Introduction Recently, Dr. Julie Sanders, the Dean of the College of Business and Technology (CBT) at Regional State University (RSU), received information from President Edwards that the CBT's budget was going down by approximately 15 percent based on a newly implemented responsibility-centered management (RCM) model. Dr. Sanders is concerned about the prospect of a reduced budget, given that the CBT number of majors and student credit hours will be up slightly. It may force her to lay off faculty and staff, reduce course offerings, and increase class sizes. She shared these concerns with the CBT Executive Committee and began to wonder about possible long-term effects on the CBT. The focus of the meeting then turned to Dr. Sander's uneasiness with the simplistic approach of allocating Administrative Costs based upon a percentage of revenues assigned to each college. She reminded the Executive Committee that the CBT footprint on the campus. The CBT shares a building with another college, lacks large expensive laboratories, and carries a somewhat small payroll compared to other colleges. Finally, CBT does not have a graduate program. Overview of University Funding and Budgets State spending on higher education has been very inconsistent since the Great Depression from the late 2000s to the early 2010s (Wikipedia, 2017). Oliff, Palacios, Johnson and Leachman (2013) found state funding on higher education was cut severely in all states except for North Dakota and Wyoming from 2008 through 2013. They also found that state spending on higher education was $2,353 (28%) less per student on average in 2013 than in 2008. When Mitchell, Leachman and Masterman (2016) compared higher education budgets for 2015- 16 to the inflation adjusted budgets for 2007-08, they found that state spending on higher education was down 18 percent per student on average and that twenty-six states cut spending by more than 20 percent. They also found that nine states cut funding by more than 30 percent and that Arizona and Illinois reduced state funding on higher education by more than 50 percent. Mitchell, et.al. discovered that state funding was up in Montana, North Dakota, Wisconsin and Wyoming for higher education during this time. When states cut funding for higher education, public universities have a limited number of options. They can 1) reduce spending, 2) raise tuition, or 3) enact a combination of both. CollegeBoard (2016, p. 12) presented the ten-year changes and percentage changes in inflation adjusted in-state tuition and fees for public four-year institutions between 2006-07 and 2016-17. They reported that in-state tuition and fees increased in the South and West Regions by $3,400 (61%) and $3,640 (66%), respectively. They also reported that the ten-year percentage changes in tuition in the New England Region (37% to 26%), South Region (61% to 27%), and West Region (66% to 16%) rose faster for public four-year universities than for private nonprofit four- year universities during the same time period. Tuition at RSU increased by 14 percent for four consecutive years, followed by an 11 percent increase in the fifth year. Consequently, a college education was becoming unaffordable for many low-income students. In recent years, elected state officials in some states were forced to respond to the outcry from their constituencies on the record increases in tuition over such a short period of time. Some states have forced public universities to freeze their tuition, while others have passed budgets that forced public universities to reduce tuition for current and future years.. Khadaroo (2015) reported that the State of Washington reduced its tuition 15 to 20 percent at several of its four- year public institutions and five percent for community colleges over a two-year period. In the past, universities allocated their budgets to colleges using an incremental budgeting approach where the current year's budget was based on the previous year's funding. Generally, budget cuts were made across the board and new revenues were allocated in a predetermined manner. Incremental budgeting worked well when universities experience stable revenue growth. Unfortunately, state funding for higher education has been unstable over the past decade. Many states have forced universities to freeze or lower their tuition in recent years. This caused many university presidents to implement new budget models to deal with these uncertainties. The RCM Model has become a relatively new approach in determining budgets for colleges and universities. Historical Information about RSU President Harold (Harry) Edwards became the 15th president of RSU in 2010. Because of his RCM experience at his previous institution, President Edwards felt that the RCM model would work well at RSU by lining up academic college budgets with its revenue generation. Almost immediately after President Edwards was hired, state funding went into a tailspin. Before the Great Recession of 2008, the state government provided about 70 percent of the funding for RSU's general operations. State revenues were predicted to be down $7.3 billion in President's Edwards first year and they drastically cut its expenditures to state funded universities. Thus, the state legislature gave the university presidents the authority to raise tuition under certain parameters. RSU raised its tuition by 14 percent per year from 2011-12 to 2014-15. Additionally, they raised it tuition by another 11 percent in 2015-16. In 2011, when Gordon Moffitt was hired as the new Vice-President of Finance, he was asked to start working ona potential RCM model for the university. While no formal committee was created to work with Gordon, he did assign this task to a couple of individuals that worked for him. President Edwards favored the RCM model at his previous university, and wanted to keep the RCM model simple. Therefore, he wanted to allocate all costs as a percent of revenues. The college deans referred to this as a revenue tax. Incremental Budgeting versus a RCM Model Hanover Research (2015) discusses several different budget models that have been used by public universities. ne of them, incremental budgeting, is a traditional budgeting model where allocations are based on the previous year's budget. Incremental budgeting is easy to implement, provides stability and allows universities and colleges to create strategic plans. Unfortunately, incremental budgeting lacks vision. Budget cuts are generally made across-the-board under this approach. Meanwhile, RCM is a combination of policies and practices that attempts to couple decision making directly to the associated financial ramifications. RCM is a budget model that prescribes precisely how revenues are shared between responsibility centers. RCM allows decision makers to be rewarded for good financial decisions that benefit the entire university. In theory, each unit receives its tuition and a portion of the governmental support. In turn, each unit must pay for its own expenses, as well as a portion of the university's general operations or administration. Education Advisory Board (EAB, 2014) shows that tuition and state appropriations are allocated based on student credit hours (SCH), number of majors and number of graduates. Bouillon, Ehoff and Smith (2016) and Bouillon, Ehoff and Tidd (2017) examined the revenue side of RCM. Bouillon, Ehoff and Smith is a case where students work through scenarios allocating revenues based on three or four different categories. Meanwhile, Bouillon, Ehoff and Tidd focused on various ratios of revenues across two categories varying levels from 100 % SCH/0% majors to 0% SCH / 100 % majors. Administrative overhead costs were allocated as a percent of revenues, or as a revenue tax. They determined there was little or no relationship between the percentages used to allocate revenues and how they were generated. Even so, it was argued that the decision to allocate based on certain percentages creates winners and losers in the budgets. College and University Budget Information for RSU RSU has four academic colleges: Agriculture (CA), Business and Technology (CBT), Engineering (CE) and Sciences and Humanities (CSH). During the 2014-15 school year, the president went to these colleges to discuss the budget and the cost of operations. When he attended the College of Business and Technology, he made it clear that he believed the college was very expensive to run. In fact, he said, "The College of Business and Technology was being subsidized by the College of Sciences and Humanities, which was not fair to them." Table 1 presents the prior-year's budgets, along with the student credit hours (SCH) and the number of majors (MAJORS) in each college. The president decided that each college would receive 80 percent of its revenues based on SCH and 20 percent based on MAJORS. Additionally, he decided that administrative and overhead costs would be assigned as a revenue tax, or as a percentage of revenues. The revenue tax was determined to be 52 percent of revenues, or $104,000,000 in costs divided by $200,000,000 in revenues. The Revenue Ratio for the College of Agriculture was found by (80% x 25.0 % ) + (20% x 19.0 % ) , or it is 23.8%. The Revenue Ratios for the other colleges can be calculated in a similar manner. In this case, we use the 80/20 allocation for revenues. See Bouillon, Ehoff and Smith (2016) for a case dealing with various revenue allocations. Bouillon, Ehoff and Tidd (2017) illustrates that the allocation of revenues in such a way is very arbitrary and determines winners and losers for no good reason. Table 1 Prior Period Budgets, Student Credit Hours, Number of Majors and Revenue Ratio (Budgets are in millions) SCH Prior Year MAJORS (20% ) 3,230 (19.0% ) . 3,060 (18.0 %) 5,440 (32.0%) 5,270 (31.0%) 17,000 Revenue Budgets (80%) 150,000 Ratio CA 23.00 23.8% (25.0% ) 66,000 (11.0 % ) 14.00 12.4% CE 26.00 159,000 27.6% (26.5%) 225,000 (37.5%) 600,000 The SCH percentages are found by taking the college's SCH and dividing it by the total SCH for the university. For the College of Agriculture, 150,000/600,000 equals 25.0 % . The SCH percentages for the other three colleges are found in a similar manner. *The MAJORS percentages are found by taking the number of majors in the college and divided by the total number of majors at the university. For the College of Agriculture, 3,230/17,000 equals 19.0 %. The MAJORS percentages for the other three colleges are found 33.00 36.2 % CSH 100.0% Total 96.00 in a similar manner. Table 2 Simple Calculation of RCM Budget and Comparison to Prior Year's Budget for the College of Agriculture (in millions) Total Tuition 200.00 Revenue Ratio from Table 1 Allocated Revenues Allocated Administrative Costs (52% of Revenues) RCM Budget Prior Year Budget from Table 1 Difference 23.80% 47.60 24.75 22.85 23.00 (0.15) Table 2 shows the calculations for the RCM budget for the College of Agriculture. Additionally, it is compared to the prior year's budget to determine the difference. Based on the calculation in Table 2, the RCM budget would be $22.85 million for the College of Agriculture and the difference is $0.15 million less than the prior year's budget. Table 3 summarizes the RCM budgets, prior year's budgets and differences. The RCM budgets for the College of Business and Technology, College of Engineering and College of Sciences and Humanities would be found in a similar fashion using Table 2 Table 3 RCM Budget Comparisons (in millions) Prior Year's Budget College CA RCM Budget 22.85 Difference (0.15) (2.10) 0.50 1.75 23.00 11.90 14.00 26.00 33.00 26.50 CSH 34.75 Total 96.00 96.00 Dean Sanders approached Gordon Moffitt, the Vice-President of Finance, and asked him to provide her with the budgeted costs associated with each of the four activity drivers in Table 4. Besides that, Gordon provided her with activity driver data per college in Table 5. Table 4 Budgeted Costs (in millions) and Activity Drivers Budgeted Costs 24.00 Type of Costs Potential Driver Square Footage # of Employees Facilities Human Resources Graduate Studies Other Administrative Costs 5.30 # of Graduate Students 2.70 72.00 Revenue Tax Total 104.00 Table 5 Activity Driver Data per College #of Employees Square Footage #of Graduate Students College 94 186 120,000 40,000 210,000 430,000 800,000 CA 72 0 456 350 258 CE CSH Total 284 900 800 Conclusion After receiving the budget information, Dr. Sanders shared it with her Executive Committee. Additionally, she pointed out that this analysis was a zero-sum game, and would require a logical and easily understood rationale if it were to be accepted. While using a revenue tax is a simple approach to allocate administrative overhead costs, it does not match costs with the activities that increases or decreases costs. Do you have any suggestions for Dr. Sanders? Allocating University Administrative Costs in a Responsibility-Centered Management (RCM) Model Learning Outcomes In completing this assignment, students should be able to: 1. Calculate RCM budgets for the four colleges at RSU assuming various cost drivers. 2. Compare and contrast various RCM budgets with the regular budgets. 3. Identify issues associated with using different cost drivers as the overhead allocation method. 4. Explain how you could improve the overhead allocation using an Activity-Based Costing system. 5. Identify ways to reduce gaming behavior and unintended consequences. Discussion Questions Show the calculations for the RCM Budgets similar to Table 2 for CBT, CE and CSH. (LO 1, 2) 7 2. 1. Calculate the new overhead rates per the activity drivers provided in Tables 4 and 5. (LO 1, 2) 3. Calculate the new RCM budgets for each college assuming that activity-based costing is being used. (LO 3) 4. Which colleges would want to allocate part of the overhead costs using square footage? (LO 3, 4) 5. Which colleges would want to allocate part of the overhead costs using the number of employees? (LO 3, 4) 6. Which colleges would want to allocate part of the overhead costs using the number of graduate students? (LO 3, 4) 7. There is usually a tension between the accuracy of cost allocations and the political pressures or games for managers to be assessed the lowest amount of allocated costs as possible. This is often called 'unintended consequences". How might we adjust the overall model or system in order to reduce gaming behaviors and unintended consequences? (LO 4, 5) Introduction Recently, Dr. Julie Sanders, the Dean of the College of Business and Technology (CBT) at Regional State University (RSU), received information from President Edwards that the CBT's budget was going down by approximately 15 percent based on a newly implemented responsibility-centered management (RCM) model. Dr. Sanders is concerned about the prospect of a reduced budget, given that the CBT number of majors and student credit hours will be up slightly. It may force her to lay off faculty and staff, reduce course offerings, and increase class sizes. She shared these concerns with the CBT Executive Committee and began to wonder about possible long-term effects on the CBT. The focus of the meeting then turned to Dr. Sander's uneasiness with the simplistic approach of allocating Administrative Costs based upon a percentage of revenues assigned to each college. She reminded the Executive Committee that the CBT footprint on the campus. The CBT shares a building with another college, lacks large expensive laboratories, and carries a somewhat small payroll compared to other colleges. Finally, CBT does not have a graduate program. Overview of University Funding and Budgets State spending on higher education has been very inconsistent since the Great Depression from the late 2000s to the early 2010s (Wikipedia, 2017). Oliff, Palacios, Johnson and Leachman (2013) found state funding on higher education was cut severely in all states except for North Dakota and Wyoming from 2008 through 2013. They also found that state spending on higher education was $2,353 (28%) less per student on average in 2013 than in 2008. When Mitchell, Leachman and Masterman (2016) compared higher education budgets for 2015- 16 to the inflation adjusted budgets for 2007-08, they found that state spending on higher education was down 18 percent per student on average and that twenty-six states cut spending by more than 20 percent. They also found that nine states cut funding by more than 30 percent and that Arizona and Illinois reduced state funding on higher education by more than 50 percent. Mitchell, et.al. discovered that state funding was up in Montana, North Dakota, Wisconsin and Wyoming for higher education during this time. When states cut funding for higher education, public universities have a limited number of options. They can 1) reduce spending, 2) raise tuition, or 3) enact a combination of both. CollegeBoard (2016, p. 12) presented the ten-year changes and percentage changes in inflation adjusted in-state tuition and fees for public four-year institutions between 2006-07 and 2016-17. They reported that in-state tuition and fees increased in the South and West Regions by $3,400 (61%) and $3,640 (66%), respectively. They also reported that the ten-year percentage changes in tuition in the New England Region (37% to 26%), South Region (61% to 27%), and West Region (66% to 16%) rose faster for public four-year universities than for private nonprofit four- year universities during the same time period. Tuition at RSU increased by 14 percent for four consecutive years, followed by an 11 percent increase in the fifth year. Consequently, a college education was becoming unaffordable for many low-income students. In recent years, elected state officials in some states were forced to respond to the outcry from their constituencies on the record increases in tuition over such a short period of time. Some states have forced public universities to freeze their tuition, while others have passed budgets that forced public universities to reduce tuition for current and future years.. Khadaroo (2015) reported that the State of Washington reduced its tuition 15 to 20 percent at several of its four- year public institutions and five percent for community colleges over a two-year period. In the past, universities allocated their budgets to colleges using an incremental budgeting approach where the current year's budget was based on the previous year's funding. Generally, budget cuts were made across the board and new revenues were allocated in a predetermined manner. Incremental budgeting worked well when universities experience stable revenue growth. Unfortunately, state funding for higher education has been unstable over the past decade. Many states have forced universities to freeze or lower their tuition in recent years. This caused many university presidents to implement new budget models to deal with these uncertainties. The RCM Model has become a relatively new approach in determining budgets for colleges and universities. Historical Information about RSU President Harold (Harry) Edwards became the 15th president of RSU in 2010. Because of his RCM experience at his previous institution, President Edwards felt that the RCM model would work well at RSU by lining up academic college budgets with its revenue generation. Almost immediately after President Edwards was hired, state funding went into a tailspin. Before the Great Recession of 2008, the state government provided about 70 percent of the funding for RSU's general operations. State revenues were predicted to be down $7.3 billion in President's Edwards first year and they drastically cut its expenditures to state funded universities. Thus, the state legislature gave the university presidents the authority to raise tuition under certain parameters. RSU raised its tuition by 14 percent per year from 2011-12 to 2014-15. Additionally, they raised it tuition by another 11 percent in 2015-16. In 2011, when Gordon Moffitt was hired as the new Vice-President of Finance, he was asked to start working ona potential RCM model for the university. While no formal committee was created to work with Gordon, he did assign this task to a couple of individuals that worked for him. President Edwards favored the RCM model at his previous university, and wanted to keep the RCM model simple. Therefore, he wanted to allocate all costs as a percent of revenues. The college deans referred to this as a revenue tax. Incremental Budgeting versus a RCM Model Hanover Research (2015) discusses several different budget models that have been used by public universities. ne of them, incremental budgeting, is a traditional budgeting model where allocations are based on the previous year's budget. Incremental budgeting is easy to implement, provides stability and allows universities and colleges to create strategic plans. Unfortunately, incremental budgeting lacks vision. Budget cuts are generally made across-the-board under this approach. Meanwhile, RCM is a combination of policies and practices that attempts to couple decision making directly to the associated financial ramifications. RCM is a budget model that prescribes precisely how revenues are shared between responsibility centers. RCM allows decision makers to be rewarded for good financial decisions that benefit the entire university. In theory, each unit receives its tuition and a portion of the governmental support. In turn, each unit must pay for its own expenses, as well as a portion of the university's general operations or administration. Education Advisory Board (EAB, 2014) shows that tuition and state appropriations are allocated based on student credit hours (SCH), number of majors and number of graduates. Bouillon, Ehoff and Smith (2016) and Bouillon, Ehoff and Tidd (2017) examined the revenue side of RCM. Bouillon, Ehoff and Smith is a case where students work through scenarios allocating revenues based on three or four different categories. Meanwhile, Bouillon, Ehoff and Tidd focused on various ratios of revenues across two categories varying levels from 100 % SCH/0% majors to 0% SCH / 100 % majors. Administrative overhead costs were allocated as a percent of revenues, or as a revenue tax. They determined there was little or no relationship between the percentages used to allocate revenues and how they were generated. Even so, it was argued that the decision to allocate based on certain percentages creates winners and losers in the budgets. College and University Budget Information for RSU RSU has four academic colleges: Agriculture (CA), Business and Technology (CBT), Engineering (CE) and Sciences and Humanities (CSH). During the 2014-15 school year, the president went to these colleges to discuss the budget and the cost of operations. When he attended the College of Business and Technology, he made it clear that he believed the college was very expensive to run. In fact, he said, "The College of Business and Technology was being subsidized by the College of Sciences and Humanities, which was not fair to them." Table 1 presents the prior-year's budgets, along with the student credit hours (SCH) and the number of majors (MAJORS) in each college. The president decided that each college would receive 80 percent of its revenues based on SCH and 20 percent based on MAJORS. Additionally, he decided that administrative and overhead costs would be assigned as a revenue tax, or as a percentage of revenues. The revenue tax was determined to be 52 percent of revenues, or $104,000,000 in costs divided by $200,000,000 in revenues. The Revenue Ratio for the College of Agriculture was found by (80% x 25.0 % ) + (20% x 19.0 % ) , or it is 23.8%. The Revenue Ratios for the other colleges can be calculated in a similar manner. In this case, we use the 80/20 allocation for revenues. See Bouillon, Ehoff and Smith (2016) for a case dealing with various revenue allocations. Bouillon, Ehoff and Tidd (2017) illustrates that the allocation of revenues in such a way is very arbitrary and determines winners and losers for no good reason. Table 1 Prior Period Budgets, Student Credit Hours, Number of Majors and Revenue Ratio (Budgets are in millions) SCH Prior Year MAJORS (20% ) 3,230 (19.0% ) . 3,060 (18.0 %) 5,440 (32.0%) 5,270 (31.0%) 17,000 Revenue Budgets (80%) 150,000 Ratio CA 23.00 23.8% (25.0% ) 66,000 (11.0 % ) 14.00 12.4% CE 26.00 159,000 27.6% (26.5%) 225,000 (37.5%) 600,000 The SCH percentages are found by taking the college's SCH and dividing it by the total SCH for the university. For the College of Agriculture, 150,000/600,000 equals 25.0 % . The SCH percentages for the other three colleges are found in a similar manner. *The MAJORS percentages are found by taking the number of majors in the college and divided by the total number of majors at the university. For the College of Agriculture, 3,230/17,000 equals 19.0 %. The MAJORS percentages for the other three colleges are found 33.00 36.2 % CSH 100.0% Total 96.00 in a similar manner. Table 2 Simple Calculation of RCM Budget and Comparison to Prior Year's Budget for the College of Agriculture (in millions) Total Tuition 200.00 Revenue Ratio from Table 1 Allocated Revenues Allocated Administrative Costs (52% of Revenues) RCM Budget Prior Year Budget from Table 1 Difference 23.80% 47.60 24.75 22.85 23.00 (0.15) Table 2 shows the calculations for the RCM budget for the College of Agriculture. Additionally, it is compared to the prior year's budget to determine the difference. Based on the calculation in Table 2, the RCM budget would be $22.85 million for the College of Agriculture and the difference is $0.15 million less than the prior year's budget. Table 3 summarizes the RCM budgets, prior year's budgets and differences. The RCM budgets for the College of Business and Technology, College of Engineering and College of Sciences and Humanities would be found in a similar fashion using Table 2 Table 3 RCM Budget Comparisons (in millions) Prior Year's Budget College CA RCM Budget 22.85 Difference (0.15) (2.10) 0.50 1.75 23.00 11.90 14.00 26.00 33.00 26.50 CSH 34.75 Total 96.00 96.00 Dean Sanders approached Gordon Moffitt, the Vice-President of Finance, and asked him to provide her with the budgeted costs associated with each of the four activity drivers in Table 4. Besides that, Gordon provided her with activity driver data per college in Table 5. Table 4 Budgeted Costs (in millions) and Activity Drivers Budgeted Costs 24.00 Type of Costs Potential Driver Square Footage # of Employees Facilities Human Resources Graduate Studies Other Administrative Costs 5.30 # of Graduate Students 2.70 72.00 Revenue Tax Total 104.00 Table 5 Activity Driver Data per College #of Employees Square Footage #of Graduate Students College 94 186 120,000 40,000 210,000 430,000 800,000 CA 72 0 456 350 258 CE CSH Total 284 900 800 Conclusion After receiving the budget information, Dr. Sanders shared it with her Executive Committee. Additionally, she pointed out that this analysis was a zero-sum game, and would require a logical and easily understood rationale if it were to be accepted. While using a revenue tax is a simple approach to allocate administrative overhead costs, it does not match costs with the activities that increases or decreases costs. Do you have any suggestions for Dr. Sanders? Allocating University Administrative Costs in a Responsibility-Centered Management (RCM) Model Learning Outcomes In completing this assignment, students should be able to: 1. Calculate RCM budgets for the four colleges at RSU assuming various cost drivers. 2. Compare and contrast various RCM budgets with the regular budgets. 3. Identify issues associated with using different cost drivers as the overhead allocation method. 4. Explain how you could improve the overhead allocation using an Activity-Based Costing system. 5. Identify ways to reduce gaming behavior and unintended consequences. Discussion Questions Show the calculations for the RCM Budgets similar to Table 2 for CBT, CE and CSH. (LO 1, 2) 7 2. 1. Calculate the new overhead rates per the activity drivers provided in Tables 4 and 5. (LO 1, 2) 3. Calculate the new RCM budgets for each college assuming that activity-based costing is being used. (LO 3) 4. Which colleges would want to allocate part of the overhead costs using square footage? (LO 3, 4) 5. Which colleges would want to allocate part of the overhead costs using the number of employees? (LO 3, 4) 6. Which colleges would want to allocate part of the overhead costs using the number of graduate students? (LO 3, 4) 7. There is usually a tension between the accuracy of cost allocations and the political pressures or games for managers to be assessed the lowest amount of allocated costs as possible. This is often called 'unintended consequences". How might we adjust the overall model or system in order to reduce gaming behaviors and unintended consequences? (LO 4, 5)