I only need Question 5 answered. Thank you

Question 5 is Alternatively, assume you are an employee of a local accounting firm that has been hired by Oak City to provide expert testimony in the case. Prepare a report analyzing the costs the city should charge businesses in the police jurisdiction. Use the same format as in part 4, but critique the plaintiff's position.

The format is:

Brief background information about the case

A critique of the city's position

An analysis of the costs Oak City should be charging businesses in the police jurisdiction, including an evaluation of the strengths and weaknesses of the analysis

Attachments of supporting calculations and schedules A list of additional data you believe might be relevant for your argument and discussion of how the data could be use

this was information i was given the case and the questions if you cant answer it how does my professor expect a student to answer it.

Issues in Accounting Education Vol 13, No. 1 February 1998 Instructional Case: Oak City's Cost Allocation and Determination Robert W. Ingram, W. Cameron Parsons and Walter A. Robbins ABSTRACT: Oak City is an interdisciplinary case that involves cost allocation and determination issues in a governmental setting. Ethical considerations re- lated to the role of accountants as expert witnesses also are included in the case. The primary issue in this case (drawn from actual events) is the amount of cost associated with police and fire services that should be charged to busi- nesses in an area adjacent to the city limits, referred to as its police jurisdiction. State law requires the city to provide these services and permits it to charge the incremental cost of providing these services to businesses in the jurisdiction. The definition and determination of incremental cost is highly subjective. City officials have been allocating a portion of total costs to the jurisdiction. A busi- ness owner sues the city, arguing that only variable costs are relevant. Students take the role of expert witnesses who are required to analyze avail- able information and to develop a position supporting either the plaintiff or the city. They are required to deal with an unstructured problem for which various positions can be argued. They must Identify relevant information and organize this information effectively. The case also serves to alert students to the impor- tance of professional judgment in accounting decisions for which little authorita- tive guidance is available. IKE Johnson, finance director city has just been hit with a civil suit for Oak City, sits in his office, by Anita Smith, the owner of Smith's peering out the window. It is Lumber Company. Her business be- the middle of February, and he is came part of the city's police jurisdic- pleased with the latest reports of the tion in 1993 when we annexed all that city's financial condition. After a few years of tight budgets, the city is get- ting back on the right track. General fund Robert W. Ingram and Walter A. Robbins revenues are larger than expected and are Professors at University of Alabama, and W. Cameron Parsons is an Attorney expenditures are under control. The city continues to grow, as a recent summary with Parsons & Sutton. of financial and demographic trends in- We gratefully acknowledge comments of dicates (exhibit 1). This looks like it is Tom Albright, Tom Howard and Bill Samson going to be a good fiscal year. on earlier drafts of this case. The comments Suddenly, the door to his office flies of the anonymous reviewers were very help- ful in improving case requirements and in open and in stomps Bob Holman, city making the case easier to understand. This attorney. case is based on actual events. Names and "Mike, you will not believe what amounts have been changed to preserve has happenedl" Bob exclaims. "The anonymity. M 158 Issues in Accounting Education Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 Population 61,212 62,448 65,330 68,206 69,455 73,524 76,409 83,059 85,922 92,076 96,549 102,335 EXHIBIT 1 Oak City: Financial and Demographic Trends Expenditures Revenues Total Police Fire Area $13,087 $13,082 $ 6,083 $4,744 57.5 14,736 14,698 6,259 4,898 58.3 15,011 14,966 6,407 5,033 60.0 15,200 15,209 6,518 5,181 61.3 16,102 16,083 6,840 6,526 62.1 16,843 16,855 7,280 5,720 66.4 17,622 17,596 7,506 5,996 66.8 18,705 18,670 7,981 6,304 67.6 18,987 19,194 8,312 6,408 68.2 20,345 20,752 8,936 6,942 75.0 22,315 22,301 9,734 7,425 76.2 24,440 23,811 10,455 7,724 76.4 Businesses 421 462 488 495 513 544 569 608 612 647 655 658 Revenues and Expenditures are in thousands and are for the General Fund. Area is in square miles. expensive residential property on the morning with city officials. Come pre- river. pared to explain how you've been de- "She claims the city has collected termining the fees we've been charging excessive business license fees from her in the police jurisdiction and the associ- and other business owners in the police ated costs." jurisdiction since 1994. She is suing to Mike can hardly believe what he's recover excess fees paid and attorney just heard. How can there be any ques- and court costs. She claims the city is tions about the way he determines cost charging her fees for costs it does not for the city's police jurisdiction? "All I incur, in violation of state law. did was allocate costs" Mike thinks to "You'll remember that state law re- himself. quires the city to provide police and fire protection to residents of the police ju- FACTS AND risdiction, which extends three miles LEGAL BACKGROUND beyond the city limits. While the law Oak City is the largest city in its re- permits the city to levy a license fee on gion of the state, with a population of all businesses located in the police ju- about 100,000. Most of the city is risdiction, the levy cannot exceed one- bounded on the west by the Black River half of the amount charged to like busi- with the city limits extended along both nesses located within the city limits or the east and west banks of the river for the actual costs incurred in servicing the about 15 miles. police jurisdiction, whichever is lower. In 1988, the state approved legisla- If Smith can prove we have been collect- tion providing for the creation of police ing excessive fees, we may be faced jurisdictions adjacent to the cities. The with a major class-action law suit. rationale supporting the law was to "You determined those costs, Mike. ensure basic services for citizens at a I sure hope you can justify them. I'll ar- reasonable cost. Cities were already range a meeting for first thing tomorrow equipped to provide services, and Ingram, Parsons and Robbins 159 extending these services to nearby resi- dents was thought to be less costly than creating new police and fire depart- ments to service the jurisdictions. As a result of this legislation, cities became obligated to provide public safety services to businesses and indi- viduals residing within its police juris- diction. Police jurisdiction is defined as all adjoining territory within three miles of the corporate limits of a city or town. Approximately 15,000 people live in Oak City's police jurisdiction, which contains approximately 40 businesses. State law authorizes cities to collect license fees from any businesses located within the police jurisdiction. These rev- enues are intended to reimburse the city for the cost it incurs in providing services to its police jurisdiction. The law explic- itly states that a city must estimate the amount reasonably necessary to provide public protection within the police juris- diction as a basis for its business license fees. A city, however, cannot use the police jurisdiction to generate net rev- enues for itself. THE MEETING The next morning, Mike arrives promptly at nine for the meeting. As he enters the room, he is met by most of the city's top officials, an indication of the importance of this case. In addition to Bob Holman, he shakes hands with Bart Flanagan, the assistant city attor- ney, City Council Chairperson Tammy Watson, and Mayor Al Tupay. Bob Holman starts the meeting: "Until now, the city has never had any business owners question the quality of services or the amount of fees we charge in the police jurisdiction. Although the city's primary responsibility for services is to its own residents, it has always tried to provide adequate service in its police jurisdiction, in spite of the expan- sion we have experienced in the last few years." Al Tupay joins in: "If I may say so, Bob, the problem relates directly to the city's annexation of property along the river. This process began only a few years ago. I was the one who questioned whether the city could adequately ser- vice this area, especially the area west of the river. You know how limited ac- cess is because we have only two bridges." "I remember, Mayor," responds Bob. "But the city has benefited from inclu- sion of the expensive residential prop- erty west of the river, and as I recall, you got quite a bit of support from those people in the last election." "Yes, Mayor," Tammy Watson adds. "And, I should point out that annexation of those expensive residential properties was necessary to increase our tax base sufficiently to cover the cost of the new city buildings and schools completed last year." Bob continues: "Whatever the cause of the problem, it's our problem now. Smith's Lumber Co. is located within the northernmost part of our police jurisdic- tion. It is nearly 10 miles from downtown and the nearest police and fire stations, as you can see from this map." (See ex- hibit 2.) "Smith is arguing that due to the dis- tance of her business from the city's fa- cilities, available services are limited. I have to admit, she is correct on this point. Actually, her company is closer to facilities in Burnt Creek than to those in Oak City. However, the law does not stipulate that facilities must be near resi- dents of the police jurisdiction, only that we must provide the services. Neither Smith nor the city has any control over the law. She is stuck with us, and we are stuck with her." Then it is Bart Flanagan's tum: "The city's position in this suit is that we have been lawfully collecting the maximum fees allowed by law from Smith's Lum- ber Co. According to Mike Johnson's 160 Issues in Accounting Education EXHIBIT 2 Map of Oak City Smith's Lumber Co. City Limits Town of Burnt Creek Police Jurisdiction Black River Bridges OAK CITY Downtown calculations, we always incur greater costs in servicing the jurisdiction than the amounts we collect in fees. I think we should let Mike explain how he has been determining those costs." Mike knew he would be at the cen- ter of the controversy. "The city pro- vides fire and police protection to busi- nesses and residents of our police jurisdiction," Mike begins. "The ser- vices are accounted for through the city's general fund. I have prepared a table (exhibit 3) that shows the total ex- penditures for these departments for each of the last three years." Al Tupay interrupts. "Mike, as you know, I own the franchise to all the lo- cal 'Long-Dog' restaurants. In my income statement the operating costs are called expenses, not expenditures. What is the difference?" "Well, Mayor," Mike begins, "while there are many similarities between business and governmental accounting, there are also many fundamental differ- ences. One of the most important is the use of the fund accounting model. Because state and local governments have restricted as well as unrestricted resources, it is necessary to use sepa- rate funds to account for those resources earmarked for specific purposes. Most of the day-to-day operations of the city are accounted for through governmental funds. In fact, we account for the major- ity of our programs in the general fund, which is the most important governmen- tal fund type. In the private sector, busi- ness organizations usually do not have such restricted resources and, conse- quently, are not required to use fund accounting." The mayor interrupts again, "So far I understand what you are saying, but how does this explain the difference between expenditures and expense?" "I am getting to that, Mayor," replies Mike. "Now, those individuals who rely EXHIBIT 3 Expenditures Allocated to Police Jurisdiction 1996 1995 1994 Total Total Expenditures: Police Department $10,455,466 $ 9,734,319 $ 8,936,038 $29,125,823 Fire Department 7,723,958 7,425,118 6,942,204 22,091,279 Total Expenditures $18,179,424 $17,159,436 $15,878,241 $51,217,101 Allocated to Police Jurisdiction: Police Department $ 585,506 $ 408,841 $ 616,587 $ 1,610,934 Fire Department 563,849 586,584 590,087 1,740,520 Total Allocation 1,399,935 1,399,655 1,365,080 4,164,670 Fees Charged to Jurisdiction 1,034,950 894,396 783,295 2,712,641 Excess of Allocation Over Fees $ 364,985 $ 505,259 $ 581,785 $ 1,452,029 on the city's financial statements know were allocated to the police jurisdiction, that the city is a political entity; it is not and the amount of business license fees a business established to generate prof- that were collected. Let me point out its. To better understand the day-to-day that the total fees collected from the po- operations of the city, users are inter- lice jurisdiction have always been set at ested in examining the flow of financial the maximum rate allowed by law, one- resources through the city's general half the rate of business license fees lev- fund. Governments measure such flows ied within the city. This rate is appro- using the modified accrual basis of ac- priate because the total cost allocated counting. Under this method, expendi- to the police jurisdiction has always ex- ture is a measure of the outflow of finan- ceeded this limit. The data from the table cial resources. In contrast, businesses illustrate this fact. For example, in 1996, that must calculate net income use the $1,400,000 of service costs were allo- accrual basis of accounting, where ex- cated to the police jurisdiction with pense measures the consumption of re- $1,035,000 of fees being collected." sources. This means, for example, that "Now, let me explain how I deter- when a business acquires a fixed asset, mined the amount of total expenditures the asset's cost is capitalized and depre- allocated to the police jurisdiction. I cal- ciated. When the city buys a new fire culate the total service effort the city truck, the cost is reported as a general exerts for police and fire protection and fund expenditure. Depreciation expense the portion of these efforts that are pro- is not recognized because depreciation vided in the police jurisdiction. The ra- does not involve the use of financial re- tio of efforts in the jurisdiction to total sources; it is not an expenditure. service efforts is multiplied by total ex- "Now, I see how governmental ac- penditures to get the amount to be counting can be so confusing, especially charged to the jurisdiction. to a novice like me," the mayor inter- "I used the number of service calls jects. "Thank you, Mike, for the expla- as a measure of service effort. Service nation. Please continue." calls and allocations are presented in the Mike begins again: "The table (ex- next table (exhibit 4). The total expen- hibit 3) that I have prepared describes ditures for each of the three years were the amount of those expenditures that taken from the account balances at year 162 Issues in Accounting Education EXHIBIT 4 Allocation Rates Determined from Service Calls 1996 1995 1994 Total Calls: Police Department 6607 6625 6436 Fire Department 2235 2126 2095 Police Jurisdiction Calls: Police Department 370 278 444 Fire Department 163 168 178 Ratio of Jurisdiction to Total Calls: Police Department 0.056 0.042 0.069 Fire Department 0.073 0.079 0.085 A service call results when a specific request is made by an individual or business for assis- tance. Usually, these are emergency calls to investigate a crime, an accident or an incident (such as a fire). Routine patrols and inspections are not included as service calls. end. The total expenditures by service amount of cost that can be charged to activity for the period are shown in the the police jurisdiction as the incremen- table marked exhibit 5 on an item-by- tal cost of providing services to the ju- item basis. An I do is take the total ex- risdiction. The court interpreted incre- penditures for the year, multiply that by mental cost as the costs the city would the allocation ratio, and use that amount avoid if it did not provide these ser- to determine fees charged in the police vices." jurisdiction. I really don't see a problem "Smith claims that most of the costs here." for police and fire services do not change Tammy Watson questions: "Mike, with the level of service activity, and why did you use the number of service therefore, they are not incremental. She calls to allocate expenditures to the po- claims only those costs that are incurred lice jurisdiction? Isn't this allocation each time a service run is made into the arbitrary?" police jurisdiction should be charged to "Sure, Tammy," responded Mike. that area. Do most of our costs change "Any allocation is arbitrary. Service calls in proportion to activity?" are simple to determine and easy to use. Mike answered: "If you mean in pro- I guess I could have used another base, portion to the number of service calls, say number of businesses in the police the answer is no. Most expenditures are jurisdiction relative to the number in the fixed during a particular fiscal year. In city, but it would be just as arbitrary." fact, I have prepared 'exhibit 5' to illus- Bart Flanagan steps in: "Mike you're trate changes in the police and fire de- probably right about all allocations be- partments' expenditures for 19941996. ing arbitrary, but Smith's claim is that These amounts are line-item expendi- many of the costs the city is allocating tures recorded in the general fund. If you would exist whether or not services are look at overtime wages, fuel and equip- provided to the police jurisdiction. She ment maintenance costs, they tend to is basing her suit on a recent case de- vary with service hours, while utility costs cided by the state Supreme Court. In change with the number of service calls. Cassidy v. Dellville, the court defined the These are the only variable expenditures EXHIBIT 5 Police and Fire Department Expenditures (Source: General Fund Financial Statements) b Police Fire 1996 1995 1994 1996 1995 1994 Wages and Salaries $ 6,134,567 $5,830,456 $5,321,110 $4,500,925 $4,392,842 $4,002,833 Overtime Wages 345,890 305,899 301,399 269,418 239,424 216,049 Employee Insurance 690,342 589,002 521,308 515,757 481,752 391,981 Retirement Benefits 878,345 814,290 760,511 640,759 615,718 569,383 Other Benefits 184,670 180,437 165,203 132,503 130,328 124,922 Training and Travel 53,591 48,911 43,232 38,193 34,683 33,424 Prevention 41,876 36,488 34,688 15,407 14,366 16,016 Uniforms 172,933 160,286 153,640 131,700 116,216 114,230 Utilities 164,006 153,806 145,605 120,005 109,355 107,204 Fuel 122,357 118,444 110,291 23,125 20.155 18,743 Office Supplies 54,519 50,793 47,067 41,889 36,095 33,400 Equip. Maintenanced 92,088 85,484 78,879 89,066 60,113 63,159 Building Maintenanced 186,550 175,223 160,895 129,913 125,417 126,271 Equipment Purchases 636,930 585,084 503,237 677,698 608,698 650,428 Lease Payments 696,802 599,716 588,973 397,600 439,957 474,161 Total Expenditures $10,455,466 $9,734,319 $8,936,038 $7,723,958 $7,425,118 $6,942,204 These costs change with changes in service hours. The percent of service hours spent in the police jurisdiction for the years 1994 to 1996 was 3.75%, 3.5%, and 3%, respectively. This cost changes with the number of service calls, though all costs change in the long run. Costs other than and are assumed to be fixed in the short run. These costs are associated with educational programs in local schools and civic meetings and building inspections. Maintenance of equipment and buildings is the responsibility of the respective departments and these costs are part of the general fund. Equipment (fire trucks, police cars, etc.) is purchased each year by the police and fire departments. Leases are for land, where some stations are located and operating equipment we have. All the other costs are largely the city and to the added size of the po- fixed. I might add that service hours lice jurisdiction. If we charged busi- represent the total labor time re- nesses in the police jurisdiction only a quired to provide services, while a ser- portion of our variable costs, every busi- vice call represents a call for help (fire ness in the city would argue that they or police). should be charged only for part of vari- "But allocating only variable costs is able costs. Who would pay for the fixed not reasonable. Many of the fixed costs costs? The original legislation on police exist because we have to provide ser- jurisdictions is ambiguous and does not vices in the police jurisdiction. Since an- provide for any capital charges. I don't see nexing the property along the river, we how variable costs can be considered the have had to add new personnel and only appropriate costs in this case." equipment. Last year, we completed the "Adding additional fixed costs to ninth fire station in the city. These ad- service the police jurisdiction is a ditions have been due both to growth in good point," stated Bob Holman. "Late 164 Issues in Accounting Education yesterday afternoon, I called a meet- ing with Fire Chief Ben Hogan and Po- lice Chief Martha Pate. Both have over twenty years experience with the city. I explained the situation and asked if they could offer any insight into the opera- tions of their departments. Interestingly, Chief Hogan provided me with the name of a retired fire chief who would be will- ing to testify that, in his opinion, one of the nine fire stations could be eliminated if we did not service the police jurisdic- tion. Thus, costs associated with one fire station could be avoided. In addition, Chief Pate stated that she thought one of eight police beats could be elimi- nated by merging the two surround- ing beats if the city did not have to service the police jurisdiction. I asked them to prepare a summary of the spe- cific cost items they thought the city could avoid if we did not service the police jurisdiction. These items are listed in 'exhibit 6. "Keep in mind that these are esti- mates. It is difficult to separate those costs that are associated directly with the police jurisdiction. Also, I'm not sure which particular station or beats would be affected or what we would do with the resources if we eliminated these fa- cilities and activities. Most stations and beats provide services to both the city and the jurisdiction." Al Tupay interjected: "Is there a chance we can settle this thing out of court?" EXHIBIT 6 Avoidable Cost Information on Police and Fire Departments Police Department One of eight beats could be eliminated. Four of 195 officers could be eliminated as a result. The following expenditures could be reduced proportionately, by eliminating officers: Wages and Salaries Overtime Wages Employee Insurance Retirement Benefits Other Benefits Training and Travel Uniforms Two automobiles could be eliminated out of the total fleet of 120. The following vehicle-related operating expenditures could be eliminated: Fuel Equipment Maintenance Fire Department One of the nine stations could be eliminated. All operating, equipment and building costs associated with one fire station could be eliminated. These costs are incurred proportionately across stations. All firefighters are full time. Each station is assigned three four-person crews. Each crew works a 24-hour, on-duty shift, with 48 hours off duty. Currently, the city em- ploys 96 firefighters. Therefore, 12 people could be eliminated. Salaries, benefits and any other personnel costs associated with these employees could be eliminated Ingram, Parsons and Robbins 165 "We have to go to court, Mayor," Bob answered. "We have to win this case. If we settle with Smith, every busi- ness in the police jurisdiction will want a similar settlement. We stand to lose hundreds of thousands of dollars over the next few years, and there go those wage increases you've been promising city employees. Have you thought about that?" "Well Bob, what do you suggest we do?" Al asked. "I think we need an expert witness. Someone who can add credibility to our position. Do you know of anyone, Mike?" "Sure, most of the CPA firms in town would be pleased to provide their services." "But can we be sure they will sup- port our position?" asks Al, worriedly. "I think so," answers Mike. "The al- location method the city has been using is a simple and easy method. I'm sure we can find an accountant who will as- sist us in presenting a convincing argu- ment. We need to emphasize that it is important for all taxpayers to bear their share of the tax burden, including those in the jurisdiction." "Well," adds Bob. "We know Smith will find someone to support her viewpoint." Bart adds: "We don't have any choice. We need to find the best expert witness we can." Everyone agrees. After they ex- change a few pleasantries, the meeting ends. QUESTIONS AND REQUIREMENTS 1) Provide a general definition of the term "cost" as used in accounting lit- erature. How is the term being used in the Oak City case? What is the central cost issue of this case? 2) Identify various methods Oak City could use for determining the "cost" of providing services to the city's police jurisdiction. 3) Which of these methods is the city currently using? Is this method fair to residents of the city's police juris- diction? Is it consistent with State law? 4) Assume you are an employee of a local accounting firm that has agreed to provide expert testimony for Anita Smith, plaintiff, in her case against Oak City. Your employer has given you the task of developing an initial analysis of the case and of writing a report supporting the position of your client. The report will provide a basis for testimony during the case. Your report should consist of the following major sections: Brief background information about the case . A critique of the city's position An analysis of the costs Oak City should be charging businesses in the police jurisdiction, in- cluding an evaluation of the strengths and weaknesses of the analysis Attachments of supporting cal- culations and schedules A list of additional data you be- lieve might be relevant for your argument and discussion of how the data could be use 5) Alternatively, assume you are an employee of a local accounting firm that has been hired by Oak City to provide expert testimony in the case. Prepare a report analyzing the costs the city should charge businesses in the police jurisdiction. Use the same format as in part 4, but critique the plaintiff's position. 6) Discuss any ethical issues an ac- countant should consider in this case. To what extent do accountants have latitude in supporting positions taken by their clients when ac- countants are providing consulting services? Issues in Accounting Education Vol 13, No. 1 February 1998 Instructional Case: Oak City's Cost Allocation and Determination Robert W. Ingram, W. Cameron Parsons and Walter A. Robbins ABSTRACT: Oak City is an interdisciplinary case that involves cost allocation and determination issues in a governmental setting. Ethical considerations re- lated to the role of accountants as expert witnesses also are included in the case. The primary issue in this case (drawn from actual events) is the amount of cost associated with police and fire services that should be charged to busi- nesses in an area adjacent to the city limits, referred to as its police jurisdiction. State law requires the city to provide these services and permits it to charge the incremental cost of providing these services to businesses in the jurisdiction. The definition and determination of incremental cost is highly subjective. City officials have been allocating a portion of total costs to the jurisdiction. A busi- ness owner sues the city, arguing that only variable costs are relevant. Students take the role of expert witnesses who are required to analyze avail- able information and to develop a position supporting either the plaintiff or the city. They are required to deal with an unstructured problem for which various positions can be argued. They must Identify relevant information and organize this information effectively. The case also serves to alert students to the impor- tance of professional judgment in accounting decisions for which little authorita- tive guidance is available. IKE Johnson, finance director city has just been hit with a civil suit for Oak City, sits in his office, by Anita Smith, the owner of Smith's peering out the window. It is Lumber Company. Her business be- the middle of February, and he is came part of the city's police jurisdic- pleased with the latest reports of the tion in 1993 when we annexed all that city's financial condition. After a few years of tight budgets, the city is get- ting back on the right track. General fund Robert W. Ingram and Walter A. Robbins revenues are larger than expected and are Professors at University of Alabama, and W. Cameron Parsons is an Attorney expenditures are under control. The city continues to grow, as a recent summary with Parsons & Sutton. of financial and demographic trends in- We gratefully acknowledge comments of dicates (exhibit 1). This looks like it is Tom Albright, Tom Howard and Bill Samson going to be a good fiscal year. on earlier drafts of this case. The comments Suddenly, the door to his office flies of the anonymous reviewers were very help- ful in improving case requirements and in open and in stomps Bob Holman, city making the case easier to understand. This attorney. case is based on actual events. Names and "Mike, you will not believe what amounts have been changed to preserve has happenedl" Bob exclaims. "The anonymity. M 158 Issues in Accounting Education Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 Population 61,212 62,448 65,330 68,206 69,455 73,524 76,409 83,059 85,922 92,076 96,549 102,335 EXHIBIT 1 Oak City: Financial and Demographic Trends Expenditures Revenues Total Police Fire Area $13,087 $13,082 $ 6,083 $4,744 57.5 14,736 14,698 6,259 4,898 58.3 15,011 14,966 6,407 5,033 60.0 15,200 15,209 6,518 5,181 61.3 16,102 16,083 6,840 6,526 62.1 16,843 16,855 7,280 5,720 66.4 17,622 17,596 7,506 5,996 66.8 18,705 18,670 7,981 6,304 67.6 18,987 19,194 8,312 6,408 68.2 20,345 20,752 8,936 6,942 75.0 22,315 22,301 9,734 7,425 76.2 24,440 23,811 10,455 7,724 76.4 Businesses 421 462 488 495 513 544 569 608 612 647 655 658 Revenues and Expenditures are in thousands and are for the General Fund. Area is in square miles. expensive residential property on the morning with city officials. Come pre- river. pared to explain how you've been de- "She claims the city has collected termining the fees we've been charging excessive business license fees from her in the police jurisdiction and the associ- and other business owners in the police ated costs." jurisdiction since 1994. She is suing to Mike can hardly believe what he's recover excess fees paid and attorney just heard. How can there be any ques- and court costs. She claims the city is tions about the way he determines cost charging her fees for costs it does not for the city's police jurisdiction? "All I incur, in violation of state law. did was allocate costs" Mike thinks to "You'll remember that state law re- himself. quires the city to provide police and fire protection to residents of the police ju- FACTS AND risdiction, which extends three miles LEGAL BACKGROUND beyond the city limits. While the law Oak City is the largest city in its re- permits the city to levy a license fee on gion of the state, with a population of all businesses located in the police ju- about 100,000. Most of the city is risdiction, the levy cannot exceed one- bounded on the west by the Black River half of the amount charged to like busi- with the city limits extended along both nesses located within the city limits or the east and west banks of the river for the actual costs incurred in servicing the about 15 miles. police jurisdiction, whichever is lower. In 1988, the state approved legisla- If Smith can prove we have been collect- tion providing for the creation of police ing excessive fees, we may be faced jurisdictions adjacent to the cities. The with a major class-action law suit. rationale supporting the law was to "You determined those costs, Mike. ensure basic services for citizens at a I sure hope you can justify them. I'll ar- reasonable cost. Cities were already range a meeting for first thing tomorrow equipped to provide services, and Ingram, Parsons and Robbins 159 extending these services to nearby resi- dents was thought to be less costly than creating new police and fire depart- ments to service the jurisdictions. As a result of this legislation, cities became obligated to provide public safety services to businesses and indi- viduals residing within its police juris- diction. Police jurisdiction is defined as all adjoining territory within three miles of the corporate limits of a city or town. Approximately 15,000 people live in Oak City's police jurisdiction, which contains approximately 40 businesses. State law authorizes cities to collect license fees from any businesses located within the police jurisdiction. These rev- enues are intended to reimburse the city for the cost it incurs in providing services to its police jurisdiction. The law explic- itly states that a city must estimate the amount reasonably necessary to provide public protection within the police juris- diction as a basis for its business license fees. A city, however, cannot use the police jurisdiction to generate net rev- enues for itself. THE MEETING The next morning, Mike arrives promptly at nine for the meeting. As he enters the room, he is met by most of the city's top officials, an indication of the importance of this case. In addition to Bob Holman, he shakes hands with Bart Flanagan, the assistant city attor- ney, City Council Chairperson Tammy Watson, and Mayor Al Tupay. Bob Holman starts the meeting: "Until now, the city has never had any business owners question the quality of services or the amount of fees we charge in the police jurisdiction. Although the city's primary responsibility for services is to its own residents, it has always tried to provide adequate service in its police jurisdiction, in spite of the expan- sion we have experienced in the last few years." Al Tupay joins in: "If I may say so, Bob, the problem relates directly to the city's annexation of property along the river. This process began only a few years ago. I was the one who questioned whether the city could adequately ser- vice this area, especially the area west of the river. You know how limited ac- cess is because we have only two bridges." "I remember, Mayor," responds Bob. "But the city has benefited from inclu- sion of the expensive residential prop- erty west of the river, and as I recall, you got quite a bit of support from those people in the last election." "Yes, Mayor," Tammy Watson adds. "And, I should point out that annexation of those expensive residential properties was necessary to increase our tax base sufficiently to cover the cost of the new city buildings and schools completed last year." Bob continues: "Whatever the cause of the problem, it's our problem now. Smith's Lumber Co. is located within the northernmost part of our police jurisdic- tion. It is nearly 10 miles from downtown and the nearest police and fire stations, as you can see from this map." (See ex- hibit 2.) "Smith is arguing that due to the dis- tance of her business from the city's fa- cilities, available services are limited. I have to admit, she is correct on this point. Actually, her company is closer to facilities in Burnt Creek than to those in Oak City. However, the law does not stipulate that facilities must be near resi- dents of the police jurisdiction, only that we must provide the services. Neither Smith nor the city has any control over the law. She is stuck with us, and we are stuck with her." Then it is Bart Flanagan's tum: "The city's position in this suit is that we have been lawfully collecting the maximum fees allowed by law from Smith's Lum- ber Co. According to Mike Johnson's 160 Issues in Accounting Education EXHIBIT 2 Map of Oak City Smith's Lumber Co. City Limits Town of Burnt Creek Police Jurisdiction Black River Bridges OAK CITY Downtown calculations, we always incur greater costs in servicing the jurisdiction than the amounts we collect in fees. I think we should let Mike explain how he has been determining those costs." Mike knew he would be at the cen- ter of the controversy. "The city pro- vides fire and police protection to busi- nesses and residents of our police jurisdiction," Mike begins. "The ser- vices are accounted for through the city's general fund. I have prepared a table (exhibit 3) that shows the total ex- penditures for these departments for each of the last three years." Al Tupay interrupts. "Mike, as you know, I own the franchise to all the lo- cal 'Long-Dog' restaurants. In my income statement the operating costs are called expenses, not expenditures. What is the difference?" "Well, Mayor," Mike begins, "while there are many similarities between business and governmental accounting, there are also many fundamental differ- ences. One of the most important is the use of the fund accounting model. Because state and local governments have restricted as well as unrestricted resources, it is necessary to use sepa- rate funds to account for those resources earmarked for specific purposes. Most of the day-to-day operations of the city are accounted for through governmental funds. In fact, we account for the major- ity of our programs in the general fund, which is the most important governmen- tal fund type. In the private sector, busi- ness organizations usually do not have such restricted resources and, conse- quently, are not required to use fund accounting." The mayor interrupts again, "So far I understand what you are saying, but how does this explain the difference between expenditures and expense?" "I am getting to that, Mayor," replies Mike. "Now, those individuals who rely EXHIBIT 3 Expenditures Allocated to Police Jurisdiction 1996 1995 1994 Total Total Expenditures: Police Department $10,455,466 $ 9,734,319 $ 8,936,038 $29,125,823 Fire Department 7,723,958 7,425,118 6,942,204 22,091,279 Total Expenditures $18,179,424 $17,159,436 $15,878,241 $51,217,101 Allocated to Police Jurisdiction: Police Department $ 585,506 $ 408,841 $ 616,587 $ 1,610,934 Fire Department 563,849 586,584 590,087 1,740,520 Total Allocation 1,399,935 1,399,655 1,365,080 4,164,670 Fees Charged to Jurisdiction 1,034,950 894,396 783,295 2,712,641 Excess of Allocation Over Fees $ 364,985 $ 505,259 $ 581,785 $ 1,452,029 on the city's financial statements know were allocated to the police jurisdiction, that the city is a political entity; it is not and the amount of business license fees a business established to generate prof- that were collected. Let me point out its. To better understand the day-to-day that the total fees collected from the po- operations of the city, users are inter- lice jurisdiction have always been set at ested in examining the flow of financial the maximum rate allowed by law, one- resources through the city's general half the rate of business license fees lev- fund. Governments measure such flows ied within the city. This rate is appro- using the modified accrual basis of ac- priate because the total cost allocated counting. Under this method, expendi- to the police jurisdiction has always ex- ture is a measure of the outflow of finan- ceeded this limit. The data from the table cial resources. In contrast, businesses illustrate this fact. For example, in 1996, that must calculate net income use the $1,400,000 of service costs were allo- accrual basis of accounting, where ex- cated to the police jurisdiction with pense measures the consumption of re- $1,035,000 of fees being collected." sources. This means, for example, that "Now, let me explain how I deter- when a business acquires a fixed asset, mined the amount of total expenditures the asset's cost is capitalized and depre- allocated to the police jurisdiction. I cal- ciated. When the city buys a new fire culate the total service effort the city truck, the cost is reported as a general exerts for police and fire protection and fund expenditure. Depreciation expense the portion of these efforts that are pro- is not recognized because depreciation vided in the police jurisdiction. The ra- does not involve the use of financial re- tio of efforts in the jurisdiction to total sources; it is not an expenditure. service efforts is multiplied by total ex- "Now, I see how governmental ac- penditures to get the amount to be counting can be so confusing, especially charged to the jurisdiction. to a novice like me," the mayor inter- "I used the number of service calls jects. "Thank you, Mike, for the expla- as a measure of service effort. Service nation. Please continue." calls and allocations are presented in the Mike begins again: "The table (ex- next table (exhibit 4). The total expen- hibit 3) that I have prepared describes ditures for each of the three years were the amount of those expenditures that taken from the account balances at year 162 Issues in Accounting Education EXHIBIT 4 Allocation Rates Determined from Service Calls 1996 1995 1994 Total Calls: Police Department 6607 6625 6436 Fire Department 2235 2126 2095 Police Jurisdiction Calls: Police Department 370 278 444 Fire Department 163 168 178 Ratio of Jurisdiction to Total Calls: Police Department 0.056 0.042 0.069 Fire Department 0.073 0.079 0.085 A service call results when a specific request is made by an individual or business for assis- tance. Usually, these are emergency calls to investigate a crime, an accident or an incident (such as a fire). Routine patrols and inspections are not included as service calls. end. The total expenditures by service amount of cost that can be charged to activity for the period are shown in the the police jurisdiction as the incremen- table marked exhibit 5 on an item-by- tal cost of providing services to the ju- item basis. An I do is take the total ex- risdiction. The court interpreted incre- penditures for the year, multiply that by mental cost as the costs the city would the allocation ratio, and use that amount avoid if it did not provide these ser- to determine fees charged in the police vices." jurisdiction. I really don't see a problem "Smith claims that most of the costs here." for police and fire services do not change Tammy Watson questions: "Mike, with the level of service activity, and why did you use the number of service therefore, they are not incremental. She calls to allocate expenditures to the po- claims only those costs that are incurred lice jurisdiction? Isn't this allocation each time a service run is made into the arbitrary?" police jurisdiction should be charged to "Sure, Tammy," responded Mike. that area. Do most of our costs change "Any allocation is arbitrary. Service calls in proportion to activity?" are simple to determine and easy to use. Mike answered: "If you mean in pro- I guess I could have used another base, portion to the number of service calls, say number of businesses in the police the answer is no. Most expenditures are jurisdiction relative to the number in the fixed during a particular fiscal year. In city, but it would be just as arbitrary." fact, I have prepared 'exhibit 5' to illus- Bart Flanagan steps in: "Mike you're trate changes in the police and fire de- probably right about all allocations be- partments' expenditures for 19941996. ing arbitrary, but Smith's claim is that These amounts are line-item expendi- many of the costs the city is allocating tures recorded in the general fund. If you would exist whether or not services are look at overtime wages, fuel and equip- provided to the police jurisdiction. She ment maintenance costs, they tend to is basing her suit on a recent case de- vary with service hours, while utility costs cided by the state Supreme Court. In change with the number of service calls. Cassidy v. Dellville, the court defined the These are the only variable expenditures EXHIBIT 5 Police and Fire Department Expenditures (Source: General Fund Financial Statements) b Police Fire 1996 1995 1994 1996 1995 1994 Wages and Salaries $ 6,134,567 $5,830,456 $5,321,110 $4,500,925 $4,392,842 $4,002,833 Overtime Wages 345,890 305,899 301,399 269,418 239,424 216,049 Employee Insurance 690,342 589,002 521,308 515,757 481,752 391,981 Retirement Benefits 878,345 814,290 760,511 640,759 615,718 569,383 Other Benefits 184,670 180,437 165,203 132,503 130,328 124,922 Training and Travel 53,591 48,911 43,232 38,193 34,683 33,424 Prevention 41,876 36,488 34,688 15,407 14,366 16,016 Uniforms 172,933 160,286 153,640 131,700 116,216 114,230 Utilities 164,006 153,806 145,605 120,005 109,355 107,204 Fuel 122,357 118,444 110,291 23,125 20.155 18,743 Office Supplies 54,519 50,793 47,067 41,889 36,095 33,400 Equip. Maintenanced 92,088 85,484 78,879 89,066 60,113 63,159 Building Maintenanced 186,550 175,223 160,895 129,913 125,417 126,271 Equipment Purchases 636,930 585,084 503,237 677,698 608,698 650,428 Lease Payments 696,802 599,716 588,973 397,600 439,957 474,161 Total Expenditures $10,455,466 $9,734,319 $8,936,038 $7,723,958 $7,425,118 $6,942,204 These costs change with changes in service hours. The percent of service hours spent in the police jurisdiction for the years 1994 to 1996 was 3.75%, 3.5%, and 3%, respectively. This cost changes with the number of service calls, though all costs change in the long run. Costs other than and are assumed to be fixed in the short run. These costs are associated with educational programs in local schools and civic meetings and building inspections. Maintenance of equipment and buildings is the responsibility of the respective departments and these costs are part of the general fund. Equipment (fire trucks, police cars, etc.) is purchased each year by the police and fire departments. Leases are for land, where some stations are located and operating equipment we have. All the other costs are largely the city and to the added size of the po- fixed. I might add that service hours lice jurisdiction. If we charged busi- represent the total labor time re- nesses in the police jurisdiction only a quired to provide services, while a ser- portion of our variable costs, every busi- vice call represents a call for help (fire ness in the city would argue that they or police). should be charged only for part of vari- "But allocating only variable costs is able costs. Who would pay for the fixed not reasonable. Many of the fixed costs costs? The original legislation on police exist because we have to provide ser- jurisdictions is ambiguous and does not vices in the police jurisdiction. Since an- provide for any capital charges. I don't see nexing the property along the river, we how variable costs can be considered the have had to add new personnel and only appropriate costs in this case." equipment. Last year, we completed the "Adding additional fixed costs to ninth fire station in the city. These ad- service the police jurisdiction is a ditions have been due both to growth in good point," stated Bob Holman. "Late 164 Issues in Accounting Education yesterday afternoon, I called a meet- ing with Fire Chief Ben Hogan and Po- lice Chief Martha Pate. Both have over twenty years experience with the city. I explained the situation and asked if they could offer any insight into the opera- tions of their departments. Interestingly, Chief Hogan provided me with the name of a retired fire chief who would be will- ing to testify that, in his opinion, one of the nine fire stations could be eliminated if we did not service the police jurisdic- tion. Thus, costs associated with one fire station could be avoided. In addition, Chief Pate stated that she thought one of eight police beats could be elimi- nated by merging the two surround- ing beats if the city did not have to service the police jurisdiction. I asked them to prepare a summary of the spe- cific cost items they thought the city could avoid if we did not service the police jurisdiction. These items are listed in 'exhibit 6. "Keep in mind that these are esti- mates. It is difficult to separate those costs that are associated directly with the police jurisdiction. Also, I'm not sure which particular station or beats would be affected or what we would do with the resources if we eliminated these fa- cilities and activities. Most stations and beats provide services to both the city and the jurisdiction." Al Tupay interjected: "Is there a chance we can settle this thing out of court?" EXHIBIT 6 Avoidable Cost Information on Police and Fire Departments Police Department One of eight beats could be eliminated. Four of 195 officers could be eliminated as a result. The following expenditures could be reduced proportionately, by eliminating officers: Wages and Salaries Overtime Wages Employee Insurance Retirement Benefits Other Benefits Training and Travel Uniforms Two automobiles could be eliminated out of the total fleet of 120. The following vehicle-related operating expenditures could be eliminated: Fuel Equipment Maintenance Fire Department One of the nine stations could be eliminated. All operating, equipment and building costs associated with one fire station could be eliminated. These costs are incurred proportionately across stations. All firefighters are full time. Each station is assigned three four-person crews. Each crew works a 24-hour, on-duty shift, with 48 hours off duty. Currently, the city em- ploys 96 firefighters. Therefore, 12 people could be eliminated. Salaries, benefits and any other personnel costs associated with these employees could be eliminated Ingram, Parsons and Robbins 165 "We have to go to court, Mayor," Bob answered. "We have to win this case. If we settle with Smith, every busi- ness in the police jurisdiction will want a similar settlement. We stand to lose hundreds of thousands of dollars over the next few years, and there go those wage increases you've been promising city employees. Have you thought about that?" "Well Bob, what do you suggest we do?" Al asked. "I think we need an expert witness. Someone who can add credibility to our position. Do you know of anyone, Mike?" "Sure, most of the CPA firms in town would be pleased to provide their services." "But can we be sure they will sup- port our position?" asks Al, worriedly. "I think so," answers Mike. "The al- location method the city has been using is a simple and easy method. I'm sure we can find an accountant who will as- sist us in presenting a convincing argu- ment. We need to emphasize that it is important for all taxpayers to bear their share of the tax burden, including those in the jurisdiction." "Well," adds Bob. "We know Smith will find someone to support her viewpoint." Bart adds: "We don't have any choice. We need to find the best expert witness we can." Everyone agrees. After they ex- change a few pleasantries, the meeting ends. QUESTIONS AND REQUIREMENTS 1) Provide a general definition of the term "cost" as used in accounting lit- erature. How is the term being used in the Oak City case? What is the central cost issue of this case? 2) Identify various methods Oak City could use for determining the "cost" of providing services to the city's police jurisdiction. 3) Which of these methods is the city currently using? Is this method fair to residents of the city's police juris- diction? Is it consistent with State law? 4) Assume you are an employee of a local accounting firm that has agreed to provide expert testimony for Anita Smith, plaintiff, in her case against Oak City. Your employer has given you the task of developing an initial analysis of the case and of writing a report supporting the position of your client. The report will provide a basis for testimony during the case. Your report should consist of the following major sections: Brief background information about the case . A critique of the city's position An analysis of the costs Oak City should be charging businesses in the police jurisdiction, in- cluding an evaluation of the strengths and weaknesses of the analysis Attachments of supporting cal- culations and schedules A list of additional data you be- lieve might be relevant for your argument and discussion of how the data could be use 5) Alternatively, assume you are an employee of a local accounting firm that has been hired by Oak City to provide expert testimony in the case. Prepare a report analyzing the costs the city should charge businesses in the police jurisdiction. Use the same format as in part 4, but critique the plaintiff's position. 6) Discuss any ethical issues an ac- countant should consider in this case. To what extent do accountants have latitude in supporting positions taken by their clients when ac- countants are providing consulting services