State law permits the State Department of Revenue to collect taxes for municipal governments that operate within the state’s jurisdiction and allows private companies to collect taxes for municipalities. To promote fairness and to ensure the financial well-being of the state, the law dictates that the Department of Revenue must charge municipalities a fee for collection services that is above the cost of providing such services but does not define the term cost. Until recently, Department of Revenue officials have included a proportionate share of all departmental costs such as depreciation on buildings and equipment, supervisory salaries, and other facility-level overhead costs when determining the cost of providing collection services, a measurement approach known as full costing. The full costing approach has led to a pricing structure that places the Department of Revenue at a competitive disadvantage relative to private collection companies. Indeed, highly efficient private companies have been able to consistently underbid the Revenue Department for municipal customers. As a result, it has lost 30 percent of its municipal collection business over the last two years. The inability to be price competitive led the revenue commissioner to hire a consulting firm to evaluate the current practice of determining the cost to provide collection services. The consulting firm concluded that the cost to provide collection services should be limited to the relevant costs associated with providing those services, defined as the difference between the costs that would be incurred if the services were provided and the costs that would be incurred if the services were not provided. According to this definition, the costs of depreciation, supervisory salaries, and other facility-level overhead costs are not included because they are the same regardless of whether the Department of Revenue provides collection services to municipalities. The Revenue Department adopted the relevant cost approach and immediately reduced the price it charges municipalities to collect their taxes and rapidly recovered the collection business it had lost. Indeed, several of the private collection companies were forced into bankruptcy. The private companies joined together and filed suit against the Revenue Department, charging that the new definition of cost violates the intent of the law.
Required
a. Assume that you are an accountant hired as a consultant for the private companies. Write a brief memo explaining why it is inappropriate to limit the definition of the costs of providing collection services to relevant costs.
b. Assume that you are an accountant hired as a consultant for the Department of Revenue. Write a brief memo explaining why it is appropriate to limit the definition of the costs of providing collection services to relevant costs.
c. Speculate on how the matter will be resolved.