ALLOCATING THE COST OF ACCOUNTING FOR COMPUTER SERVICES

By Roger K. Doost

Knowing where to spend, when to spend, and how much to spend for computer services requires extensive knowledge and expertise. Many organizations have steering committees that coordinate, forecast, and determine direction and need. Often there are project development teams comprised of members of affected departments who oversee the implementation of a project from inception to end. With regard to priorities and needs related to computer software and hardware, they all must deal with the uncertainty of what will become available next month and next year.

Product Costing

The costs of all service centers, including the computer department, need to be apportioned to final cost objectives--the producing departments, the products that the entity manufactures for sale, or in case of service organizations, to each specific service or program. From a pure cost allocation standpoint, an arbitrary allocation base could be used to simply zero out any balance in the computer service area. Even such an allocation helps, no matter how imperfect, to measure the impact of computer costs on product costs, inventory values, and cost of goods sold.

Pricing Methods

Pricing computer services can be market-based, cost-based, or flexible. Market-based pricing is established by what competitors or outside sources charge for similar services. Cost-based pricing reflects how much the service actually costs. Flexible pricing is used when different rates are instituted for service required during peak demand time (at higher rates) in order to spread the services to nonpeak periods (at lower rates).

Market-Based Pricing. This may be used when the computer department is also a profit center and similar services are readily available in the marketplace. For example, a payroll department obtains a quotation from a service bureau for processing the weekly payroll, payroll checks with pay stubs, payroll register, Federal employee tax report, state employee tax report, labor department employee tax report, and any other auxiliary reports required. The payroll department is then in a position to expect the computer department to charge no more than the market price available for
such services.

Market-based pricing has certain advantages. It is the most objective method of determining a price for a service. It forces the computer department to be more cost conscious and competitive. If the computer department consistently loses money charging the market price, it may be reflecting poor management or underutilized resources. It may be worthwhile to shut the internal service down and outsource the service. Another advantage--the user who is charged for computer services at market prices thinks before placing an order and compares prices before making a commitment for a service, even if the user doesn't have the option of going elsewhere.

Something to watch for when market prices are used is the committed versus the needed level of service. What if the production department asks the computer department to produce daily labor efficiency reports and the commitment is budgeted at a cost of $195 per report or an annual cost of $71,175 for the 365 days of operation. The production manager, later squeezed for cost control, decides he can get by with weekly efficiency reports, each of which cost the computer department roughly the same as each daily report. The expected cost now would be 52 weeks times $195 or a total of $10,140. What should be the charge to the production department?

One solution is to continue the daily charge of $195, at least for the balance of the current budget year, because many computer resource commitments are long-term--equipment and the software has probably been purchased or leased on a long-term basis. Labor and management contracts may be long-term and not easily adjustable. Where capacity requirements are not easily adjustable, the problem is probably not solvable through alternative charging schemes. As an option, the computer department may be allowed to market its excess capacity to outsiders and release the committed department, when such markets are available.

Cost-Based Pricing (or Allocations Based on Costs). The key question is what base(s) to use to come up with a unit rate. There are several methods including unit pricing, single-factor-based pricing, and multiple-factor-based pricing.

Unit pricing uses a formula approach in which all job components--CPU time, input time, storage, and print pages--are factored in to come up with a rate. The following discussion focuses on single-factor and multiple-factor-based pricing.

For single-factor-based pricing, total computer cost is divided by one major factor such as CPU time to determine cost per minute for computer services. This method is simple; but the results may be distorted if the jobs processed require differing aspects of the total system. For example, a typical engineering job may require little storage and printing, but substantial amounts of CPU time. By contrast, a typical accounting job may require considerable input, storage, and print time. If the charges for both jobs are based only on CPU time used, typical engineering jobs will be overcharged and typical accounting jobs, undercharged. To alleviate such problems, a multiple-factor-based method of pricing may be used.

When a multiple-factor-based method is used, costs associated with each major component such as data entry, processing, storage, and printing are identified, and separate bases are used to indicate the total of each activity. The price for each component is multiplied by the job activity to determine the total cost of each job.

No matter which cost-based-pricing method is used, the next question is whether to use variable costing, full costing, or dual pricing methods and whether the charges are based on budgeted or actual costs. Variable costing works if most of software development costs are contracted for separately, and hardware and other software are rented on a monthly or annual basis. In such situations, most costs, except occupancy costs, are variable and chargeable to individual jobs. However, if most contracts for software, hardware, and personnel are long-term, and thus fixed, very little would be chargeable to jobs under a variable costing mechanism. In either case, when using a variable costing route, the fixed costs of operation are not charged to individual departments. Such costs may, in fact, appear as part of the fixed costs of doing business in the income statement without ever being charged to individual products or final services.

If a full-costing method is chosen for cost allocation, all costs, regardless of their fixed or variable nature, are compiled and charged out to the users of computer services. The problem is lumping the fixed and variable costs together. Assume that department A asks for a particular service but does not use that service--under a full costing method, department A is not charged if the service forecasted is not performed. If users are charged based on services provided, the allocation base is smaller due to reduction or elimination of some services, and the remaining jobs are overcharged.

A dual pricing mechanism alleviates the problem. Fixed costs are charged to the user units based on forecasted usage regardless of whether they actually use the particular service or not. Variable costs are charged to the user units based on actual service provided. If a unit receives a service, forecasted or not, it is charged with the variable cost of that service, and it is charged with fixed costs based on budgeted capacity utilization. Fixed cost commitments are long-term and cannot be adjusted simply because an anticipated user decides not to use a particular service.

Pricing for Control and Accountability

According to the above, it appears that a dual-pricing method, using multiple-factor-based pricing where the computer services delivered significantly differ, is a more meaningful approach. It is, however, flawed if the information is based solely on actual costs, particularly from a control standpoint. For example, if based on forecasted needs and in consultation with the steering committee, the project development team, and users of their services, the computer department commits to purchasing certain equipment and software for processing, printing, and storage of needed information, it makes sense to charge the users based on their budgeted requests where capacity utilization (fixed costs) is concerned. In this manner, computer department management cannot unilaterally decide to change the hardware, software, and personnel mix, and charge the users for such excess amounts. Amounts not budgeted and agreed to by the users of computer services should be absorbed and explained by the computer department management. Any change in capacity utilization or change of equipment should receive the approval of users.

In dual costing, variable costs are treated somewhat differently. What if additional copies of checks were requested? What if there were five additional exception reports on purchases outstanding? For variable costs such as cost of paper, toner, data entry, etc., a predetermined (budgeted) rate is established. The users are charged at budgeted rates using actual service volumes. If department A receives 1,000 pages of output rather than 100 pages, it is charged for 1,000 pages (variable) at a predetermined rate, and the percent of capacity (fixed) that was budgeted. Printing 10 times as much as anticipated for department A does not necessitate increasing equipment by tenfold. In the next budget period, however, consideration is given to reallocating the capacity percentages.

Dual pricing has significance in terms of control and accountability. On one hand, it forces the participants--the provider and the users of services--to discuss the budget and to agree upon rates and methods of charging. On the other hand, to the extent that a department commits--demonstrated by their agreed upon allocation percentage--to using the computer services and resources, it is charged to them, regardless of whether or not they actually use those computer services and resources. What the user saves are the variable costs which are not charged if the service is not used.

Flexible Pricing. Flexible pricing uses different rates for different days or times of the day in order to spread out the demand for computer services. It can be used in conjunction with market pricing, full costing, variable costing, or dual costing. The question is, what portion of costs to apply to the day shift, for example, as compared to the night shift in order to absorb all costs, and make the night shift prices competitive enough so that users forego the benefit of immediate response in favor of overnight processing. It may or may not be an important issue depending on availability of resources and the level of peak demand on computer resources. *

Roger K. Doost, PhD, CPA, is a
professor of accounting at Clemson
University.

Editor:

Michael Goldstein, CPA

The CPA Journal