CORPORATE GOVERNANCE TRAINING MODULE 14: SOE’S - COSTING COMMUNITY SERVICE OBLIGATIONS ADB Private Sector Development Initiative Corporate and Financial Governance Training Solomon Islands Originally by Dr Judy Taylor

Acknowledgments These materials were produced by Dr Judy Taylor from La Trobe University, through the Asian Development Bank’s Pacific Private Sector Development Initiative (PSDI). PSDI is a regional technical assistance facility co- financed by the Asian Development Bank, Australian Aid and the New Zealand Aid Programme. 2

Community Service Obligation’s  Objective of costing CSO  Costing of CSO’s  Examples used in these slides are the same as those used by Ministry of Treasury and Finances CSO Policy Document.

CSO’s  A CSO is a non-commercial service or product purchased by the government on behalf of the community.  CSO’s are provided by SOE’s  Objective of costing CSO’s is to ensure the efficient and effective delivery of CSO’s and to inform the government of the true cost and benefit of their provision.

Costing CSO’s Three methods of costing CSO’s  Long Run Avoidable Costs (LRAC)  Preferred measure of measuring and costing CSO’s  Fully Distributed Cost  Average Cost  If an alternative to LRAC is used to cost the CSO the reasons for this should be listed in their submission or application.

LRAC  Includes  All costs associated with the provision of the CSO that would not have been incurred had the SOE not provided the CSO.  It equals the total of all costs, variable, semi variable and fixed  Revenue collected from provision of CSO less costs incurred = Cost of CSO

LRAC- an example  Provision of water to islands at same tariff as Honiara $1.80 per ML (non-commercial)  SIWA currently only provides water to Honiara and a few other centres  CSO will be paid as an operational subsidy  Forecasted water demand to new same price as Honiara 10 mega liters  Total water currently applied to Honiara 100 mega litres.

LRAC- an example  Costs for SIWA  Direct operating (islands)5  Direct operating costs Honiara50  Overheads 22  Cost of capital Islands20  Cost of capital Honiara100  Return on equity islands2  Return on equity Honiara10

LRAC  Not all costs qualify to be included  Included  Direct operating costs (wages, materials)  Direct capital costs (depreciation/amortization non- current assets)  New Overheads incurred to provide CSO  Not included  Allocation of existing overheads to CSO

LRAC- an example  Costs for SIWA totalHI  Direct operating (Islands) 55  Direct operating costs Honiara 5050  Overheads  Cost of capital Islands 2020  Cost of capital Honiara  Return on equity islands 2 2  Return on equity Honiara TOTALS

LRAC- an example  Full cost recovery pricing – allocating overheads  Honiara  total cost $180  total Units supplied to Honiara 100 ML of water  180/100 supplied =$1.80 perML  Islands  Total cost $29  Total units supplied to Islands 10ML of water  29/10 would result in pricing of $2.90  SIWA will make a commercial decision to provide water as $2.9 significantly above $1.80 Honiara price

LRAC- an example Actual calculation- not allocating overheads  Direct operating (islands)5  Overheads 0  Cost of capital Islands20  Return on equity islands2 Gross CSO Cost27.0 Less revenue 1.8* Net CSO cost 9.0 Cost per unit $.90

Fully Distributed Cost  Includes all fixed and variable costs relating to CSO output.  It includes a proportion of common fixed costs and common overheads, usually on a pro-rata basis  Can include an allowance for normal profit, a return on equity.

Fully Distributed Cost- an example  Costs for SIWA  Direct operating (islands)5  Direct operating costs Honiara50  Overheads 22  Cost of capital Islands20  Cost of capital Honiara100  Return on equity islands2  Return on equity Honiara10

Fully Distributed- an example  Costs for SIWA totalHI  Direct operating (Islands) 55  Direct operating costs Honiara 5050  Overheads  Cost of capital Islands 2020  Cost of capital Honiara  Return on equity islands 2 2  Return on equity Honiara TOTALS

Fully Distributed Cost- an example  Allocate what we can, then distribute what are common using pro rata basis.  Total water provided 100(Honiara) +10 (islands) =110  Honiara = 100/110 = 91%  Islands = 10/110 = 9%  Overheads = 22  Honiara = 91%* 22 = 20  Islands = 9 %* 22 = 2  Fully distributed cost has increased cost of CSO by $2

Fully Distributed Cost Actual calculation- not allocating overheads  Direct operating (islands)5  Overheads 2  Cost of capital Islands20  Return on equity islands2 Gross CSO Cost29.0 Less revenue 1.8* Net CSO cost 11.0 Cost per unit1.1

Average Cost  The average cost calculates the average cost of the commercial provision of all similar outputs  Total costs/total units produced = average cost  Can include an allowance for normal profit, a return on equity.

Average Cost  Costs for SIWA  Direct operating  Overheads 22  Cost of capital Islands  Return on equity Gross cost209 Less revenue 110* Loss 11 Loss Per unit cost 11/ Net CSO 10*

Comparison of 3 Cost Methods MethodCosts includedCSO cost per unit LRAV27$.90 Fully distributed Cost29$1.1 Average CostAll/all units$1.0