Overview of the Agency's regulatory costing model

Introduction

The Agency's regulatory costing model was originally developed for use in computing transportation subsidies, primarily for the transportation of western grain. While subsidy programs were abolished by the Canada Transportation Act, the basic costing model has been retained and amended to capture the evolution of the railway industry, the statutory environment, and regulatory cost accounting.

The model is updated annually for the two national Class I freight carriers, the Canadian Pacific Railway Company (CP), and the Canadian National Railway Company (CN). Regulatory cost data is required to meet the Agency’s various mandates including the setting of rates for interswitching, and to maintain the ability to intervene in a timely manner, where specified parties require Agency analysis as part of a formal dispute under the CTA.

This overview begins with a description of the regulations for railway costing and the reporting of financial and operating statistics for regulatory purposes.  We then describe the methodology and some of the techniques used to determine the costs incurred by a railway company in the movement of traffic or the provision of a service. This includes a discussion of some commonly used railway costing terms.

Railway Costing Regulations

The Railway Costing Regulations state the basis of costs for regulatory purposes. According to the regulations:

costs shall be variable costs ... and shall include the increases or decreases in rail operation expenses resulting from changes in the volume of traffic, after allowing a reasonable period of time for adjustment in view of the traffic to be handled.

Certain costs must be incurred by the railway company even if a very small quantity of output is produced; these are called fixed or constant costs. For example, the cost of maintaining a tunnel must be incurred even if a minuscule amount of traffic is carried.

Other costs vary with the size of the output. Thus, for example, for an representative train movement, there are certain minimum track maintenance costs incurred regardless of the size of the movement. As the size of the movement grows, so do the track maintenance costs. These costs which vary with the level of output are the variable costs.

Uniform Classification of Accounts and Related Railway Records

The data used in determining railway costs are prescribed by the Uniform Classification of Accounts and Related Railway Records (UCA). The UCA defines the method of accounting and the framework of accounts for railway companies under the legislative authority of Parliament. By specifying accounting rules and standards, the UCA is intended to ensure uniformity and consistency in the reporting of information required for regulatory purposes.

Federally-regulated railway companies use the UCA in preparing reports of their operating expenses, revenues, capital investments and stock, and operating statistics to the Agency, Transport Canada and Statistics Canada. Expenses and operating statistics supplied in conformance with the UCA provide the Agency with the information required to maintain a costing capability for various statutory purposes.

For more information, please refer to the Uniform Classification of Accounts and Related Railway Records .

Costing Methodology

The central aim of cost development is to trace the various costs of providing rail service to their specific and diverse cause(s).

The Agency’s regulatory costing methodology takes all the railway companies’ expenses identified in the UCA Manual, together with the costs of depreciation and ownership of capital, and determines how these are “caused” by the traffic handled by the railway companies (i.e., establish a relationship between railway expense and traffic), recognizing that some of these expenses do not vary freely with traffic and are therefore fixed costs.

A fixed cost cannot be associated with any given traffic block. This means that for any traffic block, only the variable costs can be readily identified.  As a result, the costing methodology is geared towards determining the variable costs associated with a specific block of traffic, understanding that some portion of fixed costs will need to be allocated to each specific traffic block as well.

While some of the larger expense accounts are analyzed individually for costing purposes, a large number of expense accounts are aggregated and treated as a group, which is called a cost complex (Cx). Once the expense groupings are determined, output units must be associated with each cost complex to determine the causality.

In general, the output measures used to explain various cost complexes are chosen, in the first place, on the basis of general knowledge of railway operations. The precise form of relationship can be determined based on operational knowledge, engineering studies, and statistical evidence from regression analysis.

Costing Terms

Specific and Unit Costs

The railway companies' variable costs can be determined through one of two analytical techniques: specific costs and unit costs. As previously noted, the railway costing manuals prescribe the development of specific and unit costs.

Specific costs are those costs that can be directly attributed to the traffic or service for which costs are to be determined (e.g. crew wages). The Railway Costing Regulations require the use of specific costs whenever they "are known or can be directly determined from company records". Specific costs are determined through a process known as direct assignment. Specific costs are used whenever:

• costs are 100 percent variable;
• the expense is directly related to the traffic movement or service for which costs are being determined; and
• the collection of expense data permits the cost to be identified to specific segments of the railway operation.

Unit costs are costs that cannot be directly attributed to a particular segment of the traffic or service for which costs are to be determined, but are common to all railway traffic and services. An example of a common cost is the railway company's general administration expenses. A unit cost is the cost of performing a unit quantity of a defined railway activity, and represents a mathematical relationship between two variables: the railway company’s expenses (dependent variables) and levels of output (independent variables). System-wide unit costs are used to assign common costs to services.

Unit costs are developed through one of two techniques. If the common cost is determined to be 100 percent variable with the system workload statistics to be used for cost allocation, the unit cost is developed from the direct relationship between expenses and workloads.

If the common cost is deemed to be less than 100 percent variable with the associated workload statistic or is dependent on two or more workload statistics, regression analysis (simple or multiple) is normally used. Cross-sectional and time-series data from the railway company's operating system is collected, often spanning up to five years.

Regression analysis, be it simple or multiple, is the most widely used tool to estimate the fixed and variable costs and to separate the causal effects of different workloads on grouped expenses (cost complexes).

Averaged multi-year data are often used to smooth fluctuations in the unit cost values that would otherwise occur if one-year data were used from year to year, due to fluctuations in railway companies’ expenses and system workload statistics.

Price indices are used whenever expenses spanning multi-year periods are analyzed. To eliminate the effects of the changing prices, price indices are used to normalize expense data by adjusting historical expenses to a common base year.

Price indices are developed using a Fisher index formulation for labour, material and other, and fuel costs.

Costing Manuals

The railway companies' costing manuals document the identified causal relationships between expenses and operating statistics. Cost submissions filed by the railway companies are to be compiled in accordance with such costing manuals.

In accordance with the Railway Costing Regulations, railway companies are required to prepare and file with the Agency a costing manual containing complete descriptions of the costing methods and procedures it follows in the development of its costs. The Agency is responsible for confirming the costing manual as filed, or with such changes as the Agency may direct.

The manuals identify the grouping of the expenses for cost analysis purposes (dependent variable expenses), the causal factors (independent variables), the years of analysis and the method of cost development (direct assignment, direct analysis, regression analysis).

Cost Decks

To determine the costs incurred by the railway companies for the movement of traffic, the determined unit cost values and specific costs are combined in a cost deck or listing. The listing is a set of a railway company's unit cost values and specific cost items that have been verified and determined by Agency staff. The type of traffic movement for cost determination establishes the number of specific costs that are determined by Agency staff.

The structure of the cost deck also allows the determination of costs that are dependent on other costs (overheads) rather than system workload statistics. Cost decks containing the unit costs or specific costs for all defined railway activities are prepared annually by staff and approved by the Agency.

Service Units

Service units, representing measured quantities of railway activities, are used in conjunction with unit costs, which represent the cost incurred to perform a unit of each railway activity, to determine the appropriate costs associated with a traffic movement or service. To properly assign common costs, the long-run variable costs of traffic are:

• determined on a system-wide basis;
• expressed as a cost per unit of work output (unit cost); and
• assigned to traffic by means of applying the workload of the traffic to be costed (service unit) against the unit costs.

Service units (or output units) are units of production and are, in essence, a sub-set of the operating statistics previously identified. Whereas operating statistics represent the total workloads for the railway company's entire system, the related service unit will only represent the proportion of the total system workload that is applicable to the traffic movement or service for which costs are being determined. Service units are derived from various workload tables (train performance, car cycles and empty return ratios - ERR) or through special studies (e.g., yard switching).

The Agency's Regulatory Costing Model

The Agency's regulatory costing model marries the applicable unit cost values in the cost decks/listings to the appropriate service units, adds the specific cost values and computes the overhead costs. The end result is a total variable cost figure that is an estimate of the costs incurred by the railway company in the movement of some specified traffic or in the provision of a particular service. With the addition of a commercially fair and reasonable contribution to constant costs, this forms the basis of regulatory cost determination.