Application of Cost Recovery Principles
Entities audited: Australian Maritime Safety Authority
Department of Agriculture and Water Resources
Department of Health
Introduction
4.1
Cost recovery is an element of the Australian Government’s ‘Charging Framework’ which was implemented in July 2015 to improve the consistency of charging activity across government and help determine when it is appropriate to charge a non-government entity for a government activity. The Department of Finance (Finance) produces and maintains governance frameworks for cost recovery activities. As such, Finance has issued Cost Recovery Guidelines to support the implementation of the government’s Charging Framework.
4.2
The Cost Recovery Guidelines are a sub-set of the Charging Framework and must be applied by all non-corporate Commonwealth entities, and by corporate Commonwealth entities where the Finance Minister has made a ‘government policy order’ that applies the Australian Government cost recovery policy to them.
4.3
The audit considered the application of cost recovery principles in the Australian Maritime Safety Authority (AMSA), Department of Agriculture and Water Resources (Agriculture), and the Department of Health (Health) for the Therapeutic Goods Administration (TGA).
4.4
The ANAO selected the three entities in recognition that they all undertook significant cost recovery activities, represented a wide selection of organisational types and were not under pressure from concurrent or recent audit activity. The ANAO confirmed that the Department of Finance was consulted in respect of which entities were selected.
Audit Scope
4.5
The objective of the audit was to determine if the selected entities effectively applied the cost recovery principles of the cost recovery framework. Paragraph 15 of the Cost Recovery Guidelines state that entities must apply the principles of transparency and accountability, effectiveness and efficiency, and stakeholder engagement across all stages of the cost recovery process.
4.6
As a result, the audit criteria examined: if the entities cost recovery arrangements were transparent and promoted accountability, if cost recovery arrangements were effective and efficient, and if entities engaged with stakeholders effectively in the design, planning and implementation of their Cost Recovery Guidelines. The scope of the audit focused on the application of cost recovery principles for particular programs and activities managed by each entity.
4.7
The audit cost the ANAO approximately $560 000, with seven staff engaged.
Overall Audit Conclusion
4.8
The ANAO concluded that all three entities have been partially effective in implementing the cost recovery principles of the cost recovery framework.
4.9
The audit found that AMSA and Health had significantly over-recovered costs in recent years, whilst Agriculture over-recovered costs through levies and under-recovered costs through fees. The ANAO concluded that each entity had scope to improve the effectiveness of its cost recovery arrangements. The report stated that ‘there is no assurance that entity charges recover the efficient costs of their activities.’ The ANAO highlighted:
Entities’ cost recovery policies and cost recovery methodologies are at varying levels of being fit for purpose, with Health’s approach for the TGA the most complete.
4.10
The ANAO found that although governance and internal accountability arrangements of the three entities are fit for purpose, there is scope for improvement in relation to transparency and accountability of cost recovery arrangements through comprehensive reporting of performance in Cost Recovery Implementation Statements (CRIS).
4.11
In relation to stakeholder engagement, the ANAO concluded that whilst each entity regularly engages with stakeholders, none have documented cost recovery engagement strategies. Health was identified as being largely effective in engaging with stakeholders and regularly updating their CRIS to support this engagement.
4.12
The audit makes six recommendations that focus on ensuring the Cost Recovery Guidelines are reflected within the Cost Recovery Implementation Statements of individual entities. All recommendations were accepted by AMSA, Agriculture, Health and Finance.
Governance
4.13
The ANAO concluded that each entity has established effective cost recovery governance and accountability arrangements in accordance with the Cost Recovery Guidelines. Arrangements within entities include internal management committees and executive board consideration of cost recovery performance.
4.14
The ANAO also found that each entity has policy or legislative support to charge for its regulatory activities and services. Health has ministerial, not government policy approval, that allows charging to meet the cost of fee-free activities through higher charges on other users. The audit found that all cost recovery actions are occurring in compliance with the law.
4.15
To improve governance, the ANAO suggested that Finance clarify the use of the term ‘model’ in paragraph 33 of the Cost Recovery Guidelines as it is unclear when ministerial approval is needed prior to changing the model of cost recovery. Whilst Finance advised the ANAO that policy approval is only required where changes to charges are material, sensitive or complex and that the responsible minister or accountable authority can approve changes of an operational nature, a clear limit or scope could be included in the Cost Recovery Guidelines.
Cross-subsidising Practices
Australian Maritime Safety Authority
4.16
The Australian Maritime Safety Authority (AMSA) advised the Committee that over the past five years there has been a cumulative surplus of over $30 million over-recovered:
There’s no getting away from the fact that this over-recovery contributed to AMSA’s reserves, which we used to build the capability for the national system.
4.17
The AMSA has a funding gap of approximately $20 million for the development and transition of a new national system [National System for Domestic Commercial Vessel Safety]. The AMSA stated that development costs have been included in levies:
To some extent they have been [included]. Whether that’s correct in terms of cost recovery principles is an issue for us. We do recognise that that is something that needs to be worked through.
4.18
The AMSA confirmed it is currently reviewing cost recovery activity associated with marine orders to ascertain if current levies are correct.
4.19
The AMSA further stated:
AMSA has identified internal governance as a key to implementing and maintaining a consistent and transparent approach to cost modelling. AMSA is working towards implementing procedures and enhanced costing rules as part of developing the 2020-21 Cost Recovery Implementation Statement.
Health
4.20
In 2016, Health undertook a portfolio charging review which found that the TGA’s costing model could be improved by reducing the level of cross-subsidisation that has occurred across industry sectors. The review also found cross-subsidisation of fee-free services. The review recommended that this cross-subsidisation should continue, but with disclosure in the TGA’s CRIS.
4.21
The audit found that this approach is non-compliant with the Cost Recovery Guidelines, which provide that where costs cannot be reasonably attributed to an individual or organisation, they should not be cost recovered. The audit suggests it would be more appropriate for these costs to be met from the Budget. The audit stated:
While noting that the Minister for Health approved the continued cross-subsidisation of these costs, paragraph 33 of the Cost Recovery Guidelines requires that entities and responsible ministers must have policy approval from the Australian Government to cost recover. The ANAO considers that the continued practice of cross-subsidising fee-free services should be further reviewed and that Health submits a proposal to seek a government decision on the funding of the cost of these services.
4.22
Health added that cross-subsidisation of the information technology upgrade using over-recovered funds will not commence without prior government approval. Health clarified that the government is considering how to best respond to the growing challenge of ‘fee-free’ services that cannot be appropriately assigned to an industry for recovery purposes. Health stated:
The challenge we have now is that it’s predicted there will be $17 million of so-called fee-free services that can’t be appropriately assigned to an industry. … Our projections are that it will be almost $24 million next year. Government is aware of this. It’s under government consideration, but that’s obviously beyond the department.
Risk Management
4.23
The audit identified that whilst the TGA had made changes to its charges framework, Health has not completed a risk assessment of the impact of these changes since 2016.
4.24
The audit also found that AMSA and Agriculture have not reviewed their risk ratings since charges were last changed in 2015. Whilst both AMSA and Agriculture argued that there have been no changes requiring a re-examination of risk, the ANAO stated that it is important to ensure that the risk assessment of charging arrangements remains appropriate, even where there are no changes to charges.
4.25
The ANAO suggested that the Cost Recovery Guidelines could require entities to review the continuing suitability of the risk assessments of their cost recovery arrangements at set minimum periods or whenever significant changes are made to the cost recovery arrangements.
Performance Measurement and Management
4.26
The ANAO clarified the nature of efficiency and effectiveness in the context of cost recovery activities:
[E]ffective cost recovery arrangements generally involve a fit-for-purpose activity-based costing model, with the costs of providing activities linking to the prices and estimated revenues for those activities. This provides alignment between revenues and expenses for each activity over time, with minimal cross subsidies between activities. Where misalignment occurs, entities should be proactive in addressing structural over and under-recovery of the costs of their activities. Entities should use levies to charge for activities provided to a group of individuals or organisations, and fees for activities provided to specific individuals or organisations. Efficiency is best captured in cost recovery arrangements by entities incorporating efficient costs in their cost recovery models, which can be determined through benchmarking with comparable entities and activities.
4.27
Accurate measurement of program operation against key performance indicators is essential to ensure efficient and effective cost recovery activities. In 2017-18, reported revenue from regulatory charging in entity financial statements was $2 billion against reported expenses of $2.2 billion. In the same period, the revenue raised from the cost recovery activities covered in this audit as approximately $372 million. The AMSA recovered $128 million, Agriculture recovered $91 million and Health recovered $153 million. The cost recovery practices of each entity are examined in detail below.
Australian Maritime Safety Authority
4.28
The audit examined the AMSA’s cost recovery performance over five years from 2013–14. Over this period AMSA did not recover the full cost of its fee-based activities, and funded the shortfall from levy-based revenue. The ANAO concluded that the AMSA:
over-recovered costs across all of its regulatory activities by $28 million;
over-recovered costs in each year for activities covered by the Regulatory Function Levy and had an accumulated surplus for the period of $40 million;
over-recovered costs for four of the five years on activities covered by the Protection of the Sea Levy and had an accumulated surplus for the period of $17 million;
under-recovered costs for four of the five years on activities covered by the Marine Navigation Levy and had an accumulated deficit for the period of $14 million; and
under-recovered the cost of fee-for-service activities in each year and had an accumulated deficit of $15 million.
4.29
The ANAO suggested that the cost recovery model used by the AMSA be improved to correct current over and under-recovery trends. Currently the Marine Navigation Levy and the Marine Navigation (Regulatory Functions) Levy are based on a sliding scale on the net registered tonnage of ships, while the Protection of the Sea levy is based on a rate per tonne of the tonnage of ships. This means that cost recovery is not directly linked to activity.
4.30
In relation to the under-recovery of fees the ANAO stated:
AMSA does not recover the full cost of its fee-based activities, and funds the shortfall from levy-based revenue. If it is not feasible to recover the full costs of these activities, AMSA should seek the government’s approval of the partial recovery, and how the shortfall is to be met, with disclosures of any cross-subsidies included in its Cost Recovery Implementation Statements.
4.31
In relation to the over-recovery of levy amounts, the AMSA acknowledges that whilst there could be improvements to ensure full compliance with the Cost Recovery Guidelines, tonnage-based levies are easy to administer and are accepted by industry. The AMSA acknowledged it had over-recovered a significant amount in the Regulatory Functions Levy and explained:
As ships enter into Australian ports it is difficult to predict precisely which ships, their frequency and the exact tonnage. So the basis on which we recover levies is not directly tied to our specific service actions.
4.32
The AMSA indicated it is intending to review its charging arrangements following the introduction of the National System and there is an opportunity to examine suitable proxies for levy-based charges in this context. The AMSA stated that:
AMSA is currently preparing to publish its 2019-20 Cost Recovery Implementation Statement in December 2019, with plans to publish 2020-21 in June 2020 (prior to commencement of budget year).
The 2019-20 statement addresses many of the items identified in the recommendations, such as greater explanation of costing model, more appropriate cost-drivers for corporate functional costs, break-down of financial performance at regulatory functions level, providing financial estimates of budget and forward estimates, and engagement with stakeholders.
Health
4.33
The audit found that there has been significant misalignment between revenue and expenses for the TGA, with the costs of some activities being consistently over-recovered and others consistently under-recovered. The audit concluded that Health should be more proactive in addressing structural over and under-recovery of the costs of its activities.
4.34
Health confirmed that it had over-recovered $28.8 million over a seven-year period, noting this represents an over-recovery of two percent of annual revenue.
4.35
The ANAO suggested that Health could improve the attribution of effort to regulatory activities. Health agreed that there is scope for improving the costing model and gave the example of legal service fees not being included in the current cost recovery model despite being a significant cost of some reforms.
4.36
Health added that there have been improvements made in the past 18 months that significantly changed the costing model for manufacturing inspections with a fairer and more transparent model for cost-recovery now in place.
4.37
Health also cautioned that in small sectors, such as cells and tissues, there would be a ‘very significant impost on industry’ if the total cost of regulatory framework development was recovered. Health advised that the government is aware of this issue and the need to cross-subsidise smaller industries.
Agriculture
4.38
The audit found that Agriculture’s use of a levy as a charging mechanism for the recovery of expenses is inconsistent with the Cost Recovery Guidelines and should use its current review to align the structure of its fees and levies with the requirements of the Cost Recovery Guidelines. The audit also highlighted concerns about Agriculture recovering the costs for expenses that fall outside the scope of the Guidelines:
In its Charging Guidelines, Agriculture justifies recovery of these charges through levies on the basis that they have broad benefits, and do not benefit individual clients. However, this is not always the case. Further, many of the costs recovered through levies are enabling or indirect costs, and the Cost Recovery Guidelines indicate that fees should include both direct costs and an appropriate share of indirect costs.
4.39
The audit also highlights that Agriculture could review fees that have not changed for around a decade.
4.40
These audit findings reflect issues identified in an internal review which was commissioned in 2017. This review identified an imbalance between revenue and expenses for some activities. The internal review concluded that Agriculture should revise the way in which it distributes the expense base associated with the Program Management and Administration cost pool to accurately determine the levels of any over-recoveries.
4.41
Agriculture stated that most over or under-recovery occurs where the volume expectation or forecast is not realised, and it is difficult to adjust costs quickly in response to changes in volume.
4.42
The ANAO recognised that Agriculture has been reviewing its charges and is planning to revise them in 2019–20. The ANAO suggested that this presents an opportunity for Agriculture to align the structure of its fees and charges with the requirements of the Cost Recovery Guidelines.
Benchmarking
4.43
The Cost Recovery Guidelines are clear that the Australian Government should only charge the non-government sector some or all of the efficient costs of a specific regulatory activity. The ANAO suggests that in order to comply with the Guidelines, financial estimates need to be based on ‘efficient costs’ which are defined as ‘the minimum costs necessary to provide the regulatory activity while achieving the policy outcomes and legislative functions of the Australian Government’. To ensure that efficient costs are recovered, the entity should, where possible, benchmark the regulatory activity and its business processes.
4.44
The audit found that none of the three entities have incorporated efficient costs in their cost recovery models and only Agriculture has sought to benchmark the costs of its regulatory activities with those of other entities. The ANAO considered this an opportunity for Finance to examine how benchmarking can be further encouraged and facilitated across all cost recovery entities.
4.45
The ANAO highlighted that benchmarking is essential and a key message from this audit for all Australian Government entities is:
Cost recovery approaches should clearly apply the Cost Recovery Guidelines’ principle of efficiency. Entities should benchmark key activities, understand trends in charges and prices over time (that can demonstrate efficiency improvements), otherwise identify where efficiencies can be achieved, and incorporate these elements in cost recovery models.
4.46
The audit found that Health has attempted to benchmark the TGA’s operations with those of other international medicines regulators. For example, it has sought to compare its operations with those of the European Medicines Agency and the US Food and Drug Administration. Given the differences in the operations of these administrations, no meaningful results on the efficiency of TGA charges were obtained. The audit noted:
Benchmarking of some aspects of Health’s operations, such as records management and information and communications technology has also been attempted. Again, these have not focused on the cost of these operations.
4.47
Whilst Agriculture has sought to benchmark the costs of its regulatory activities, it has not updated costs since 2015.
4.48
The AMSA has also not changed any recovery amounts since 2015 and is currently working to set a benchmark:
AMSA is currently working on two approaches to benchmarking activities; one based on internal measures and trends over time, and the other based on comparing activity costs, prices and service delivery provided by similar external regulatory agencies.
4.49
The audit also found that entities can better work together to share benchmarking findings:
[M]any of the services provided by the three entities, such as inspections, although related to different regulatory activities, are similar and therefore could be benchmarked across entities. For example, there is the opportunity to benchmark the full daily and hourly costs by APS classification (for example, APS 1 to 6 and EL 1 to 2) across all entities and efficiency rates (how long it takes to complete tasks) across entities with similar tasks. This suggests an opportunity for collaboration between entities in benchmarking some costs of their regulatory activities and reviewing why some activities take longer than others.
Reporting
4.50
The audit found that all entities failed to fully comply with the requirements of the Cost Recovery Guidelines in respect to their Cost Recovery Implementation Statements (CRIS).
4.51
Whilst each entity had slightly different results, overall findings from the audit identified the need to update the CRIS annually. Updates should include consideration of estimates and the underlying methodology used to determine them and key forward dates.
4.52
Both AMSA and Agriculture questioned the need to update their CRIS each year, as no changes in charges were proposed.
4.53
Agriculture advised that it sets CRIS on a four-year cycle and there have been no changes to legislated prices over this period. Agriculture also noted that it had delayed updating its CRIS because of continuing work requested by the Minister on proposed changes to charges since 2015–16.
4.54
The ANAO stated that updates to an entity’s CRIS are needed not just to explain changes in charges, but to provide performance information and updated estimates of revenues and expenses for each forward estimates period.
4.55
Finance advised the ANAO that it is aware that many entities do not update their CRIS, as required, although it does not systematically take this up with them.
4.56
Entities have been part of various processes and working groups to discuss possible improvements to the Cost Recovery Guidelines.
4.57
The ANAO recommended that Finance refine the Cost Recovery Guidelines to provide greater clarity on some requirements, including the requirements for updating the CRIS. The ANAO also recommended that Finance take steps to promote greater levels of compliance as none of the three entities fully complied with key requirements of the Cost Recovery Guidelines, particularly those relating to CRIS, with Agriculture and AMSA not updating them at least annually as required.
Stakeholder Engagement
4.58
The ANAO found that whilst all entities engage with stakeholders by various means, none have documented ongoing cost recovery engagement strategies. The audit concluded that there is scope for all three entities to implement performance measures for consultation on cost recovery to promote continuous improvement of cost recovery stakeholder engagement processes.
4.59
Following the ANAO report, stakeholder engagement by Health has been strengthened by ‘having a consultation paper that follows the bilateral meetings and then taking those submissions before we go to government’.
4.60
The AMSA stated that stakeholder engagement was limited as ‘those that pay the regulatory functions levy are largely made up of international shipping operators.’ In relation to domestic stakeholders, the AMSA clarified:
[I]t would be fair to say that we haven’t had, until now, a rigorous program of engagement, and we’ve started this year with a more comprehensive program to specifically engage on the cost-recovery detail.
4.61
Agriculture stated that engaging with the ANAO has been ‘very interesting, useful and timely’ and that the ANAO ‘did point out that we could have greater use of the cost recovery implementation statement itself to consult more generally and more widely than those [industry consultative] committees’.
Concluding Comment
4.62
In relation to governance, the Committee is concerned at the longstanding practice of entities using over-recovered funds to cross-subsidise activities which may fall outside the scope of the Cost Recovery Guidelines. The Committee agrees that the Cost Recovery Guidelines need to be reviewed in this regard. The revised Cost Recovery Guidelines should provide entities with clear advice on what recovered monies can be used for.
4.63
The Committee acknowledges the ongoing challenges associated with both small industries and fee-free services. The Committee strongly encourages Health to work with Finance to establish clear guidance on what activities require ministerial approval, and what actions are outside the scope of appropriate cost recovery actions and require Government or budget consideration.
4.64
The Committee acknowledges the ongoing challenges associated with both small industries and fee-free services. The Committee strongly encourages Health to work with Finance to establish clear limits on which activities require ministerial approval and what actions are outside the scope of appropriate cost recovery actions and require Budget consideration.
4.65
The Committee is concerned that current Cost Recovery Guidelines are not specific in relation to the regular consideration of risk and agrees with the ANAO that there should be minimum timeframes set in relation to the assessment of risk. The Committee also agrees that each entity should be supported to update their Cost Recovery Implementation Statements annually.
4.66
In relation to performance management, the Committee agree that there is scope for the AMSA to improve its costing model to correct the current structural issues that create patterns of over and under-recovery. The Committee consider the introduction of the National System as an opportunity to address these issues across the organisation.
4.67
The Committee is concerned at the lack of benchmarking activity occurring across the three entities, and agrees that Finance needs to be more proactive in encouraging and supporting entities to undertake benchmarking activities. The Committee agrees with the ANAO that building a culture of sharing benchmarking information can create efficiencies and should be considered by a working group facilitated by Finance.
4.68
In respect of stakeholder management, the Committee is encouraged that the audit process has assisted all three entities in considering how best to engage with domestic and international stakeholders. The Committee considers that this may be appropriate for further consideration between entities at workshops hosted by the Department of Finance.
4.69
All recommendations focus on ensuring that internal and external reporting is based on benchmarking and strong communication with stakeholders. When implemented the Committee is confident that there will be improvements seen across government agencies in respect to all cost recovery actions.
4.70
The Committee recommends that the Department of Finance review the Cost Recovery Guidelines to:
provide clear advice to entities on what activities can be funded with cost-recovered monies and;
prescribe that entities update risk ratings within six months of changes to charging guidelines being introduced, or biennially in the absence of changes to cost recovery practice.
4.71
The Committee recommends that the Department of Finance facilitate a working group to encourage and support benchmarking activities by cost recovery entities. The working group should also examine methods to encourage information sharing in respect of benchmarking results for the purposes of cost recovery activities. The findings of the working group should be reported back to the Committee within 6 months.