FM 303
Date of issue: 3 October 2000

1.     This FM replaces PPARC FM 67 dated 6 January 1994 which is hereby cancelled.

2.     This FM sets out the principles and procedures to be applied in determining the cost of resources used in an activity, with particular regard to the setting of fees and charges for repayment work (ie work undertaken for another organisation for which a charge is levied) and costing for market testing. Further guidance and information can be found in the Costing Guide and the Fees and Charges Guide (both published in 1992 by HM Treasury), copies of which are held in Establishments' finance sections. Specific guidance on market testing is available in The Government's Guide to Market Testing (HMSO, 1993). These publications are still extant.

4.     Attached at Annex A are the elements which make up the FEC of activities. They may be divided into categories of direct costs and indirect costs (or overheads):

Direct Costs: These costs are normally directly attributable to activities through financial accounting systems. The main items will be labour costs, materials and services. These cash costs will generally be under the control of the management currently providing the services. Establishments should ensure that wherever possible and reasonable as much expenditure is attributed directly to activities. This aids the production of accurate costings.

Indirect costs: These costs are not easily attributable directly to particular outputs and normally have to be apportioned by an appropriate method. Indirect costs will include local support costs such as finance and personnel sections. The attribution of indirect costs is currently being considered as part of the introduction of RAB/ PUFFS2 Project and review of the PPARC DSY costing system by Finance Officers. Conclusion to these exercises will form an update to this FM when complete.

5.     It is the responsibility of each Establishment to determine the FEC of any repayment activity. Local overheads should be apportioned in the most appropriate manner, balancing the requirements of precision against the cost of producing the data, but to ensure that cross-subsidisation between areas is kept to a minimum.

6.     A significant part of indirect costs will be in respect of depreciation of Land and Buildings and Plant and Machinery. All PPARC assets are recorded on the Capital Assets Register, and depreciation is currently calculated annually at the end of each financial year. In addition, the cost of capital on the current written down value of the capital employed (6%) is to be included in the costing. This will be the average of aggregate values on 1 April and 31 March in the financial year of the net assets. Where equipment is leased, capital equipment costs will comprise the rental and maintenance costs.

7.     The Employers' Superannuation Contribution (ESC) should be included in the FEC at the current rate of 10.1% of pensionable pay (as at 1.4.99). (ESCs are the employers contribution to the Research Council’s Pension Scheme and this percentage is updated periodically based on actuarial forecasts.) Swindon Office Personnel Group can advise on the current rate.

8.     Costings should be based on current actual costs and re-stated at future price levels using the latest GDP Deflators issued by HM Treasury. These are circulated to key personnel in Swindon Office and Establishments on receipt from HM Treasury, by Planning and Budgeting Group in Swindon Office, from whom further copies can be obtained if necessary.

Definition of repayment work and types of work that PPARC can undertake

9.     The term "repayment work" means all work funded other than from the Science Budget (SB) allocation from OST, ie from external income with the exception of jointly-funded operations.

10.     PPARC’s policy is to encourage Establishments to undertake repayment work and maximise the financial and scientific benefits that the work brings. However, increased repayment work can cause problems in relation to SB funded priorities, to other current repayment activities and to the planning of both - particularly when income does not cover all the FEC of the work.

11.     It is necessary therefore to establish guidelines in respect of the repayment activities that can be undertaken:

(a) the work must be within the scope of PPARC's Charter and be appropriate to the skills and interests of the Establishment involved;

(b) in all cases there should be scientific and/or financial benefits to PPARC. Establishments should not use SB resources to subsidise under-funded repayment activities, except in the specific circumstances detailed in paragraph 14. For commercial work, unless there are quantifiable benefits to PPARC, the customer must be prepared to meet at least the FEC of the service, with PPARC’s aim being to charge the highest price the market will bear;

(c) PPARC should not normally undertake work for which ample capacity exists in the private sector.

Calculation of Fees and Charges

12.     As with all public-funded bodies, PPARC is required to recoup the full cost of providing goods and services from its customers in both the private and public sectors. FEC should be determined as a basis for all charges for repayment work, although the final charge for the work could be higher or lower.

13.     It is important to distinguish between costing and charging. The former is the financial resources consumed to carry out an activity while the latter is the price charged for the goods or service being supplied. The general aim should be to charge as much as the market will bear and to maximise the benefits of repayment work, both scientific and financial.

15.     For strictly commercial work the FEC also serves as a basis but the aim should be to charge more if at all possible. In view of the unique nature of PPARC's activities, the comparative market price may be difficult to determine and a degree of judgement followed by negotiation will be required. The aim should be to exploit the uniqueness of the service by setting a higher price for the work.

16.     Establishments must be cautious in what information is revealed to potential customers. Staff should not, for example, reveal the content of this FM. Prices should not be quoted for work until costings have been completed. In many cases the market may bear a lot more than is thought initially and revealing FEC or a minimum acceptable price would undermine negotiations. Establishment Directors will be responsible for setting the negotiating brief but as a general guide, it is recommended that an opening negotiating price should be set out as FEC plus 30%. Procurement staff have an important role to play in negotiations and should be brought in at an early stage of the process.

17.     If the market price is less than the FEC of providing the work and there are no other benefits to PPARC, then the activity is not viable and should not be started.

18.     It is fairly common practice that potential customers will offer equipment, staff resources etc in part or even full payment for repayment work. In these circumstances, the resources offered need to be costed accordingly. When equipment is provided that will become the property of PPARC on termination of the repayment contract, the full cost of the equipment may be included in the costing algorithm, providing it remains of value to PPARC. (Note: the cost to PPARC of running or maintaining the equipment should also be taken into consideration.) If reclaimed by the customer, only a relevant proportion of the value should be used. Cases of this kind need to be judged on their merits through a cost benefit analysis (see FM 301 Economic Appraisal).

Work for Government Departments

19.     In accordance with HM Treasury rules, government departments should be charged at FEC. However, in circumstances where government departments and private sector customers might be in competition for the same PPARC service, the FEC should reflect the market price, if the latter is higher. In these circumstances it is considered reasonable to charge departments a price similar to those set for the private sector.

Working to a price

20.     In these circumstances it may be difficult to use the procedure as described above. Depending on whether the work falls in the commercial or collaborative category, an estimate should be made of the amount of work which can be afforded. This should then be costed in detail. If there is a difference from the funds available then the amount of work should be adjusted up or down. The important principle is that, if the budget is restricted, the work done and not the price charged should be adjusted to fit.

Diversions from FEC

21.     There may be occasions where FEC is not an appropriate basis for setting charges:

        (a)     Excess capacity

Where the opportunity cost (defined as the value of resources in their best alternative use) of excess capacity is zero (eg under-utilised facilities or buildings which have no other use and cannot be disposed of) it may be appropriate to reduce the charge to a marginal costs basis although the aim should be to charge higher in order to make a contribution to the fixed costs involved.

        (b) Differential charging

In certain cases charges may be made at less than FEC in respect of:

• fluctuating demand: where it is appropriate to charge less than FEC at off-peak periods. This will normally be compensated by charging more at peak periods so that at least the FEC is recovered over the accounting period.

• incentive charging: this will normally be work of small value which may act as an incentive for future business. This work may include feasibility studies.

In all cases, justification for charging less than FEC must be fully documented.

Work for the European Commission (EC)

22.     Work undertaken for the EC must be costed in accordance with the Commission's regulations. The latest guidelines of which costs can be included in EC contracts are detailed at Annex B. Further information on EC contracts can be found at http://www.cordis.lu/fp5/financial-guides.htm . EC contracts are usually collaborative with at least one other partner, and the EC usually contributes up to 50% of the eligible costs. (The Full Cost Model should be used as PPARC produces full annual accounts.)

Approval and authorisation of repayment work

23.     Proposals to undertake repayment work must conform to the guidance given in paragraph 11 and be costed in accordance with the principles set out in paragraph 4. In all cases, proposals seeking approval to provide repayment work must at the same time seek approval in principle for the associated staffing requirements.

25.     The Director Administration’s approval should also be sought for projects valued below £300k which:

(a) involve issues of propriety;

(b) are major departures from agreed policy;

(c) incur a substantial financial risk;

(d) contain a sensitive foreign policy aspect.

27.     The approving officer should be provided with full details of the proposal under the following headings:

(a)	Summary of project:	background, description, milestones, collaborators, intellectual property rights (eg patents)
(b)	Personnel:	roles, time allocation
(c)	Finance:	analysed FEC of work, proposed price, justification for diversion from FEC, sources of funding
(d)	Effect on science programme:	eg non-financial benefits to PPARC

28.     Proposals which require approval from the Director Administration should be sent via PPARC’s Head of Finance, Swindon Office, who will advise the Director Administration on the financial aspects of the proposal..

The formal offer

29.     The appropriate procurement personnel will prepare the formal offer (or tender) which will form the basis of the contract for the repayment work. Procurement staff should be consulted early in the negotiations with the prospective customer to agree appropriate terms and conditions. The Head of Procurement is also able to provide advice where necessary. Account will be taken of such aspects as firm and variable elements in the price, payment arrangements (including stage payments if required), any need for sub-contracts to be placed, delivery, packaging, default, break, indemnities, confidentiality, publication of results of research and exploitation and protection of any of PPARC’s intellectual property.

Responsibilities

30.     Annex B to this FM identifies the salient points in the form of a note on the procedures for dealing with enquiries and requests for the provision of repayment work.

31.     Where there is doubt, the responsibility for determining whether it is appropriate for PPARC to undertake a proposed repayment service will rest with the Director Administration.

32.     PPARC Finance Division, Swindon Office, will be responsible for the implementation of costing policy and procedure across PPARC, and will carry out "dipstick checks" on individual cases as appropriate. Establishments will be responsible for setting the level of charges. Additional guidance can be obtained from PPARC Finance Division, Swindon Office.

33.     The Head of Procurement will be the first reference point for questions on contractual matters.

Introduction

35.     When an activity is identified for market testing, and an in-house bid is to be made, the following will be required:

(a)     the FEC of the current service;

(b)     the FEC of the in-house bid; and

(c)     the cost data for tender bid evaluation.

The need for accurate costings is paramount for three reasons:

(a)     to ensure that bids submitted by the in-house team are not:

• too high (resulting in lost work)
• too low (resulting in inability to deliver Service Level Agreements);

(b)     to provide a reliable basis for tender bid evaluation;

(c)     to ensure a reliable basis for future calculations of efficiency savings.

General Costing Principles

36.     In principle the comparison between the cost of an in-house bid and a bought-in service should be based on the FEC of each option. In practice, however, some elements may be excluded from the in-house bid as they would remain as a cost whether the service was provided in-house or by an outside supplier. These are known as unavoidable costs and are explained in paragraph 40(a). As a first step in the market testing costing exercise, the FEC of the existing in-house service should, however, be ascertained.

37.     The FEC represents the total cost of resources used in providing a particular activity and comprises both cash and non-cash (or notional) costs. These are either directly attributable to services through financial accounting systems or, in the case of overheads, apportioned between services by an appropriate manner. Annex A lists the items of cost which make up the full cost.

38.     Costing of in-house bids for market testing requires as much precision as possible. Establishments should ensure that as much expenditure as possible is attributed directly to activities. Staff effort accounting systems should be used to identify staff effort on activities. Full project cost accounting is already available at Establishments and will be introduced in Swindon Office as part of the PUFFS2 financial project.

39.     The assessment of FEC applies equally to an activity which is an output of the Establishment (eg research grant processing or instrument development) as it does to one which is a support activity (eg secretarial support) to one or more output activities. The range of overhead costs appropriate to a support activity may well differ from those appropriate to an output activity. For example, a policy unit might provide an input to grant processing activity but not secretarial services, whereas both would attract a share of costs from the personnel section.

Reductions and exclusions from FEC

40.     As part of the evaluation process, it will be necessary to make adjustments to the FEC of activities in order for in-house bids to be on a common footing. For example, in-house bids should not include activities and support services which would still be needed if outside contractors were employed. Establishments are required to take account of the following elements:

(a)     Unavoidable Costs

These are likely to be costs which form part of the FEC of an activity, but would be common whether the service was provided in-house or by an outside supplier. As an example, the cost of internal audit services may not necessarily change because of a decision to move an activity to an external contractor. Similar considerations could apply in the case of policy and senior management time. These are termed "unavoidable costs" and need to be excluded from in-house costs in order to be comparable with external bids. A significant part of the central overheads are likely to be unavoidable costs and these will be deducted at source from the sums which will be communicated to Establishments for inclusion in the costings. However, there may well be other unavoidable costs at both Swindon Office and Establishment level, the treatment of which may depend upon the unit being costed; these should be dealt with at the evaluation stage. Establishments will therefore be required to identify separately in their costings those elements which it believes fall in the category of unavoidable costs.

(b) Other Modifications

There could be reductions from the FEC to reflect instances of temporary spare capacity or loss of economies of scale which might arise if an in-house bid was unsuccessful. The timing of when resources could either be re-deployed or relinquished will be a crucial factor in these cases. If staff numbers, accommodation, etc could be immediately reduced or transferred to other activities, the FEC (ie the opportunity cost) should remain in the in-house bid. However, in other cases it may not be possible to dispose of surplus accommodation or plant and machinery; nor might there be alternative uses for it. In these circumstances the savings would not materialise until the buildings needed replacement. To include this in the opportunity cost of the in-house bid could leave PPARC with higher total costs if a contractor's bid was acceptable. (See the HM Treasury publication "Appraisal & Evaluation in Central Government", also known as "The Green Book", paragraphs 4.12 to 4.15 for further guidance concerning "opportunity costs".)

The position is unlikely to be clear-cut and there may be other relevant factors which need to be taken into consideration. For example, a reduction in direct staff may result in a reduction of workload for support areas, eg personnel. Although this is unlikely to have an immediate effect on the staff numbers (or costs) in those support sections, if there were other changes taking place from a dynamic programme of market testing, the effects of successful external bids could be accumulated to produce changes to the staffing of that activity. This would result in a reduction of overhead costs.

(c) Sunk Costs

When costing an in-house bid, any previous expenditure which would have no realisable value should not normally be included and should be regarded as a sunk cost. For example, any consultancy costs of developing an in-house bid for market testing should not be treated as part of the cost of the in-house activity, given that the decision on whether or not to contract out would be taken after completion of the bid. However, any future consultancy costs of assisting the in-house operation if the bid was successful should be included.

(d) Costing for equipment

Where the in-house team use existing equipment which has no alternative use, and which would not be due for replacement until after the expiry of the first contract period, the value placed on the equipment for purposes of depreciation and interest on capital should reflect this situation:

(i)     where the in-house team was the sole user and the equipment would be disposed of if the in-house bid was unsuccessful, the valuation to be used for purposes of depreciation and interest on capital could be based on the recoverable amount rather than net current replacement cost;

(ii)     if the equipment was shared with other users there would be some spare capacity until it was due for replacement. If the equipment would last longer as a result of the in-house team not using it, the total of depreciation and interest on capital of that equipment would reduce. That reduction could be used as the amount to include in the in-house bid. If use by the in-house team had no effect on the timing of replacement, the amount of depreciation and interest on capital would be nil.

41.     As with unavoidable costs, Establishments will be best placed to determine when modifications to the FEC of in-house activities are appropriate. Full details should be provided by Establishments for these to be considered at the evaluation stage.

VAT

Presentation of costings

43.     To recap from the foregoing paragraphs, the costing of activities subject to market testing should be as follows:

(a) Existing in-house service

(i) The FEC of the existing in-house service (in order for PPARC to monitor the efficiency savings on the areas market tested)

(b) Proposed in-house service

(i) FEC

(ii) Less unavoidable elements of operating service

(iii) Less modifications to FEC

(iv) Below the line: transfer and redundancy costs if in-house bid unsuccessful.

44.     In the evaluation process, cost comparisons will be made on figures expressed in real terms. In-house bids should therefore be set out at constant price levels of the first year of the contract period. GDP deflators should be used to bring this to this price level. Current versions of these deflators are circulated to key personnel in Swindon Office and at the Establishments, but can also be obtained from Planning and Budgeting Group, PPARC Finance Division, Swindon Office.

46.     In order to maintain a common approach across PPARC, costings of in-house bids should be agreed with the PPARC Head of Finance, Swindon Office. All costing elements should be clearly identified. This should be done before the evaluation process to allow any amendments to be incorporated in the in-house bid.

47.     Any queries concerning the content or interpretation of this FM should be referred to Paul Blackford, Planning & Budgeting, PPARC Finance Division, Swindon Office, tel: 01793 442062, e-mail: paul.blackford@pparc.ac.uk.

Paul Blackford
Planning & Budgeting
PPARC Finance Division, Swindon Office

The following is a list of the more common items which comprise the FEC of an activity. Decisions regarding cost apportionment are matters of judgement within Establishments.