prices are expected to increase at significantly higher or lower rate than gen- eral inflation. In these cases, this relative price change should be calculated.
Some examples where relative price changes may be material to an appraisal include high- technology products, prices which may be expected to fall in real terms and fuel prices, where the resource supply is scarce.
• Risk and uncertainty – issues of risk and uncertainty in public services management are discussed in detail in Chapter 12. However, the basic dis- tinction between the terms is that risk exists where there is a probability, based on past experience, that can be attached to an event. Uncertainty is where there is no such probability available. In investment appraisals, there is always likely to be some difference between what is expected, and what eventually happens because of biases, risks and uncertainties. Two issues need to be looked at critically:
• Inherent bias – there is a demonstrated, systematic, tendency for project appraisers to be overly optimistic. This is a worldwide phenomenon that affects both the private and public sectors. Adjusting for such optimism should provide a better estimate, earlier on, of key project parameters.
Such adjustments for optimism may be reduced as more reliable estimates of relevant costs are built up, and project- specific risk work is undertaken.
• Rigour – in assessing uncertainty, an expected value is a useful starting point for understanding the impact of risk and uncertainty between dif- ferent options. But however well these are identified and analysed, the fu- ture is inherently uncertain. So, it is also essential to consider how future risks and uncertainties can affect the choice between options. Sensitivity analysis is fundamental to appraisal. It is used to test the vulnerability of options to unavoidable future risks and uncertainties. Therefore, the need for sensitivity analysis should always be considered and, in practice, dispensed with only in exceptional cases. Scenarios should be chosen to draw attention to the major technical, economic and political risks and uncertainties upon which the success of a proposal depends.
As a consequence of the above phenomena, risk management strategies should be adopted for the appraisal process. Appraisers should calculate an expected value of all risks for each option, and consider how exposed each option is to future uncertainty. Before and during implementation, steps should be taken to prevent and mitigate both risks and uncertainties.
It is vitally important to be transparent about the potential impact of risks and bias on proposals. Relating back to the behavioural aspects of man- agement accounting in Chapter 6, this is an area where risks and uncer- tainties can be underestimated in an attempt to get a project approved.
CHAPTER 8 Operational decision making 143
• Operational pricing decisions are made on a marginal cost basis. The ex- ample in Table 8.4 illustrates this.
Having identified the total costs and marginal costs, the organisation can fix a price anything in excess of £2,200 and in doing this, it will need to take account of a variety of factors such as how much do they want the work, risk, cost un- certainties, etc.
However, caution is needed in the use of marginal costing. If all service ac- tivities were priced on a marginal cost basis, there would be a risk of generating
TABLE 8.4
Marginal cost pricing in a university
A university undertakes a variety of short courses in various aspects of business management. It has been asked to quote for a once- off job to provide a series of courses for a local private company.
Using total costing principles, it calculates the costs associated with this work as follows:
• Materials: £1,200
• Staffing: £10,500
• Variable overheads: £1,000
• Fixed overheads: £2,000
• Total costs: £14,700
However, an examination of each of the cost elements suggests the following:
Cost type Comments
Materials Materials are available at costs shown above.
Staffing The work associated with these courses can probably be absorbed by the existing lecturing staff.
Variable overheads There is some uncertainty about these costs.
Fixed overheads These are definitely fixed.
The costing results are shown below:
Cost type Comments Amount (£)
Direct materials Assume directly variable 1,200
Direct labour Assume it can be absorbed by existing staff Nil
Variable overheads Assume directly variable 1,000
Fixed overheads Definitely fixed Nil
Total marginal costs 2,200
The university is keen to win this work because it could be the prelude to a longer- term relationship with the company. However, it does not want to set a precedent by offering a very low price which is unsustainable. They are also aware that the company will also be asking other universities and private providers in the city to quote.
Hence it submits a quotation of £12,000, which is well above the marginal cost but slightly below the total cost.
insufficient revenues to finance the overhead costs of the service. Thus, it should only be undertaken in the following circumstances:
• The proposed activity is for a o nce- off event of fairly short term in nature.
Thus, it is not applicable to ongoing activities.
• Pricing the activity at marginal cost will not affect the price charged for the mainstream provision of the same activity. For example, a client given a once- off price based on marginal costs cannot ask for this to be repeated.
• The proposed activity level is a fairly small proportion of the existing workload of the service department and thus most costs would remain unchanged.
CHAPTER
9
Management accounting and
public service strategy
INTRODUCTION
In Chapter 3, the issue of public service strategy was discussed in some depth.
In this chapter, we consider, in more detail, the ways in which specific manage- ment accounting methods can contribute to strategic decision m aking in public services.
Initially, it is probably worth recapping on a few key points in relation to the concept of strategy:
• The term strategy or strategic management comprises three aspects – strategic planning, implementing strategy and strategic control.
• Strategy is concerned with identifying the longer- term objectives of the public service organisation and what it needs to do to achieve those objectives.
• Strategies that are developed need to be assessed for their strategic feasibil- ity ( can they deliver the organisations’ objectives?) and resource feasibility, especially financial feasibility.
• Implementing strategies will usually involve a significant element of organ- isational change. This will need to be properly planned and resourced.
• Management accounting has a large contribution to make with regard to a number of strategic issues. This contribution is not always optimised.
In this chapter, we describe and discuss a number of management accounting approaches which can be used to facilitate the strategy process in public service organisations. These are
• Cost and income benchmarking
• Strategic capital investment appraisal
• Strategic cost improvement
• Programme/ client group analysis and budgeting
• Strategic options evaluation
• Strategic financial forecasting
• Decision support models ( DSM)
• Pricing strategies
• Strategic financial leadership