
for being overly relied upon by local government in certain contracting and budgeting
decisions (Brown et al. 1999; Mullins and Zorn 1999), but other research showed that it was
valuable for helping to set accurate rates and compare costs in these decisions (Coe and
OSullivan 1993; Weiss 1997; Hendrick 2011). One of the only recent empirical examinations of
cost accounting in U.S. government came from the federal government and showed that the
source of funding inuenced the use of cost accounting (Geiger and Ittner 1996). Federal
agencies that rely on charging other federal agencies or outside organizations for the majority of
their revenue such as the Coast Guard are more likely to utilize cost accounting to establish the
rates to be charged.
These experiences with ABC and the practical realization that accurate rates for utilities or
enterprise activities require an assessment of the indirect cost of production leads to cost
accounting being more likely in a government with higher levels of enterprise activity. The
counter to this claim is that governments may rely upon the use of outside consultants to help set
their rates. As Mullins and Zorn (1999) charged, the cost accounting system does not consider
externalities or transactions costs, and governments may want to consider these costs in their rate
setting by employing a more thorough method of evaluation that can evaluate externalities such
as benet-cost analysis. The level of enterprise expense relative to total expense proxies for the
relative use of user charges because enterprise funds are the activities for which a fee is charged
(Gauthier 2005). All else equal, it is expected that cities that have higher levels of enterprise
activity have a positive correlation with the use of a cost allocation plan.
Is Grant Reimbursement Correlated With the Use of a Cost Allocation Plan?
Another reason that U.S. governments use cost accounting is to recover the cost of overhead and
indirect costs in the reimbursement of their grants. Organizations that receive over $500,000
from the federal government are required to le single audits. If the public organization is going

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to count any indirect expenses such as building space, utilities, or other administrative expenses
to go along with the direct expenses charged back to the grant, they must have a cost accounting
plan to establish indirect cost rates (Circular A-87, and 2 CFR Part 215). Other programs that
include the need for cost accounting, such as FEMA disaster assistance, require that to be
reimbursed for time spent cleaning up after a storm or natural disaster that the city keeps separate
records that also account for indirect expenses.
The need for cost accounting at both the state and federal level for grants promotes the use of
cost accounting plans. If governments forgo cost accounting, they may forgo receiving
compensation for the cost of common indirect costs. Some organizations may choose to not
account for these costs because they feel that the cost recovery does not justify the cost of
measurement. Further, they may also believe that including these costs in grant applications
makes their grants less competitive. So, while cost accounting is required to recover indirect costs
for grants, it is not necessary that all governments that receive grants use cost accounting.
However, organizations that get more of their resources from grants may also have a higher level
of indirect resources that will be utilized in the discharge of grant activities for which the
organization needs to be compensated. Therefore, it is expected that organizations with higher
levels of grant resources will have a positive correlation with the use of a cost allocation plan.
Is Fiscal Stress Correlated With the Use of a Cost Allocation Plan?
A nal purpose of cost accounting is the management of the costs of providing a service, or cost
management. Cost management is all of the activities that a government might employ to drive
down its cost. It is a response to scal stress that forces governments to prioritize services and
look at alternative means of service provision. Cost management may mean simply cutting out
things that are not needed in production, or it might be a very painful elimination of a service that
does not have the priority of other valued services. Either way, cost accounting and cost
management is a common response to scal stress (Levine 1985, 694).
Cost management can be done in a variety of ways. Coe and OSullivan (1993) found that
cities that used cost accounting thought it was important for justifying budget decisions and
deciding whether to contract services. The City of Indianapolis used cost accounting to learn that
many of its public works procedures were inefcient. The city then put its services out for bid and
allowed the city department to bid on the job. The department won most of the bids because the
department was able to drive costs down by 60 percent (Kehoe 1995, 1011). The Army had a
similar experience with cost accounting and managing for costs. When they looked at how much
the cost of keeping additional warehousing and dining facilities was adding to the total cost of
running a garrison, they concluded that the over-use of these indirect costs could be reduced and
the savings could be spent better elsewhere (Geiger 2010).
These examples justify cost accounting as a useful response to reduce total costs, but cost
accounting is important for making informed decisions about alternatives as well. As the case
study of the public health clinic in Kaplan and Atkinson (1998) notes, a lack of cost accounting
could obfuscate the least costly of two equivalent services such as in-home versus hospital
dialysis treatments. In this case study, the treatment options produced equivalent results for the

Mohr / An Analysis of the Purposes of Cost Accounting

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patients but, because the method of cost accounting obscured the true cost of indirect resources
used in the hospital treatment, the apparently more protable clinic treatment was actually losing
money and being subsidized by the in-home service. This example shows that cost accounting
can be useful when choosing between equivalent forms of service provision for a public
organization. By not accounting for indirect resources, the hospital may have incorrectly chosen
to eliminate the protable service.
As cities struggle to nd resources in the current climate of scal stress, they must actively
work to reduce costs and to target cuts where they are the most benecial. Having accurate cost
data are critical in this effort. Cost accounting provides the means to both manage costs and make
accurate cost comparisons. This suggests that cost accounting is most important to cities that are
experiencing high levels of scal stress and need to make important cost savings. This cost
management is a targeted blood-letting that is in stark contrast to the predominant salami slicer
approach of across the board cuts which may be favored when accurate cost data does not exist.
Providing cuts to services is in stark contrast to the predominant approach of trying to smooth
expenditures across scal cycles (Khan 2000; Marlowe 2005). Fund balance has been
operationalized as scal slack (Marlowe 2005), as a response to scal stress (Hendrick 2006), and
as an indicator of scal stress in local government (Kloha et al. 2005). As organizations have
declining fund balances, they have fewer resources to use for decit spending. Additionally, it
may signal a need for greater borrowing but the government may need to pay a premium for
borrowing to make up the decit (Marlowe 2011). In this paper, unreserved fund balance is used
to indicate scal stress (Kloha et al. 2005) and higher levels of fund balance are likely to be
negatively correlated with the use of a cost accounting plan.
Controls for Institutional Variables
Many additional factors have been noted in the literature on why organizations use cost
accounting. A variety of commentators have noted that cost accounting faces several institutional
impediments (Mullins and Zorn 1999; Rivenbark 2005). Additionally, the literature on business
cost accounting contains an important literature on the variables that facilitate the use of cost
accounting. Along with competitive pressure, which others have suggested is similar to scal
stress (Brimson et al. 1999), the business literature nds that contextual or institutional variables
account for the use of certain cost accounting methods and the perception of its usefulness
(Anderson and Young 1999). These variables are used in the current study to extend what is
already known about cost accounting in the realm of business organizations into the similar but
distinct realm of local government.
One of the most important variables in the business literature is the impact of leadership.
Lower level managers and employees look to the upper level managers in the organization to
see if cost accounting is considered to be important by the organization. As lower level
employees would prefer to keep the costs of their department to a minimum (Simon et al.
1954a) and preserve valuable departmental knowledge (Crozier 1964), employees tend to
resist cost accounting. Leadership that can demonstrate the critical importance of cost
accounting and cost management for the organization is necessary to get the organizational

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buy-in that is necessary to start managing the full cost of services. The typical way that cost
accounting research is studied suggests that cost accounting is a professional managerial
tool (McCue 2001; Purtell and Fossett 2010). While a more thorough variable that could
indicate the level of professionalization of the entire budget and nance function would be
desirable, the professional leadership of the organization is proxied by the appointment of a
professional city manager.
A second and important institutional variable that affects cost accounting is the hierarchy of
the organization (Anderson 1995; Gosselin 1997). The hierarchy of the organization is thought to
be important for two primary reasons. The rst is that hierarchical organizations have decision
makers that are further away from the actual act of creating products and services and so they
have a greater need for cost accounting information that can summarize the indirect and direct
costs of their products. The second reason that hierarchical organizations utilize cost accounting
more is that the hierarchical organization reduces transaction costs from lower level managers
not being able to inuence the organizations leaders directly. As stated before, the lower levels
will tend to resist the use of cost accounting if it puts their department in a negative light, and they
may use gaming and bureaucratic politics to avoid revelation of the full cost of the service (Mohr
2013). The organizations structure can minimize gaming and transactions costs by having a
strong hierarchy, which will also benet from useful cost accounting information.
The next common variable in the literature is the size of the organization. This is especially
important for cost accounting because larger organizations tend to have more activities and more
overhead to spread around. More services and more overhead are related to a greater likelihood
that large cities will use cost accounting plans. The size of the city in terms of population is
relevant because larger population cities tend to have more roads, more sewers, more parks and
more of everything for which it is useful for leaders to have accurate costs. Large budget cities
need cost accounting because they may have more benets, more indirect costs, and more
services to accurately cost. Size variables are important to why organizations would use cost
accounting, and generally a larger city would have a greater need for a cost accounting plan.
A restraint upon cost accounting is the inuence of interest groups. Within the cost accounting
literature the interest group that is most concerned is typically the unions (Anderson and Young
1999). Unions tend to discourage cost accounting as it tends to show that divisions are not as
protable or cost effective as they would otherwise appear to be. Positive union relations and
positive working arrangements with unions are expected to increase the use of cost accounting.
Conversely, laws and rules that limit the power of unions in relationship to management are
likely to facilitate the management tool. Where unions are weak, the expectation is that the city
will be more likely to have a cost accounting plan. As an attentive reviewer pointed out, there are
likely many interest groups that inuence the cost accounting practices of a city, including
business groups such as Chambers of Commerce and the for-prot and non-prot organizations
that contract with the government. It is likely that these organizations would like the government
to use cost accounting because it will allow the government to better manage their nances for all
of the reasons outlined. However, there is very little empirical evidence in the literature on cost
accounting that contract partners are likely to be a key advocate for cost accounting, but it should
be noted that there is almost no recent scholarship on government cost accounting. The need for

Mohr / An Analysis of the Purposes of Cost Accounting

101

good cost accounting is highly linked to the contract, or make-versus-buy, decision. At present,
there is simply a dearth of literature on the topic but it should be noted that this could be a very
important future line of research. Following the standard practice of the previous literature on
cost accounting implementation, this research controls for the inuence of unions as the primary
group to inuence cost accounting.
Controls for Fiscal Capacity
The level of scal capacity of the government may also importantly inuence cost accounting.
Fiscal capacity may be either untapped potential resources or it can be the resources that a
government is using (Jacob and Hendrick 2012). In times of scal stress, scal capacity is
increasingly noted as an important factor for local government (Kincaid 1989; Hendrick 2011).
The problem with scal capacity for cost accounting research is that it is not clear how it should
affect the use of cost accounting. On the one hand, there is the argument that less scal capacity
will lead to greater use of cost accounting because of greater scal stress (Brimson et al. 1999).
However, there is the opposite nding that nancial resources are needed for the development
and use of cost accounting (Anderson 1995; Anderson and Young 2001). According to the
literature, the presence of greater scal capacity will tend to reduce the need for cost accounting
but increase the probability that cost accounting can be maintained. Therefore, the presence of
scal capacity has an indeterminate affect upon the use of cost accounting plans.
The external scal capacity of the government is exogenous to cost accounting, but the
directionality of the effect is not clearly determined. In this paper, median income is used to
measure economic capacity and revenue per capita is included to proxy revenue capacity (Jacob
and Hendrick 2012). Controlling for these scal capacity and institutional variables, the
following research examines which factors are correlated with the use of cost accounting plans.

DATA AND METHOD

The data for this analysis comes from two email requests made to the nance directors of cities
over 100,000 population in November and December of 2011. An initial request was sent at the
end of November and a follow up request was sent two weeks later. This resulted in a response of
51 cities out of the 272 total cities. This was not quite 20 percent of cities in the sample and so a
follow up random telephone survey that simply asked whether the city had a centralized cost
accounting plan was conducted on 30 cities in April of 2012. The total number of observations
including both email requests and telephone surveys is 81 or 29.8 percent of the sample.3 The
results of the second random survey were similar to those of the rst sample of cities that
3. The small sample size is not unusual for cost accounting research that has a typically very low response rate
Ernst and Young 2003 had a response rate of 9 percent and a recent survey of local governments ABC practices had a
response rate of only 16 percent (Kennet, Durler, and Downs 2007). Again, the analysis of respondents to nonrespondents does not reveal a signicant difference between the sample and non-sample cities.

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TABLE 1
Descriptive Statistics
Variables

No

Yes

Mean

SD

Min

Max

Cost plan
Grant funding/Total expensea 100
Business-like activity/Total expensea 100
Fund balance/Total expenditurea 100
Performance measures
Median income
Revenue per capita
Control variables
Population (in thousands)
Total expense (in thousands)
Hierarchy
Manager
Right to work

28

26

53

55

24
45

57
36

17.95
31.34
7.2

25002
1026.8

321.04
717729.7
3.04

13.28
19.76
11.14

6014.73
818.94

397.04
1125521.8
0.75

1.06
0
24.06

13556
288.55

102.43
80390
1

74.52
82.53
47.82

45354
6727.53

2695.6
8528286
5

81 observations.

responded to the email request. The similarity between the random telephone survey and the nonrandom email request alleviates concerns about generalizability4 (Mohr 2013). The observed
variable is the presence or absence of a centralized cost accounting plan (Table 1). The use of a
cost allocation plan is a dichotomous dependent variable and logistic regression is used in the
analysis.
The explanatory variables of interest are taken from the cities 2011 nancial statements and
their 2012 budgets, which were retrieved from their websites. The measure for performance is
whether the organization includes performance measurements in its budget document (Ho and Ni
2005). Total expense was taken from the government-wide statement of activities in the
comprehensive annual nancial report (CAFR). The grant variable is also taken from the CAFR
and is the percentage of total expense that was accounted for by grants. Likewise the need for cost
accounting for rate setting is proxied by the amount of business-like expense divided by the total
amount spent on all primary government taken from the government-wide statement of activities,
and the level of scal stress was the unreserved governmental fund balance divided by the total
governmental expenditures taken from the governmental activities statement of the CAFR.
Fiscal capacity and control variables were taken from several sources. The scal capacity
variable of median income comes from the 2010 Census and the revenue variable is the total
revenue taken from the government-wide statement of activities divided by population of the city
from the 2010 Census to provide a measure of revenue per capita. The variables for manager and
hierarchy were generally found in the city budget. The manager variable is a city manager that
has executive responsibility and that is not elected. The hierarchy variable is the number of levels
4. Size and regional differences were not statistically different for the sample and non-sample cities.

Mohr / An Analysis of the Purposes of Cost Accounting

103

in the organization chart taken from the budget or CAFR between the public and the police
department. For example, an elected sheriff would be 1 because there is only one level for the
police department. A mayor with a sheriff that reports directly to her would have two levels. A
mayor that has a chief of staff or a city manager that reports to her would be a 3, and so forth. This
level counting method proxies for the usual survey questions regarding hierarchy. The union
variable comes from the National Labor Relations Board list of states that have right-to-work
laws (NLRB 2012) and population comes from the 2010 Census.

ANALYSIS
The results of the logistic regression indicate that two of the common purposes of cost accounting
are signicantly related to the use of cost allocation plans in large U.S. cities (Table 2).
Additionally, the level of hierarchy may also inuence the use of cost allocation plans. Due to the
limited amount of research on the topic, the non-ndings are also likely of interest to those that
study certain aspects of public nancial management and are discussed.
As the model shows, fund balance is negative and signicantly correlated with the use of a cost
allocation plan. As fund balance increases, the government presumably experiences less scal
stress and the model suggests that there is a negative correlation with the use of a cost plan. The
odds ratio shows that the change in the odds of one unit, which in this case is a 1% change in the
fund balance relative to total government expenditure, decreases the odds of the use of cost
accounting by 11.7%. The predicted probability of a citys use of cost accounting over a range of
TABLE 2
Factors Influencing the Use of Cost Allocation Plans
Variables
Grant funding /total expensea *100
Enterprise expense/total expensea *100
Performance measurement
Fund balance/total expenditurea *100
Total revenue/population
Median income
Total expense
Population (in thousands)
Hierarchy
Manager
Right to work
Intercept
N
AIC
a

Est.

Odds ratio

Std. error

0.018
0.044
0.268
0.125
0.001
0.000
0.000
0.005
1.240
1.294
0.808
2.494
81
101.46

0.982
1.045
0.765
0.883
1.001
1.000
1.000
1.005
3.456
0.274
2.244
0.083

0.026
0.024
0.691
0.044
0.001
0.000
0.000
0.004
0.603
1.007
0.686
2.283

z
0.699
1.823a
0.388
2.865b
0.983
0.718
1.091
1.260
2.055b
1.284
1.178
1.092

p  05 one tailed signicance.

p  01 one tailed signicance.

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FIGURE 1
Predicted Probability of Cost Accounting- Fundbalance.

fund balance shows that at a zero fund balance the model predicts that cities have a high, 87.2
percent, probability of using cost accounting (Figure 1). The predicted probability graph also
shows that as fund balance increases to 20 percent of expenditures the predicted probability of
the use of a cost allocation plan declines to 36.1 percent. This indicates that there is a
practically signicant relationship between the level of scal stress on cities and their use of cost
accounting.
The enterprise activity was positive and reached standard levels of signicance with a one
tailed test. The results indicate that cities that have larger enterprise expense are more likely to
have a cost accounting plan. The nancial management literature is clear that this is because the
city should be reimbursed for the cost of providing the service, which would include indirect
costs. As the percentage of enterprise expense relative to total expense increases, the likelihood
of utilizing cost accounting increases. The odds ratio indicates the change in the odds of one
percent increase in the enterprise expense as a percentage of total expense increases the odds of
the use of cost accounting by 4.5 percent. Again plotting the predicted probability of the model
over a range of enterprise expenses shows that cities with no enterprise fund expense have a
42.9% predicted probability of using cost accounting and as enterprise expense increases to 40
percent of total expense the predicted probability of using cost accounting increases to 81.1
percent (Figure 2). Although the condence intervals increase at the extremes, these results
indicate that the use of cost accounting is likely related to the provision of services through

Mohr / An Analysis of the Purposes of Cost Accounting

105

FIGURE 2
Predicted Probability of Cost Accounting- Enterprise Expense.

enterprise funds. This result offers support to the expectation that local governments use cost
allocation plans to help set justiable rates for the services that will be paid with user charges.
The other explanatory variables of interest were not signicant. The coefcient for grant
revenue was negative and had an odds ratio of .982 which indicates that a one percent increase in
grant revenue for the total expense of the government decreased the odds of use of cost accounting
by 1.8 percent. Therefore, the model correlation between grant revenue and cost accounting is
neither statistically or practically signicant. Likewise, performance measurement decreased the
odds of the use of cost accounting plans by 26.8 percent, but the equation does not approach
standard levels of statistical signicance. The inuence of grants and performance failed to show a
signicant correlation with cost allocation plans. These results are not signicant and may indicate
that there is either no relationship, or these results may indicate that further study is needed in this
area. These relationships are discussed further in the next two sections.
Only one of the control variables, organizational hierarchy, achieved standard levels of
signicance. Organizational hierarchy was signicant and had an odds ratio of 3.46, which
indicates that a one unit change in the hierarchy scale increases the odds of the use of cost
accounting by a factor of 3.46, holding all other variables constant. On this measure, the model
demonstrates that organizational structure is related to the use of cost accounting in U.S. cities.
The other institutional variables were not signicant. Particularly interesting non-ndings in
this regard are found in the two controls for organizational size. The population variable was
positively but not signicantly related to the use of cost accounting. Population size had a very

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Public Budgeting & Finance / Spring 2015

small .005 percent increase in the odds of using cost accounting with a change in the population
by 1000 people. So, while population was not signicantly related to the use of cost accounting, it
was in the direction determined by theory. The other size variable was the total expense of the
organization and is not signicantly or practically related to the use of cost accounting. This is
interesting because organizations with greater expenses should have a greater need for cost
accounting according to cost accounting theory.
The use of a city manager form of government was in the opposite direction predicted by the
literature review. This proxy measure for the leadership characteristics of the administration may
not capture all of the relevant characteristics of cost accounting leadership. Individual and other
leadership characteristics are likely more important than a city manager form of government
when determining whether the government will use cost accounting.
The right-to-work variable was positively correlated with the use of cost accounting as would
be predicted by the literature, but it also failed to achieve statistical signicance. The right-towork variable may not adequately capture the full range of relationships between unions and the
city administration. Future work may operationalize this variable further and add other interest
groups that may encourage the use of cost accounting.
The scal capacity variables did not have a signicant effect on the use of cost accounting.
Revenue and median income had a negligible effect on the model and neither variable was
statistically signicant. This null nding with scal capacity may be due to the operationalization
of the concept and the scal capacity of the government may need to distinguish between internal
and external scal capacity (Hendrick 2011).
The model presented was determined to t the data well. To alleviate concerns over the use of
a stock variable as an indicator for scal stress, a post hoc analysis was conducted which used
ow variables such as percent change in net assets for governmental and total assets from the
statement of activities. Neither of these variables are signicant at a standard .05 level of
signicance. This is likely due to the fact that this is a single cross sectional dataset and many
factors can inuence this ow scal stress variable in a single year. Post hoc analysis of whether
including component units in the analysis, showed that accounting for service provision via
public authority was not correlated with cost accounting. Additionally, these models and the one
presented were estimated as linear probability models and the logistic regression results are
robust to modeling strategy.5

LIMITATIONS OF PRESENT RESEARCH

The present research has some important limitations that should be addressed in future research.
Most importantly, the present analysis uses a cross sectional dataset to address relationships that
evolve over time, which is why the results of the model were presented as conditional
correlations and not causal statements. This means that the ndings for this research may only be
5. All of the variables that were signicant maintained their signicance at the .1 level and no signs changed. The
adjusted R squared value for the linear model was .159.

Mohr / An Analysis of the Purposes of Cost Accounting

107

relevant for the study year 2011 and are exploratory in nature. Future research should collect data
over time to analyze the inuence of variables that change over time and determine causality.
Additionally, the factors that inuence the adoption of cost accounting may not be related to the
variables that inuence its continued utilization. In other words, a city may adopt cost accounting
for performance or grant purposes and nd that it is useful for setting its rates or addressing issues
of scal stress. Data over time are needed to establish causal relationships to support the
conditional correlations presented here.
The variables that were used to operationalize the key concepts may also need to be developed
further. Performance was simply proxied by the use of performance in the budget document, but
the governments that use performance to report outputs and outcomes may not be particularly
concerned about giving them further nancial perspective, especially if it creates a negative
perspective (Lu, Mohr and Ho, in press). However, those cities that use a benchmarking
performance regime may be much more likely to have cost accounting plans. More nuance and
further study is called for in the study of performance and cost accounting. Likewise, the variable
that proxied for the organizational need to capture grant overhead expenses may be capturing
programs that do not allow for grant overhead expenses. Conversely, some governments may
choose not to utilize cost accounting and not to collect overhead costs because they do not want to
make their grants non-competitive.
Future research should also develop the scal stress and rate setting variables further. Rate
setting may be different for services that are either provided in house, contracted out, or provided
by a public authority. While this paper has used a relatively crude measure of the need for rate
setting, how the service is provided may nullify the use of cost accounting and more nuance could
be benecial for understanding cost accounting in relationship to contracted service provision.
Finally, the scal stress variable of fund balance is supported in the literature as a measure of
scal stress but it may be related to other variables in the model. Further renement and
exploration of the inuence of scal stress is strongly encouraged.
Additionally, more control variables would also improve our understanding of inuences on
cost accounting. The measures of organizational structure may be expanded. Hendrick suggests
that there are different types of internal and external scal capacity that could inuence the model
(Hendrick 2011). External scal capacity was examined here but future research may need to
operationalize and test internal scal capacity. Cost accounting may be positively related to the
sophistication of the government and this may be related to both lower fund balances and
performance. Additional controls for capacity and sophistication of the budget and nance staff
seem especially warranted.
As was noted in the literature review, there may also be other external interest groups such
as the Chamber of Commerce or contract service providers that may inuence the use of cost
accounting. These groups should be included in future analyses. The inclusion of more
variables including greater operationalization of organizational structure requires larger
samples, particularly time varying samples, and a further development of cost accounting
theory for public organizations. While there is still much work to be done on the topic, the
present study may provide a foundation for future research on the purposes of government cost
accounting.

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POLICY IMPLICATIONS
While the limits of the present research are acknowledged, the dearth of literature about cost
accounting presents an opportunity for public nancial management scholarship. Research about
cost accounting has been described as limited (Rivenbark 2005) and the advancement of
knowledge about its actual use for policy and practice is useful for understanding public
organizations and nancial management. This research has set out to address what purposes are
correlated with cost accounting. The following observations point toward a research agenda
based upon this research.
The business literature on cost accounting in recent decades has taken on the different costs for
different purposes approach (Horngren et al. 2011). There is little current discussion of cost
accounting in the public nancial management literature beyond basic textbook treatments (Khan
2000; Finkler 2012). Generally, this literature takes the approach that more specic cost accounting
is better. The tendency is to encourage the use of ABC, as it is generally shown to produce a better
estimate of cost (Kaplan and Atkinson 1998). However, the cost of collecting and analyzing cost
accounting data is seldom discussed6 and even less often discussed is the purpose for which the cost
accounting will be used (Flury and Schedler 2006). For reasons listed below, studies of cost
accounting should recognize that there are different reasons for public organizations to use cost
accounting and these reasons may logically lead to different types of cost accounting. These
different types of cost accounting may be even more relevant for public cost accounting because
public programs often have multiple purposes (Fabricant and Lipsey 1952).
There are generally three variables that can be changed within the cost plan that affect the cost
estimate: the indirect cost, the indirect cost basis or cost driver, and the hierarchy of the cost, also
known as absorption (Flury and Schedler 2006; Mohr 2013). The rst two are central to ABC,
and these factors have been shown to produce better costs when there are more indirect costs
accounted and the indirect cost driver is more specic (Kaplan and Cooper 1998). The more
indirect costs and more specic the cost drivers are in the cost accounting plan produces better
estimates of costs and makes the system better for cost management purposes.7 However, the
more the organization develops the cost system to have more indirect costs and more specic cost
drivers, the more that the cost system will have greater collection, analysis, and transaction costs
(Kaplan and Cooper 1998; Kaplan and Anderson 2003; Mohr 2013).
These differential costs of collecting and organizing cost accounting lead to different types of
cost accounting. Cost accounting for compliance and reporting are likely to have fewer and less
6. Importantly, Kaplan and Anderson (2003, 2007) note that the collection and analysis of large amounts of data
necessary for ABC are extremely difcult and limit the actual use of ABC.
7. An important caveat is that the use of different frameworks for the proper amount of direct and indirect costs that
are necessary are likely based upon the use of cost accounting. This is discussed in the following paragraphs but
generally it is noted that the more specically that the indirect costs can be broken down the more accurate the cost
estimate will be. This is not to say that it will be better for the purpose that it is intended but that, generally, the cost of
errors from the system will go down. See Kaplan and Atkinson 1998 pages 110112. This is not to suggest that more
indirect costs are better than direct costs or vice versa but that the development of cost accounting is related to the
needs of the government.

Mohr / An Analysis of the Purposes of Cost Accounting

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specic cost drivers because the organization is simply responding to an external mandate for
cost accounting and would like to achieve the requirement at the lowest cost. If the cost
accounting is compliance for a grant, the cost accounting will meet the minimum requirements of
the granting agency but may include more indirect costs so that it can achieve a higher level of
reimbursement. Using cost accounting for performance improvement and reducing scal stress
will have more indirect cost and more specic cost drivers. Cost accounting for rate setting is
likely to strike an optimal balance in the number of indirect costs and the specication of the
driver that are used. Even within these two most common variables of the cost accounting system,
there is likely to be a wide variation in the development among cities and services. Future
research should examine actual cost accounting practices in terms of the types of indirect costs
that are used and the specicity of the cost drivers.
A third variable that importantly inuences the cost estimate is the level of absorption (Flury
and Schedler 2006), or hierarchy of cost that is allowed in the cost accounting (Kaplan and
Atkinson 1998). This is also known as full costing or full absorption costing and is particularly
problematic for public organizations that have additional costs such as political costs of
legislative bodies that cannot be avoided and cannot be rationally allocated to individual products
and services (Flury and Schedler 2006). Economic theory suggests that the only costs that matter
for setting the optimal level of output is the costs that can be avoided. Contingency theory
(Lawrence and Lorsh 1967) suggests that cost accounting for grants and rate setting will promote
a fuller cost accounting, while cost accounting for management and performance purposes will
be limited to only those costs that can be traced directly to the product or service and that can be
avoided. The issue of the level of absorption or the proper hierarchy of costs is perhaps the
biggest need in public cost accounting research because there is often not the guide of market
forces to determine the degree of absorption that is appropriate. Flury and Schedler (2006) found
in Switzerland that different actors within the system want to see different levels of absorption
between managers, which tend to prefer only the proportion of cost that they can control, and
politicians who prefer to see the full cost. Presently, there is little research on this topic in relation
to U.S. governments, but it has the potential to importantly inuence the cost estimate. Future
research needs to look into the level of absorption or hierarchy of costs that are allocated to
services for different purposes.
An important caveat about different costs for different purposes is that cost accounting is
also often used to compare the resources used to produce public programs and benchmark it to the
outputs of comparison programs or organizations. Where comparison is the purpose for the cost
accounting, the indirect costs, the cost drivers, and the absorption level needs to be uniform and
consistently applied. So, performance and benchmarking systems, such as the North Carolina
benchmarking program, develop standardized methods of cost accounting (Ammons et al. 2001).
It is also interesting that the cost accounting standards of the U.S. federal government do not
support a uniform system of cost accounting (Circular A-87, and 2 CFR Part 215), but this may be
due to additional factors that inuence the implementation of cost accounting, which is another
avenue for future research. Additionally, the U.S. federal government may want to consider
standardizing its cost accounting principles for local government to ensure that it is making an
apples to apples comparison as it allocates resources.

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Continued research on cost accounting for grants and performance purposes is still relevant
for public organizations and public nancial management. The present research indicates that
cost accounting is primarily used for rate setting and organizational responses to scal stress, and
the research does not nd a signicant correlation between cost accounting and performance or
grant reimbursement. This does not mean that these purposes have not been important at a
previous time and may not be important in the future. The present research seems to indicate that
in this present climate of scal stress that cost accounting is used primarily for rate setting and
cost management, but cost accounting continues to be relevant for performance comparisons and
grant reimbursement and should continue to be studied.
Another line of research that is necessary, especially if public organizations are using cost
accounting to deal with scal stress and set rates, is what types of internal and external resistance
the cost accounting encounters as public organizations implement cost accounting and use it for
decision making. The use of accounting for decision purposes is known to encounter resistance
within organizations (Simon et al. 1954b) and may also generate resistance by interest groups
(Anderson and Young 2001). Future research should look at how this resistance shapes cost accounting practices and the estimates of cost that are developed for public programs. This could
importantly determine the winners and losers as governments shift to greater reliance on user
charges.
Perhaps the most important ndings of the present research is that a signicant number of large,
local governments do not use cost accounting plans. This is important given the many benets of
cost accounting. The managerial accounting literature, though, is suggestive of many technical
(i.e., Anderson and Young 2001) and political impediments to the implementation and use of cost
accounting (Collier 2006; Flury and Schedler 2006). Another theoretical perspective based upon
transaction cost theory is suggestive of both technical and political impediments to cost accounting
(Mohr 2013). The analysis of the impediments of public cost accounting critically informs this
broader research agenda on the implementation challenges of cost accounting.
Finally, the present research has examined the use of cost accounting as an important tool of
nancial management within an organization. Managerial accounting research has shown that
cost accounting is also important for managing interrm relationships (Caglio and Ditillo 2008).
In one case study of municipal cost accounting, Mohr (2013) found that cost accounting was
useful for raising the awareness of the costs to the government of collaboration. One local
government noted that when the indirect cost of staff members time was included in the total cost
of collaborating with the community that the cost was several times what the budgeted costs
indicated (p. 88). With increasing interest in public administration and policy on collaboration,
networks, and governance (Frederickson and Frederickson 2006; Rethemeyer and Hatmaker
2008), research on cost accounting may also be an important avenue for future research on the
nancial management of these types of organization (Thurmaier and Mitchell 2013).
CONCLUSION
This research has presented a cross sectional analysis of the purposes associated with the use of
cost allocation plans in U.S. cities. The results indicate cost plans are associated with scal stress

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and enterprise expense. A major limitation of this research is that the cross sectional nature of the
data does not allow causal discussions of the relationship between cost accounting, rate setting,
and scal stress. However, knowing the uses of cost accounting may be important to determine
the appropriate development of cost accounting in cities.
Although the current research has important limitations, it also provides some of the rst
evidence of why U.S. local governments use cost accounting in the 21st century. The current
research provides a foundation that may be expanded upon in future studies. It is also noteworthy
that signicant numbers of local governments are not using cost allocation plans. Future research
should address the factors that limit the use of cost accounting and address the factors that may
inuence the many important technical aspects of cost accounting.
ACKNOWLEDGMENTS
I would like to acknowledge the help of Jacob Fowles, Chris Silvia, John Nalbandian, Rajestra
Srivastava, and particularly, Alfred Ho for many helpful comments and suggestions on an early
draft of this article, which was a part of my dissertation. I would also like to acknowledge the
helpful suggestions and guidance of three anonymous reviewers. Of course, these people are not
responsible for any problems or omissions of this work.
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to privatization of local government services? Public
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cost war through leadership driven management
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powerful path to higher profits:
Cost & effect: using integrated cost systems to drive
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2010

1999
2011
1998
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2007
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Appendix: Sources for Cost Accounting Concepts

Textbooks and academic publications

Coe, C.K.
Finkler, S.A., Smith, D., Purtell, B. and Calabrese, T.