Slides 14 3 calculate volume and performance variances for

Calculate Volume and
Performance Variances for Output-Based
Control Case Study Scenario
Letterkenny Army Depot

Intermediate Cost Analysis
and Management

© Dale R. Geiger 2011

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Terminal Learning Objective
• Task: Calculate Volume and Performance Variances for OutputBased Control Case Study Scenario
• Condition: You are training to become an ACE with access to
ICAM course handouts, readings, and spreadsheet tools and
awareness of Operational Environment (OE)/Contemporary
Operational Environment (COE) variables and actors
• Standard: with at least 80% accuracy
• Describe the cost-rate-price structure at Letterkenny Army Depot
(LEAD)
• Calculate surcharge and price for depot services based on
Accumulated Operating Result (AOR)
• Discuss performance control issues in revolving funded organizations

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Letterkenny Army Depot
Teaching Points
Letterkenny is typical of many, manufacturing-like revolving funded
operations that have common issues:
1. Price Setting: non appropriated organizations generate revenue
by providing goods or services
• This requires a mechanism to set prices
• How does this work?

2. Performance Evaluation

• Does “revenue less cost” yield a meaningful performance measure?
• How important is volume variance in manufacturing operations with
significant fixed costs?
• How does one evaluate performance in such a complex environment?
© Dale R. Geiger 2011

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Price Setting in the Business World
• The theory in the business world is that the market
sets the price
• The forces of supply and demand clear the market at an
efficient price
• This appears to work fairly well for commodity goods

• There are circumstances where this doesn’t apply
• Specialty items where there is not a market and/or
there are significant barriers to entry
• Internal transfers where one division of a company sells
to another (vertical integration)
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Price Setting in Government
• Most government organizations are funded by
appropriation and have no pricing
• Some are non-appropriated and generate revenues

by charging for their goods or services
• Usually not competing in the market place so market
pricing not applicable
• Sometimes there are social motivations to consider
• Budget constraints are expected to increase the
interest of government organizations in charging for
services
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Price Setting in Government: Examples
• Public water department:
• Sets price of water to cover all costs of water acquisition
and delivery
• May also include a sewer charge

• Parking meter:
• Covers more than the costs of meters
• Provides revenue source to cover other city costs

• Public bus fare:
• Covers less than the costs of transportation
• Subsidized by appropriated funds to encourage use
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Consider Some Federal Examples
• National Institutes of Health: Supply and Service Fund
• Supplies thousands of laboratory supply items via catalog
• Competes with outside sources

• General Services Administration: Public Building Service
• Charges all users a basic standard charge
• Provides optional services on a fee basis

• National Institutes of Health: Management Fund
• Maintains capabilities but doesn’t charge on basis of usage
• Negotiates agreements from users like an allocation

• U.S. Army: Army Material Command
• Sets prices for outputs based on previous profit and loss record
• Over time profits and losses offset each other
© Dale R. Geiger 2011

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Revolving Fund Pricing
• The Army has many non-appropriated organizations: depots,
labs, arsenals
• These are sometimes called revolving, industrial, stock,
enterprise, or working capital funded
• Usually have no social motivation or political agenda
• Generally have no comparable free market
• Represent internal transfers

• General rule is that the price or user fee must reimburse the
costs of providing the goods or services
• Some “contracts” specify frequent invoices of incurred cost
• Other “contracts” utilize a “stabilized pricing” practice that gives
customers a firm price for the budgeted years
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Stabilized Pricing Objectives
• The rationale behind stabilized pricing is that government
customers value stability
• Customers are appropriated organizations subject to AntiDeficiency Act violation
• Changing incurred costs would create problems
• Increased incurred costs reduce the quantity that can be purchased or
create ADA violations
• Decreased incurred costs increase the quantity that could be
purchased or result in unused budget

• The revolving funded organization absorbs the variations of
incurred cost to stabilized price:
• Adjusts future years pricing accordingly
• (Incurring cash flow risk in the process)
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Stabilized Pricing Process

•
•
•
•

Books a gain or loss in the current period
Adds a compensating pricing surcharge to the third year
Seeks a long run breakeven = full reimbursement
Timing issues result in a three year lag
• Execution Year: Uses prices set in previously and books a
gain or loss compared to incurred cost
• Budget Year: Experience in execution year is evaluated
and projected into Budget Year +1 pricing
• Budget Year +1: Uses prices set in budget year based on
execution year experience
© Dale R. Geiger 2011

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AMC Pricing Sequence
• NOR (net operating revenue) is the AMC term for profit
Year -2

Year -1

Execution
Year

Budget

Year

Budget
Year +1

units

units

units

units

units

price

price

price

price

price

Revenue Revenue

Revenue

Revenue Revenue

Cost

Cost

Cost

Cost

Cost

NOR

NOR

NOR

NOR

NOR

• The goal is that NOR over time (AOR) is zero
© Dale R. Geiger 2011

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AMC Pricing Sequence
• NOR (net operating revenue) is the AMC term for profit
Year -2

Year -1

Execution
Year

Budget
Year

Budget
Year +1

units

units

units

units

units

price

price

price

price

price

Revenue Revenue

Revenue

note the
time lags

Revenue Revenue

Cost

Cost

Cost

Cost

Cost

NOR

NOR

NOR

NOR

NOR

• The goal is that NOR over time (AOR) is zero
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ISO 9001

Why do we have “rates”?
• Industrial Operations (AWCF) sites are
different from Appropriated (OMA) funded
installations
• Army Working Capital Fund is a Revolving
Fund account

ISO 14001


ISO 9001

OMA Basis
•

For example Ft Belvoir, Ft Detrick and Ft Meade

•

Are provided annual operating funds from various
Operations and Maintenance, Army sub accounts:

– To pay military and civilian employee salaries and
benefits
– To pay utility bills
– To fund real property maintenance and improvements
– To maintain its vehicle fleet (to include Motor Pool)
– To fuel and operate vehicles, facilities and base
infrastructure

• Technically this is termed OBLIGATION AUTHORITY

ISO 14001


ISO 9001

Industrial Sites
• Do not receive Operating Funds
• We receive orders to execute assigned
missions that involve core competencies,
or new missions
• We are granted “Cost Authority”, which
allows us to incur costs that must be
recovered via “rates”

ISO 14001