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Cost and allocation methods for computer services.

Cost and Allocation Methods for Computer Services

Computer services account for a substantial portion of a company's budget. This article discusses the type of costs involved in running a computer department and elaborates on issues that deal with allocation of computer services to the using departments.

Costs of a Computer Center

A typical computer organization has a number of one-time costs up to the point of installation and running of a system and a number of recurring costs for periodic operation of the system. One-time costs include system design, system installation, system conversion, system site preparation, system hardware costs and system software costs. Recurring costs of a computer system typically include data preparation and conversion to the computer readable form; data transmission from the point of entry to the processing unit and back to the user upon processing; operation of the system; control of input, processing and output; documentation of programs and systems, maintaining of files on-line, on-site or off-site; operating system and application program maintenance; data base management system maintenance; operations' security and data processing administration. Costs may also be classified in terms of hardware costs, software costs, personnel costs and operating costs.

Benefits of a Computer System

Benefits of a system can be measured in terms of efficiency as well as in terms of customer satisfaction, employee morale, inventory reduction and long-term competitiveness of the organization. Cost/benefit analysis is a necessity in conjunction with studying the feasibility of a proposed system. Many of the anticipated benefits may be intangible and hard to quantify. As such, a seasoned judgment is necessary in conjunction with selection of any system. Because of typical high-dollar-value investments in computer technology and the risks of obsolescence associated with such an investment, the options of renting, leasing or purchasing must be weighed carefully. In either case, the initial one-time costs must be depreciated during the anticipated life of an investment, whereas the periodic costs of renting or lease payments would be directly included as part of the operating expenses.

Objectives for Computer Cost Allocation and Pricing

The following are often cited as the most important objectives in cost allocation and determination of the cost of computer services(1): a) equitable allocation of the computer resource to its most worthwhile uses while discouraging frivolous use; b) motivation of computer management and personnel to provide efficient, high-quality service to users; c) establishment of an objective basis upon which to evaluate the performance of computer management and d) encouragement of user interest and participation in the development and implementation of information systems.

The above classification provides the framework for internal pricing and cost allocation for computer services. Without charging the users for computer services, a frivolous and unchecked rise in computer costs would result. Through creation of a pricing mechanism, the computer center would be motivated and required to provide services at reasonable prices, and computer management would be evaluated based on the level and quality of service that they are able to provide for their users within the guidelines established and the budget restrictions imposed. Finally, users would get more directly involved in understanding what computer resources cost and how they can benefit from those services.

Approaches to Pricing of Computer Services

Computer services may be priced based on market or cost. Market pricing is contingent upon being able to determine the comparable cost for a computer service by service bureau or time-sharing organizations and charging the users based on those rates. This is a profit center approach to pricing which is a good practice both for motivation and efficiency in proper use of computer services. Unfortunately, market prices for exact kinds of services are not usually available.

Cost-based pricing is, of course, based on periodic costs of the computer service and is subject to many of the same problems and difficulties which are associated with cost allocation and unit cost determination. The proposed methods include full costing, direct costing and flexible pricing.

Under a full costing approach, total cost (variable and fixed) is divided by a common basis to arrive at a cost per unit, and that unit cost is used to charge the users based on services provided. The question in this respect is whether to use actual cost divided by actual volume of activity to arrive at the unit cost to be charged to the using organizations or instead use the budgeted cost for the department divided by budgeted volume of activities to arrive at unit cost and charge the users based on budgeted cost per unit times actual volume of activity. The latter approach is more conducive to control and accountability because lower or higher levels of activity as well as lower or higher levels of costs as compared to budget would result in volume and cost variances to be explained by data processing management, particularly with regard to spending variations, and user department management with regard to volume variation for computer services.

Under a direct costing approach, variable costs may be charged to user departments based on actual volume of service (again at budgeted or actual rate per unit), whereas fixed costs would be divided based on predetermined percentages. The advantages of this method over the full costing approach, particularly when we use budgeted variable cost per unit times actual volume of activity and budgeted fixed costs times predetermined percentages, are that a) the user knows ahead of time the costs per unit and the department's share of predetermined computer fixed costs, b) the computer department is directly responsible for spending variations and their inefficiencies are not carried over to the using departments and c) fixed cost allocation would not be affected by changes in volume of activity.

A flexible pricing approach could be based on full cost, variable cost or even market price. Under a flexible pricing approach, two or more sets of prices would be provided for users based on processing priorities. Batch processing which may be done overnight or when time permits may be at a substantially lower charge as compared to rush orders or capabilities that require realtime processing.

Cost Allocation Bases

Whether we use a full costing, direct costing or flexible pricing approach, the following allocation bases may be used(2): single factor base, multiple factor base and unit pricing. Under a single factor base approach, total cost is divided by central processing (CPU) time or wall clock time (WCT) to arrive at a per unit cost which may be expressed in terms of cost per minute or second of processing. The problem with this approach is that jobs that require little processing but substantial input/output time would be charged substantially less than jobs which require high processing time and little input/output operation. For example, accounting jobs typically require little processing time but substantially high input/output time for preparation of a variety of reports based on the same data for different purposes such as governmental reports, SEC reports, financial accounting reports and management accounting reports. On the other hand, engineering jobs typically require more processing time but little input/output time.

The second approach to cost basis for computer services attempts to address this problem. This method is commonly referred to as multiple factor base. Under this approach, the cost and time associated with each major component (such as CPU, core storage, card reader, card punch, lines printed, tape accesses, disk accesses, etc.) are measured separately in order to determine the cost of a project. This is a somewhat more complicated procedure but provides more accurate cost figures.

The third approach to cost basis is the unit pricing approach. Under this approach, each component is given a weight through the use of an algebraic formula developed by data processing management based on an experience factor. Then the time elapsed for each activity such as processing, disk access, etc., is plugged into the formula in order to determine cost per unit of service provided. This method results in a fairly consistent and equitable charge for computer services.


The fixed and variable costs of computer services must be identified, budgeted costs must be periodically reviewed and updated and a cost allocation mechanism should be put in place that attempts to motivate the data processing as well as the using departments in providing services at reasonable prices with due accountability in terms of volume and spending variations. A good system would show spending variations in the data processing department's periodic performance reports and volume variations in user departments' performance reports. The cost method and the allocation criteria as well as the allocation base used should take into account the notions of flexibility, understandability, consistency, equitability and usefulness.


(1)Barry E. Cushing and Marshall B. Romney, Accounting Information Systems And Business Organizations. Menlo Park, Massachusetts: Addison-Wesley Publishing Company, Fourth Edition, 1987, p 411. (2)Cushing and Romney, pp 412-413.

Roger K. Doost is associate professor of accountancy at Clemson University in Clemson, South Carolina.
COPYRIGHT 1990 National Society of Public Accountants
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Author:Doost, Roger K.
Publication:The National Public Accountant
Date:Jun 1, 1990
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