Management Accounting

(a) Cost management is important today in the public sector because there is a need to manage the cost of social goods and services to deliver them as efficiently and effectively as possible. Goods and services must be produced with as few resources as technically feasible. In addition, it assists with decisions such as whether to subsidize, abandon or outsource (all or some of the components) the service or product.

Functional cost analysis can be applied to cost management in the public sector through incorporating the external value that consumers place on products’ functions with the internal cost of the components of a product that provide these functions. A component’s contribution to the value customers place on a product’s functions is used to determine its allowable, or target, cost. The difference between a component’s current and allowable costs is used to determine ways to reduce the resources consumed by a component or its processes and as such, a component can be produced more efficiently therefore reducing its cost to achieve its allowable cost.

Balancing the external value that users place on its goods and services with the internal cost of producing the goods and services is critical for delivering social goods and services in a manner that maximizes their benefits to society. Also, functional cost analysis allows governmental administrators to evaluate both the benefits and costs of the components that comprise social goods. It may also be used to integrate the external and internal value of social goods and services with the political considerations needed for resource allocation decision-making within the public sector.

(b) Functional cost analysis is derived from value engineering or value analysis. Value engineering originated in the U.S. during the 1960s and the application historically, was largely restricted to the private sector. Value engineering attempts to analyze the functions performed by a product or service in an effort to design and produce an item at the lowest possible cost.

Functional cost analysis differs from other cost management techniques because it does not focus solely on a single cost