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Use of chargeback systems in the allocation of computer departments.


Chargeback or chargeout systems, as used in this context, facilitate the allocation of electronic data processing (EDP) departmental costs to the users of computer services. Such systems have long been put to beneficial use by businesses and more recently by governmental units concerned with the economical and efficient operation of their EDP department.

Early charging mechanisms which were developed in the 1950s were relatively simplistic given the serial processing type of systems then in use (Hootman, 1977). Recent advancements in chargeback methodologies have occurred out of necessity; technological advances leading to multi-programming and multi-processor computer systems have resulted in increasingly complex chargeback systems so as to permit the allocation of hardware, software, and data processing personnel costs to multiple and simultaneous users. As networking becomes more commonplace with numerous off - premise users accessing the computer via network communication lines, chargeback systems will continue to evolve to meet the demands of both those using and providing EDP services.

A computer department's level of maturity generally influences an organization's immediate need for a chargeback system. Four stages of growth in the life of a data processing department have been identified: initiation, expansion, formalization, and maturity (Hoffman, 1984). In the initiation stage, data processing is operated as part of another department, such as accounting. The costs incurred and benefits derived are easily identified and generally are not allocated to other divisions. The expansion stage is characterized by a growth in applications and users and hence costs; allocation problems begin to surface and arbitrary methods are often utilized. Rapid cost increases lead the organization into the formalization state, whereby control measures are implemented and the focus is on equitable chargeback systems. Finally, when data processing has reached maturity and its activities are integrated with the rest of the organizational goals, a systematic chargeback system generally exists.

Acceptance and implementation of chargeback systems generally occurs because top administration or management eventually decides the place it wants EDP to take within the organization (Hootman, 1977). Top management or administration must specify specific objectives for the data processing center to help ensure the center works toward accomplishing the goals set for the organization as a whole. Not every objective of the data center will necessarily be consistent with other objectives set for it or the organization. If not, priorities must be set so the objectives most compatible with top management's goals are emphasized.

When fully developed and functional, a chargeback system should at best maximize worthwhile and minimize frivolous computer usage, encourage efficiency within the data processing center itself, and spark interest in and participation by users to develop and implement innovative applications (Cushing, 1976). The following non-exclusive list of specific objectives of chargeback has been formulated (Hootman, 1977):

Cost Recovery. For many organizations recoupment

of the computer costs incurred is the most important

goal or possibly the only ambition of a chargeback

system; total charges to users should be equal to at

least the cost of providing the services. Whether the

charge should include a profit element will be discussed


Equitability. The billing algorithm producing the

charge should consider only the work the application

requires and the resources that the project uses. To be

completely equitable, precise distinctions must be

made with respect to the resources used. This objective

will very often result in a complex charging system.

Reproducibility. A similar if not exact charge should

be made for a particular job regardless of when or how

the job is run, and regardless of whether other jobs are

also being executed concurrently.

Understandability. A billing algorithm which

produces charges that are easy to understand and

explain helps facilitate the evaluation of the computer

resource and the estimation of the cost of the proposed


Conformance to Strategic Plan. The charging system

should be designed in such a way to assure it conforms

to the operating policies, philosophies, and goals of the


Cost Competitiveness. Internal charges should be

comparable to rates offered by outside service bureaus,

especially where user departments have access to

external sources.

Extendability. The charging structure should be

flexible and forward-looking to eliminate (or minimize

the chance of) the necessity of a billing overhaul

resulting from technological computer advances.

Stability. Changes in the published rate structure are

detrimental to users in budgeting computing costs, and

can lead to lost users and lost confidence in the center's

ability to control its own costs. Absolute stability is

impossible, however, until usage and future costs can

be predicted with certainty, and the requirement to

break even is abandoned.

Stability of Reported Usage. Advocates believe

there should be no change in the measuring or charging

system that would substantially alter reported usage.

Critics disagree where modifications can be properly

documented and users adequately informed in advance.

Differentiation. The charging mechanism should be

designed to attract usage or control the timing of usage.

Allocation of Dollars. The billing algorithm in place

should facilitate the allocation of funds available for

computer services in a rational manner.

Regulation of Purchase. The charging system itself

should regulate the demand for computing services by

setting the rate in such a way to generate a level of


A properly designed chargeback system which incorporates some or all of the afore-mentioned objectives offers numerous advantages that can improve the efficiency and effectiveness of the organization. From the computer center prospective, a chargeback system enables the recovery of costs associated with the information processing department (Choudhury et al., 1986). Depending on the budgetary and the performance evaluation system used, the data processing manager may have incentive to keep his or her operating costs down; further incentive is provided if the user is permitted to go outside the organization and acquire the computer resources and services it needs. Chargeback can also aid in the planning and acquisition of additional computer resources; the need for additional hardware and software should become more meaurable. It also facilitates decentralization within the organization with its accompanying advantages such as specialization, autonomy and motivation (Choudhury et al., 1986). From the user standpoint, greater involvement in the availability of services and the pricing structure itself is encouraged. Users, when paying for the service, generally will more closely analyze a prospective project from a cost-benefit perspective, thereby reducing the number of suspect ventures being undertaken. Computer resources will be released for the processing of worthwhile, potentially more profitable projects, however defined.

While chargeback has many pluses, there are also perceived, if not actual, disadvantages. However, it has been suggested that these drawbacks are costs of operating the system, rather than grounds for not having one (Choudhury, et al., 1986). When users are required to pay for their usage, they may be discouraged from taking chances; innovation may be inhibited. The pricing structure may also lead to dysfunctional (anti-organization) decision making in that a prospective application may be rejected because it yields a lower profit than expected or which is normally generated (Choudhury, et al., 1986). Or alternatively, the user may purchase its requirements from an outside service bureau at a price greater than the internal incremental cost, even though there is excess capacity internally. Certain users, in particular those with smaller operating budgets or less technological expertise, may have limited access to the artificial intelligence resources. The system can be costly to develop and implement (McGee, 1984); likewise, accounting complexity and costs generally increase. Finally, the chargeback system may create controversy and disputes as most every user views "equity" in a light most favorable to themselves.

If some form of chargeback is favored by management, the computer center may be organized and operated as either a cost (service) center or a profit center. If the cost center approach is adopted, the computer center allocates its costs to those user departments consuming its services on the basis of some measure of usage. Costs that are allocated to users include the computer department's own costs as well as its share of central overhead charges that have been themselves allocated to it (Choudhury et al., 1986). Under such an approach, the objective is to break even, although the definition of costs that are to be recovered can vary among organizations. If the department is to be run as a profit center, the charge to user divisions (often called a transfer price) will contain a profit element. A true profit center is one that is able to sell to outside users; a quasi profit center charging a cost plus or a market price can still capture benefits generated through decentralization (Choudhury et al., 1986).

Obviously a cost center type approach to chargeback should result in a lower price than the profit center approach due to the lack of the profit element; as a direct result, this approach should tend to encourage more extensive use of the computer facilities (Cushing, 1976). In addition, the price should generally be lower than market, which should keep users from going outside the organization where that option is available. Fewer user disputes over the equity of the price charged should arise. Alternatively, the profit center approach is superior in motivating the data processing department manager to keep costs down and equality and efficiency up (Cushing, 1976). He or she has incentive to provide new services and to remain technologically current in order to remain competitive, although this motivation is diminished if users must remain within the organization. Top management will also have available better data to evaluate the economic feasibility and strength of the data processing department (Cushing, 1976).

When the data processing department is structured as a profit center, typically a transfer pricing policy is used, most commonly market oriented. The minimum transfer price or charge should be the variable or incremental cost in providing the service plus the opportunity cost in selling to a particular user. If there are no other users, or if the center has available capacity, then this opportunity cost is zero. When data processing is treated as a cost center, price is based solely on cost recovery. Cost under either the profit center or cost center approach includes two elements, the computer system operational cost (including hardware) and the manpower cost in the form of systems development and maintenance staff (Hootman, 1977). Both need to be considered, either in terms of actual or standard costs.

While actual computer department costs are generally available, the use of standard costs is often more desirable. A standard cost system uses predetermined rates based on projected costs and usage as of the beginning of the period involved (Lin, 1983). This rate or rates should remain constant throughout the period, although provision can be made for rate modifications where users are informed of the changes well in advance. Standard rates make budgeting and planning for computer users less complicated. In addition, users have more direct control over their own computer usage expenses under a standard cost system. When actual costs are used, rates will go up when usage goes down, and rates will go down when usage goes up; a particular user's computer charge may as a result become more influenced by other's usage than by its own (Wenk, 1986). Standard cost systems also facilitate performance evaluations of the EDP and user departments as actual costs and resource utilization can be compared with expected levels (Wenk, 1986).

The implementation of a chargeback system normally involves three or four steps, depending on whether a service center or profit center approach is adopted (Willits and Alley, 1985).

Step 1. Select usage indicators. Many different allocation bases can be used to allocate costs. Historically charging algorithms have been complex and at times irrelivant to users because they have been designed by computer technicians. Some users find detailed charges to be incomprehensible and thus not directly controllable. In addition, personnel costs have often been considered indirect costs and added as overhead to hardware charges. Since manpower costs have become one of, if not the largest component of computer processing costs, charging inequities have resulted. Users requiring heavy hardware resources may bear much of the personnel costs even though they do consume only small increments of human resources. Care must be taken in selecting the correct number of usage indicators or allocation bases so as to ensure users are equitably charged, while at the same time not overwhelmed and confused.

Step 2. Allocate costs to indicators. Direct costs, i.e., those costs directly traceable to a particular computer resource in an economically feasible manner, are first assigned to each selected usage indicator. Indirect costs, those that aren't directly traceable to a particular function or those that are too minor in amount, must then be assigned to allocation bases in a manner that fairly and clearly distribute the computer center's overhead.

Step 3. Determine indicator unit costs. This step relates to setting the predetermined rate to be used. As previously discussed, either actual or standard costs can be used in the numerator, with consideration being given to future or replacement costs if so desired. Many choices exist as to what denominator level to use; actual usage, expected usage, and normal operating capacity have all been suggested and used. Normal operating capacity is based on the number of usage measure units users could consume if the computer center operated at normal capacity (Willits and Alley, 1985).

Step 4. Set prices. If the service center approach to chargeback is adopted, the price charged equates to the indicator unit cost as determined in step three. If a profit center approach is utilized (which may arise where the institution has an objective to replace hardware, etc., but has not included such costs in step three), then a pricing structure must be incorporated that is consistent with the administration's objectives.


While chargeback systems may not be justifiable for every organization, many may benefit from its implementation. Even if the system is not accompanied by actual transfers of funds between the user and provider departments, goal congruence, efficient resource allocation, and cost containment, as well as other objectives, can be achieved. Given the degree of flexibility in structuring, implementing, and monitoring a chargeback system, such a system can be specifically tailored to meet the organization's special needs.


Cushing, B.E. "Pricing Internal Computer Services: The Basic Issues." Management Accounting. (April 1976) 47-50.

Chodhury, Nandan, Sumit Sircar, and K. Venkata Rao. "Chargeout of Information Systems Services." Journal of Systems Management. (September 1986) 16-21.

Hoffman, Michael J. "DP Cost Allocation: A Management Perspective." Journal of Systems Management. (January 1984) 16-20.

Hootman, Joseph T. "Basic Considerations in Developing Computer Charging Mechanisms." Data Base. (Spring 1977) 4-9.

Lin, C. H. Michael. "System for Charging Computer Services." Journal of Systems Management. (November 1983) 6-10.

McGee, Robert W. "Accounting for EDP Department Costs." Management Accounting. (January 1984) 72-73.

Wenk, Dennis. "Managing the Cost of IS." Infosystems. (November 1986) 41-45.

Willits, Stephen D. and Lee R. Alley. "Capacity-based Pricing Offers Viable Chargeback Alternative." Data Management (November 1985) 22-28.
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Author:Davies, Thomas L.
Publication:South Dakota Business Review
Date:Dec 1, 1989
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