The Cost Allocation Process of Information Technology - Essay Example

The word I.T (information technology) has grown four-fold during the last decade or so. Every firm now has a separate I.T department. I.T infrastructure such as servers and networking equipment are a major source of costs in contemporary organizations. The cost allocation process of this equipment is difficult and is so vast that often there are bias estimators being used in the system. Even measuring the data and allocating the usage to each department incur costs as lots and lots of devices are to be installed for measuring this data and computerized requisition. The purpose of I.T department is to assist the various other departments in the firm about computer related issues. As more firms have adopted computer softwares over manual functioning. Similarly computer networks also help the departments within a firm to coordinate and communicate among themselves. With all of these advancements come costs of setting up computer networks and other related costs. Allocation of I.T costs(charging cost to each department according to its usage of a resource) is among current hot-topic in the corporate world. According to study done by Forrester, Computer Hardware and Network costs make up to one-third of I.T department budget. However, the main problem is of allocating costs among various departments within a firm. The most widely used method by accountants is to allocate these costs is by dividing these costs according to the consumption by respective department. By relative consumption we mean that each department will be charged a share of cost according to their use. For example, if there are two departments who both use I.T network, now when at the end of fiscal year , the time for cost allocation comes , the department with more usage will be charged more and with less usage will be charged less. The fundamental reason behind charging this method is to avoid the multiple free-riders problem. Free-riding occurs when those who do not pay for a resource could also use the resource , so no-one is foolish enough to put up his hand and say I will pay for the resource because he knows that even if he doesn't pay for the resource he would be able to use it. For example, let's take an example from out of context here. Suppose that there is a community of fishermen is living near sea. During the main fishing season, these fishermen have to go to sea even at night. Many fishermen noticed that during night journeys they had problems of navigating their way back to the village because of one factor or another. The possible solution to the problem is to build a light house to guide these fishermen who are working at night. Though there are many fishermen working at night but no body wants to pay for the lighthouse because he thinks that even if he doesn't pay for it, village will pool the money and will build a light house any way. And after a light house has been built no one can stop him benefitting from it. So, he won't pay for it and still utilize all the possible benefit of a light house. Similarly, if the costs are not allocated among the departments according to their usage and these departments are charged a fixed proportion then all the departments will try to use these I.T resources as much as they can, as they have to pay a fixed amount no matter how much they use it. In such an event, there will be wear and tear of resources, an obvious wastage will occur and these resources will not be used efficiently. All departments will try to free-ride on the back of others. So, the charges of these resources are based on consumption so that no one will use the resources inefficiently and if any wear and tear occurs then the responsible department has to bear the cost which leads to efficient and careful use of these resources. (Example taken from "Economics" book written by Collin Bamford, 2005, Section Public Goods and Costs)1 Now let's take an example from our I.T context. Suppose that a person develops an application. There are very high costs involved into developing this software which makes it difficult for him cover these costs. What he can do is that he can monitor and meter each request of resources from various departments of a firm that is a usage-based-model is going to be used. What happens in this process is that each department is given a unique ID or number. The problem with this system of cost allocation is that it's really expensive to monitor and meter individual requests of various departments and it is further difficult to record how many requests each department sends because in the large organization environment there are million of requests and ever minutes. In their professional paper, Mr. Reinhard Brandl, Martin Bichler and M.Stroblel, they developed and elaborated on the new model of these cost allocations. The first and foremost part of the cost allocation process according to them was to accurately estimate the cost of I.T infrastructure and other costs associated with it. There should be neither understatement nor overstatement of these costs. Every department usage should also be accurately and neither it should be over stated and nor underestimated. Secondly, they believe that the cost allocation should be applicable to the entire I.T infrastructure. There shouldn't be any need of changing the operating systems or using other softwares to determine costs from one department to another. Thirdly, that this estimation should fit all the standard procedures of the company and should not be a new innovation which harms other standards of the company. According to the developers, the first step of estimation is directly related to apportioning the costs whereas the second and third steps determine the viability of the method. The developers derived a series profiles for every service. These profiles for each service are going to tell the accounting department how many requests a particular department has sent to use the I.T service and based on this costs will be allocated to each department. However, the problem that I think is with this system is that the final cost figure for each department will be based on an estimate only and is not necessarily a concrete and valid figure. As a result, this system can overcharge some departments in some fiscal years and may under charge others. So, the entire reason behind developing such a system fails and this system also fails our acid-test. (The diagram of this system and testing of this system can be viewed at ibis.in.tum.de/docs/docs_staff/docs_bichler/docs/CostAccounting.pdf In order to accurately estimate the usage, many companies also used the requisition slips to apportion the cost to each department. Though, this process could have calculated and apportioned the actual and true amount. But this system also failed because the process was too cumbersome, the process for requesting and then getting the permission to use a particular service took too much time consuming and this system quickly out dated because the business world has become more volatile than ever and such time-consuming activities could destroy the reputation of a business and could not ensure fast decisions which are vital in the current volatile business climate. If you look at the different literatures of the past then following concepts should be seen to arrive at the cost allocation process of the I.T infrastructure costs. Controlling and Cost Accounting (Rieb pp. 94; Horv06) Accounting 4th Edition by Harold Randall (Chap 10-13) "Management" by Richard L. Daft (Section: Controlling) Frank Wood Accounting International Addition (Chapter Department Accounting) Similarly apart from these you can also type "Apportionment of Costs" at Google or yahoo and can get hold of various ways of cost allocation based on usage is determined. ACADEMIC AREA COST ALLOCATION Recently, at tuition centre also I observed a new way of cost allocation being used. We there had 10 different subjects being taught. There were overheads in the form of Generator Costs, Electricity Bills and etc. How the owner used to apportion costs among the various teachers teaching at centre was by number of student each teacher has registered under his name. Also by the amount of time a teacher spends at tuition centre. For example a teacher who teaches hour at the centre will be charged more than a teach who is teaching for only 2 hours. Similarly, if one teacher has 200 students registered under his name while the other only has 100 students. Then the one with 200 teachers will be charged more. All expenses in our tuition centre were apportioned this way. The problem with this system was that you cannot measure how much overhead each teacher was inflicting on the total cost and the entire system was based on estimate. Suppose, that a teacher with 200 students has used less electricity generator hours than the one with 100 students. Yet, he'll be charged on the basis of the strength of students he has and not the actual usage. COMMON USAGE RESOURCE COST ALLOCATION: Similarly, at my university, we have a common printing facility. The costs of printing are cost of electricity and cost of print cartridge. What our university does is that it records the printing done by each student during a month. It then divides it's total costs by the number of print outs and then apportion the cost to each student on the basis of print-out he has taken. This way if apportions the fair-cost to each student. However, the only problem with system was what if there was no check and balance and if someone prints under anyone else's name than the person whose name was taken was charged and not the one who is benefiting from the printout facility. Therefore, a correction to the system can be of taking on-spot payments from people who are using the printing facilities based on estimates. SOCIAL SCIENCE ALLOCATION OF COST: Similarly, road pricing was introduced in Singapore to charge cars for traffic when they enter a charging zone. Similarly, this charge was based on frequency meaning that a car that enters the charging zone will be charged more than those who drive at alternative routes. However, the problem with this system is that due to this system cars might divert to other roads and create traffic problems on alternative routes whereas those using the same charging route are charged more. The solution to this problem can by fitting out meters to each car and then charging cost to each car according to the distance they travel.2 In the end we can conclude that, with the advances in the modern sciences it has become much more easy and possible to measure that data and to apportion the cost to various departments within an organization. The specialization in I.T department and due to wide-scale outsourcing it has become possible to hire a firm the purpose of which will only be to measure the data. They could do this more professionally and efficiently than I.T department based within a firm with thousand of other things in mind. This is why we say, that science can make everything possible, it's just a matter of days. As from our earlier discussion, it has been easily proved that the job of cost allocation is full of complexities and technicalities which induce biases in the cost allocation process, a best solution to avoid these biases and to adopt a fair system of cost allocation would be to outsource the process data measurement of each department to an outside firm who'd be able to collect and collate data much easily which would not only enable the firm's IT department to focus on their core competencies but it would also help a fair allocation of costs to each department which would be bias (understatement or overstatement) free. Thus, this system would be a drive towards efficiency and one can hope that in future, by following this system by efficiently allocating costs, the firm would achieve all its costs and would be able to achieve all its goals.3 Read More