Cost Recovery Framework
July 2010

4. OBSERVATIONS – COSTING MODEL


4. OBSERVATIONS – COSTING MODEL

4.1 Single Model to Charge Departments and Agencies

The costing model for legal services is based on a sound and reasonable methodology that is consistent with TB requirements.

The costing model used to charge for legal services should provide a relevant, complete, and fair representation of the costs incurred by the Department in the provision of legal services, in accordance with the TB Policy on Common Services. Rates are to be applied consistently across the Government and should be used for all types of legal services delivered to client departments (i.e. advisory, litigation, and legislative/regulatory drafting).

Department of Justice legal services are considered a mandatory common service under the TB Policy on Common Services. As a guiding principle, mandatory services are funded mainly through appropriation, and optional services are funded mainly by full cost recovery through Net Voting Authority. For those mandatory services not funded by appropriation, rates charged must be set to recover, but not exceed, the full costs of providing each specific service.

We reviewed the costing model (including the rates) for legal services to ensure it is appropriate and consistent with applicable TB policies, to assess its completeness, and to verify that it fairly represents the costs incurred by the Department of Justice. We examined the five different cost categories:

We reviewed the costing framework, which outlines the steps used to create the costing model and which was developed by the Costing and Charging Section. We examined the Costing Procedures document, which identifies the steps followed to download financial information from the Integrated Financial and Materiel System (IFMS) and staffing information from the SMS. We also examined a report prepared by external consultants. This report concluded that the costing model was based on sound costing methodology and reflected all appropriate costs; that the costs per FTE of legal services computed by the costing model were a reasonable estimate of the actual costs; and that the administrative overhead resources, as a percentage of total FTEs, were, if anything, at the low end of comparably sized departments. We found the costing model for legal services to be appropriate.

4.2 Simplification of Invoice Processing Procedures

Invoice processing related to cost recovery transactions from client departments should be simplified.

Invoice processing related to cost recovery needs to be streamlined and efficient. This would be indicated by a billing process based on the financial and administrative requirements of Justice Finance, the client department, and the TB Directive on Payment Requisitioning and Cheque Control as well as theReceiver General's Information Notice 2006-002 Appendix 6. Cost recovery invoicing processes should not involve Justice Finance performing invoice-related work tailored to meet the specific requirements of the accounting processes of various client departments.

We found that Justice staff in the regions and DLSUs expend significant time and effort in attempting to identify the area of a client department that has incurred the legal service and is responsible for payment. These staff are also having difficulties in obtaining from the client department the approvals for the transaction that are required before the transaction can be forwarded to the Cost Recovery Section of Finance for recovery through the IS process. This is occurring both with regard to legal services recoveries and disbursements. Under the current cost recovery invoicing processes, Justice Canada is performing much of the accounting work that should rightfully be done by the client department itself.

The implementation of the new standardized legal services agreement beginning fiscal year 2009-10 represents a move toward improving and standardizing the management of interdepartmental arrangements including the invoicing process. The new legal services agreement emphasizes the steps required to conform to the federal government’s IS process and the need to restrict the level of FIS codes to limit the number of client invoices prepared by Justice Canada. Client departments are expected to provide Justice with a single set of financial (FIS) codes or, at most, one set per organizational unit led by an Assistant Deputy Minister or equivalent. Restricting the level of FIS codes is designed to limit Justice’s administrative burden in effecting payment. We found that during 2008-09 Justice invoiced against 475 different cost centres within the 154 client departments it serves. In Health Canada alone, we identified 78 units in its five branches where invoices are sent for approval.

The Health Canada DLSU has now addressed this issue by using a unique approach. The DLSU will use only one financial code for Health Canada when the new legal services agreement is implemented in April 2009 and will pay Justice under this one financial code for all legal services. To ensure that each transaction is sent to the appropriate Health Canada unit, the DLSU will assign the iCase Client Cost Centre code to each of the active Health Canada legal files. The iCase Client Cost Centre code enables the DLSU to quickly identify which organizational unit within Health Canada is responsible for approving the costs to be recovered. This approach facilitates the routine review of file status. During the DLSU’s implementation of the iCase Client Cost Centre, a file review was conducted and 4,521 of the 10,751 files were closed. Of the remaining 6,230 open files, 3,772 were deemed to be "active" (i.e. time has been recorded against them during the fiscal year). As files become active or new files are opened, the iCase Client Cost Centre Code is appended.

In our opinion, a more simplified invoicing process that allows for timely approval of cost recoverable transactions by client departments is needed. This will require a collaborative approach on the part of both Justice and client departments to explore the different opportunities available to simplify invoicing processes.

Recommendation and Management Response

10. It is recommended that the CFO, in consultation with the ADM, Management Sector, assess opportunities to simplify invoicing related to cost recovery transactions in client departments.

Agree. See response to Recommendation 4. One of the anticipated outcomes of the business process re-engineering project will be to simplify invoicing related to cost recovery.

4.3 Disbursements

A review of rates charged for some disbursements and an analysis of the various options for recovering disbursements are required.

The recovery of legal disbursements from client departments should be managed fairly, efficiently, and effectively to minimize the risk of loss and ensure clients pay for bona fide disbursements related to litigation cases for which they are accountable.

Disbursements are generally non-FTE-related costs paid by the Department in the conduct of a particular file or initiative. These costs include court fees, witness fees, and the costs of transcripts, interpretation, photocopying, printing, travel, and online research. These disbursements generally occur when litigation cases take place. They do not significantly affect the DLSUs, because few litigation cases are managed there and client departments generally provide the office, equipment, and supplies.

Disbursements currently represent approximately six percent of the total recoveries in the Department of Justice. In fiscal year 2008-09, disbursements totalled $6,336,048 as of December 8, 2008, of which $2.1 million had yet to be recovered.

The recovery of disbursements poses a problem for the Department of Justice, both at headquarters and in the regions. Disbursements are paid by the regional offices on behalf of client departments and are recorded in Fund 29 against a specific FIS code in the departmental financial system (IFMS). FIS codes are IFMS accounts provided by the clients that enable interdepartmental settlements (IS). The Cost Recovery Section of Finance does the actual recovery through IFMS, which produces a Cost Recovery Report.

Delays occur in the collection process for two reasons. First, there are data input errors and coding issues within the Department of Justice itself and the litigation case to which the disbursement applies is not always properly identified. Secondly, clients experience difficulty sorting out billings, because of the complexity and volume of transactions, and often require additional information before they will provide the Department with a FIS code.

The Cost Recovery Section currently employs 1.5 FTEs to recover disbursements. We were told that there are plans to increase this number by an additional FTE. Due to coding errors related to disbursement charges such as insufficient or improper billing information, the Section often returns items for correction, sometimes months after the fact. In the interim, the same error may be repeated several times before it is corrected. Year-end rejections often come too late for staff to re-process them. As a result, the portfolio or regional office must incur the charge against its own budget. The B.C. and Prairie regions each estimated an annual loss of about $100,000 because of this. The A/Chief of the Cost Recovery Section estimated the Department is losing about $500,000 annually to non-recovered disbursements from client departments. He maintained that managing disbursements continues to be a significant challenge.

The volume of transactions, the nature of the work, and the continual need to settle accounts with clients make it difficult for the Cost Recovery Section to keep staff. Staff turnover has been significant and we found that the section has seen three different people in the Cost Recovery Officer position in the last two years. Significant time and costs are incurred throughout the Department of Justice and in client departments to settle these accounts and the process affects the harmony of Department-client relationships.

The Department took a big step to try to ease the problems it was having before the 2008-09 legal services rates were released. An analysis of the disbursements showed that in 2006-07, 41,194 (i.e. 78.9%) of the 52,210 disbursement transactions were for amounts under $200, which represented $900,000 of the $13 million being recovered. With TB approval, management incorporated disbursements under $200 into the legal services rates. An additional $0.40 per hour was added to the rates for lawyers and paralegals for fiscal year 2008-09. Disbursements under $200 are currently recorded in Fund 26. However, a recent analysis of Fund 26 by the Resource Management Division found that these disbursements exceed original forecasts and will total $2.2 million in 2008-09. The $0.40 per hour built into the rates was based on annual disbursements of $900,000. This analysis suggests that the increase was insufficient to recover these disbursements fully and this component of the rates must be revisited.

The change to streamline the management of disbursements was supported by client departments. Notwithstanding, the Department continues to have problems managing disbursements and needs to further explore this issue. The implementation of the new legal services agreement with client departments set for April 2009, which calls for the provision of a single set of financial codes, or at most, one set per ADM or equivalent, should assist in this regard. Factoring disbursements above the current $200 threshold into the legal services rates could also assist with managing disbursements. Data shows that in 2007-08, 53,989 of the 57,907 transactions were under $500. Those over $500 (i.e. 3,918) accounted for $9,042,965 or 81.4% of the $11,104,380 in disbursements. Other options that the Department might consider include showing both disbursements and timekeeping on the same Department of Justice invoice (i.e. similar to private practice) or decentralizing the recovery of disbursements to the regional offices.

Recommendation and Management Response

11. It is recommended that the CFO conduct an annual review of Fund 26 to ascertain the adequacy of the rate being charged to cover costs associated with disbursements under $200.

Agree. Fund 26 is reviewed annually and the analysis of small value, high volume disbursements is part of the annual process of establishing legal services rates. It is to note that, due to the high volatility of these costs, we use historical data to determine the amount to be included in the rates. In our analysis, the risk of under/over estimating in this particular element is embedded in the global Risk Factor wherein all parameters with high volatility or high fluctuation are covered in a global risk mitigation approach. Various thresholds (e.g. $200 or $500) are analyzed in terms of total cost for the Department and fairness for clients. The analytical process is followed by a formal departmental approval process where options are challenged and best “value for money” threshold is approved by the Department’s senior management.

Recommendation and Management Response

12. It is recommended that the CFO explore various options for recovering disbursements to improve efficiency and address the issues noted in this report.

Agree. See response to Recommendation 4. The recovery of disbursements will be included in the scope of the business process re-engineering project.

4.4 Monthly Billing

There is a need for the Department to move to a monthly billing process.

Generally accepted accounting practices call for billing of services to be initiated, recorded in an accounts receivable system, and generated within an established time period after initial service delivery. This time period is often no longer than a month unless there is agreement with the client to some other billing frequency.

The current system followed in the Department is to bill clients on a quarterly basis and this is presenting serious cash flow issues for management. Currently, approximately 60% of cost-recovered revenues flow into the Department during the last three months of the fiscal year. This can create constraints on spending (e.g. for training and purchase of assets) and reduce flexibility to expend earlier in the year. As of December 8, 2008, the Department had collected $98 million (i.e. 44%) of the anticipated $225 million in revenue for 2008–09, with seven organizations having collected less then 40% of forecasted revenues. One DLSU indicated in an interview that, as of January 13, 2009, the billing for the first quarter of 2008-09 had yet to be completed. We also found that one client is only paying its Department of Justice account at the end of the fiscal year.

In our view, there are several benefits for the Department in increasing the frequency of its billing to client departments to be more in line with normal business practice, which is monthly or less. Not only would more frequent billing have a positive impact on the cash flow of the Department, but it would also enable administrators to identify billing errors more quickly. Instead of attempting to resolve errors that have built up over a three-month period of time, administrators would only have to deal with issues that occurred during the previous month. Year-end invoicing would also be greatly simplified and any billing errors would only pertain to one month of transactions.

More frequent billing should be easy to apply where departmental cost recovery is on the basis of full-time equivalents (FTEs) rather than on billable hours. Portfolios that have a single client department with a stable, constant demand for legal services are generally utilizing the FTE basis as a method for recovering costs. Close to 80% of recoveries is done through the FTE method. In this case, the SMS is the financial system used to track employee movements and assignments to specific cost centres.

In the case of clients whose legal services are charged on the basis of billable hours and for whom iCase is used as the management system to track information on specific cases and practitioners’ time, it would be important for practitioners to comply with the requirements of the National Timekeeping Protocol. This method currently accounts for about 16% of the recoveries. (The remainder of recoveries in the Department relate to disbursements.)

It is our view that it is important for the Department to increase the frequency of its billing practices by invoicing client departments on a monthly basis.

Recommendation and Management Response

13. It is recommended that the CFO and the ADM, Management Sector, move to invoicing client departments on a monthly basis.

Agree. For FTE-related billing, the implementation of monthly billing has been proposed to commence on October 1, 2010. For timekeeping and disbursements billing, see response to Recommendation 4, as these will be included in the scope of the business process re-engineering project.