In all enterprises, be they governmental institutions or commercial companies, the charging of services provided to internal customers and the allocation of general overheads represents a difficult issue. The charging or allocation of these costs and overheads to cost centres, activities, programmes or products is the subject of permanent and sometimes difficult discussions.
A balance has to be struck between a fair charging or allocation of costs and overheads and a system that is simple enough to be operated and understood by everyone and that provides the transparency required to make it acceptable to all. A support user must know exactly what price he is going to pay for a service and how that price (including the constituent cost elements) has been built up. Only if the prices charged for internal services are based on true cost and general overheads allocated on an equitable basis, can both parties, the support provider and the support user, gain in the long run. In addition, a well-functioning cost accounting system is a necessary tool to control internal costs efficiently and thereby manage internal resources properly.
The Agency's present budget structure and charging policy have been in force since 1983. During that time reform proposals have been discussed by ESA's Administrative and Finance Committee (the AFC is composed of representatives of all Member States and Canada) on several occasions without reaching a consensus to implement changes. By 1995, the shortcomings of the present system had become so apparent that the Council meeting at Ministerial Level in October that year adopted a Resolution that "underlined the need to define and to implement a new charging policy ..... and to achieve its entry into force by 1 January 1997", or by 1 January 1998 at the latest. The agreement of Member States that a reform of the system was needed was due to the necessity to reduce the Agency's indirect expenditures and therefore to implement a charging policy tailored to better controlling and managing internal costs, and to the shortcomings of the present system described in detail below.
The Director General therefore submitted to the AFC in March 1996 a proposal for a comprehensive reform of the Agency's budget structure and charging policy. This proposal was examined by the AFC throughout 1996 and finally adopted by Council at its meeting in December 1996. The new structure and charging policy will apply as from the 1998 budgets onwards.
Under the present charging policy, the support expenditures and overheads are composed of:
The main shortcomings of this system are that:
When the Executive began, with the support of the consultancy firm Price Waterhouse, to study reform of the ESA charging policy, the objectives assigned to the project were to define a system that should:
Given the unique nature of the Agency's functioning, several constraints were to be respected:
Maximising the benefits of the new charging policy whilst at the same time respecting the above constraints was a difficult challenge, especially considering that any proposed reform needed to be approved by a two-thirds majority of ESA Member States.
The proposal for a new budget structure and charging policy should not be seen in isolation, but rather as one of the elements of the Agency's on-going Transformation Programme. The new charging policy has therefore been developed in coherence with a broader cost-management system with the overall objective of providing improved costing information to support management decision-making. It quickly became obvious that a simple adjustment of the present system would not be sufficient and that there was a need for a complete reform of the budget structure and charging policy.
The new concepts that have been defined in close consultation with the ESA Member States can be summarised as follows:
Corporate costs
This new Basic Activity output regroups the costs for the
basic sustaining activities of the Agency, i.e. those relating
to activities deemed essential, of common interest and (more
or less) independent of the level of the Agency's programmes.
This output will be totally financed by contributions within
the General Budget.
The main expenditure items of Corporate Costs are the Agency's top management and basic administrative infrastructure, running costs not directly attributable to programmes, investments, maintenance and operation of the basic administrative data-processing systems and their related communication costs, the Audit Commission and the Agency's basic technical capability, including activities contributing to the framework of an efficient support capacity, e.g. standardisation, technical overseeing, development of analytical tools, technical assessments, reviews and studies, ensuring that the Agency can rely on a minimum level of know- how in critical technical areas.
A simulation based on the 1997 Budget shows that Corporate Costs would represent some 80 MECU this year.
Site services and office automation
This new support output regroups the costs for site
services (expenditures for building maintenance,
communications, canteens, cleaning, security, etc.) and for
office automation.
Total expenditure for site services will be recharged at establishment level (thus improving transparency) pro-rata to the number of staff (ESA staff and contractor staff on-site). Total expenditure on office automation will be regrouped and recharged at Agency level pro-rata to the number of staff (ESA staff and contractor staff on-site).
The projected rates for 1998 are of the order of 20-25 kECU per head for site services, and 3 kECU per head for office automation.
Administrative support
This new support output regroups the costs of staff that
are responsible for the day-to-day administrative support to
all activities and programmes of the Agency, including
Finance, Personnel, Contracts and the Publications Division.
Total expenditure for administrative support, including its
share of site services and office automation, will be
recharged at Agency level pro-rata to manpower costs. The
projected recharge rate for 1998 is of the order of 35% of the
manpower costs.
Technical and operations support
This new support output will include expenditures for the
technical support capacity which are generated by activity and
programme requirements comprising:
Recharges for Technical & Operations Support, including its share of site services and office automation, to all users will be made according to usage on the basis of unit prices. Unit prices for facility usage will include manpower, consumables, spares and the operating maintenance for these facilities. Unit prices will remain stable throughout the years due to the introduction of the concept of 'capacity support' (see below).
Technical infrastructure and capacity support
The new Technical Infrastructure support output will include
expenditures for:
A Technical Infrastructure Review Board will analyse the future support requirements of programmes and their impact on the Agency's support capacity. This Board will report to the Director General and propose:
Thus, all parties concerned will participate in these decisions, which will have a direct bearing on the overheads that will ultimately be charged to programmes and projects for which they have the overall responsibility.
The usage of Technical & Operations Support will be recharged to users on the basis of unit prices that are calculated on the assumption of a 'nominal capacity' and 'nominal cost', i.e. the total number of technical units that could, under normal circumstances, be produced per year by the unit concerned and the total annual cost associated with operating the facility or service at nominal capacity.
The expenditures for existing essential technical support capacity which is not used to its nominal capacity during the financial year, but which is retained due to future requirements in the framework of the European Space Policy, will be financed under the Capacity Support output. In particular, in all cases where a facility or service will be used at below-nominal level, it will cover the difference between the planned/actual total cost required to operate the facility or service and the planned/actual recharges to users based on the unit prices calculated on the basis of a 'nominal capacity' as explained above, if these costs are unavoidable. The total amount of this output has been strictly limited by ESA Council to 10 MECU.
The total expenditures of Technical Infrastructure & Capacity Support, outputs including their share of recharges for site services and office automation, will be recharged at Agency level to all programmes, pro-rata to their Direct Expenditure ( projected rate for 1998 is of the order of 6.5% of the Direct Expenditure of programmes).
In order to preserve the purchasing power of the Scientific Programme, as requested by the Council at Ministerial Level in Toulouse on 20 October 1995, this Programme will be recharged under Technical Infrastructure & Capacity Support on the basis of only one third of its direct expenditures for the present Level of Resources, with a review of this situation foreseen by mid-1998.
Considering that the Ariane Programmes are financing all of their investments, including those of a general-purpose nature, the ESA Council decided to exempt all on-going Ariane Programmes from recharges for Technical Infrastructure & Capacity Support. The Ariane-5 ARTA and Evolution Programmes will be charged with 20% of the Agency's annual contribution to the Coordinated Facilities.
As noted above, the new charging policy has been developed in parallel and in coherence with the implementation in ESA of a new Analytical Cost Management System (ACMS). The overall objective of this cost-management system is to provide improved costing information to support management decision making, and to meet the following objectives in particular:
In addition, the Council meeting at Ministerial level in Toulouse in October 1995 highlighted the need to reduce the Agency's costs over the next three years. In order to achieve these savings, there is a need for increased visibility of the right financial and non-financial information for management to support its decision making. The ACMS is therefore an important element for controlling and efficiently reducing costs in the years to come.
The ACMS is effectively a framework of modern management techniques and generally accepted best practices in the public sector and industry, and is designed to enable ESA to meet the key cost management needs identified above.
The aims of a costing system (ACMS) and of a funding system (the new charging policy) are different. The ACMS is a management tool with the primary objective of controlling and managing costs, while the role of the charging policy is to distribute the support expenditures and overheads as Indirect Expenditures to programmes with full transparency and on a fair basis. However, important parts of the cost-management system and the charging policy are closely interrelated, e.g. the concept of Corporate Costs and Capacity Support.
There are also further advantages to establishing links between the two systems in order to:
The ACMS system will provide the Agency's management with a multitude of data that go far beyond those needed for the charging policy through the introduction of 'cost centres'. A generalised cost-centre system at Agency level will make sure that the people with key cost-management responsibilities have the right information and incentives to carry out their role to the maximum benefit of the Agency.
It will provide improved transparency in how costs are built up and as such will create cost-consciousness and foster change. Cost-centre managers will be responsible and accountable for the technical management of the cost centre, the use of its resources, the overall quantity and quality of the services provided, for providing appropriate information to support the charges made to service users, reporting on the performance of the cost centre and ensuring the appropriate utilisation of the capacity of the cost centre.
The introduction of cost centres within the Agency will allow their managers to manage their budget at the appropriate level, to establish draft budgets and implement approved budgets at cost-centre level, and to determine the cost of individual activities. This information will be used to determine the total cost of support entities and to calculate realistic unit prices.
A trade-off has been made in order to define the level of detail needed for a fair charging policy given the need to have a concept that is easy to operate both during the budget- preparation cycle and during the financial year for budget implementation.
The implementation of the proposed ACMS system will provide greater visibility and control over how and by whom costs are incurred within the Agency, and for which activities and programmes. The outputs of the ACMS will provide a sound basis for a more equitable policy in the way in which the Basic Activities and the Programmes are funded by Member States.
The main advantages expected from the recently approved new budget structure and charging policy for the Agency are:
According to generally accepted best practices, a cost- accounting system must be based on accruals and not on cash. For legal and practical reasons, the accounting system of the Agency is based on cash accounting. With the arrival of AWARDS, the Agency's future financial system, accruals will be available in addition to information on payments made. Accruals could be defined as prices for work carried out and accepted by the Agency and for which the information has been made known by the contractor to the Agency, e.g. as a cost report, invoice, milestone report, etc. Whether the Agency's financial system will in future be completely based on accruals remains to be seen, but the tools necessary for such a reform will be available when the AWARDS project is implemented.
In an ideal world, cost accounting equals budgetary accounting and cost accounting is based on accrual accounting and includes amortisation of assets. The new budget structure and charging policy of the Agency, as approved by Council, is a first step in this direction. ESA not being a commercial enterprise, changes in cost-accounting techniques cannot be implemented at the same pace as in private organisations. However, considering the increased budgetary pressure that the Agency is facing, the support of modern accounting techniques and analytical tools is more and more necessary. Full transparency on costs and the right tools for capacity management is one of the main objectives of the already achieved and still on-going reforms in the Agency's financial and management structure.
The overall aim is to make the Agency more cost efficient and easier to manage, and to reduce response times to changing requirements.
ESA Bulletin Nr. 90.