Answer Question

AIP 8.7 Allocating Computer Costs The Independent Underwriters Insurance Co. (IUI) established a Systems Department two years ago to implement and operate its own information processing and storage systems. IUI believed that its own system would be more cost effective than the service 390 30% 60% 20 50 bureau that it had been using. IUI's three departments - Claims, Records, and Finance - have different requirements with respect to hardware and other capacity-related resources and operating resources. The system was designed to recognize these differing demands. In addition, the system was designed to meet IUI's long-term capacity. The excess capacity designed into the system would be sold to outside users until needed by IUI. The estimated resource requirements used to design and implement the system are shown in the following schedule. Hardware and Other Capacity-Related Resources Operating Resources Records Claims Finance Expansion (outside use) Total IUI currently sells the equivalent of its expansion capacity to a few outside clients. At the time the system became operational, management decided to redistribute total expenses of the Systems Department to the user departments based upon actual computer time used. The actual costs for the first quarter of the current fiscal year were distributed to the user departments as follows: Department Percentage Utilization Records Claims 15 15 5 5 100% 100% Amount 60% 20 15 Finance Outside $330,000 110,000 82,500 27,500 $550,000 5 Total 100% The three user departments have complained about the cost distribution since the Systems Department was established. The Records Department's monthly costs have been as much as three times the costs experienced with the service bureau. The Finance Department is concerned about the costs distributed to the outside user category, as these allocated costs form the basis for the fees billed to the outside clients. Melinda Poon, IUI's controller, decided to review the distribution method by which the Systems Department's costs have been allocated for the past two years. The additional information she gathered for her review is reported in the three tables that follow (Exhibits 1 to 3). Melinda has concluded that the method of cost distribution should be changed to reflect more directly the actual benefits received by the departments. She believes that the hardware and capacity-related costs should be allocated to the user departments in proportion to the planned, long-term needs. Any difference between actual and budgeted hardware costs would not be allocated to the departments, but remain with the Systems Department. The remaining costs for software development and operations would be charged to the user departments based upon actual hours used. A pre-determined hourly rate based upon the annual budget data would be used. The hourly rates that would be used for 391 the current fiscal year are shown in Exhibit 4. Exhibit 1 Systems Department Costs and Activity Levels Annual Budget Budget First Quarter Actual Hours f Hours f Hours 600,000 562,500 150,000 141,750 155,000 130,000 18,750 4,725 4,250 Hardware and other capacity-related costs Software development Operations: Computer-related Input/output related 3,750 30,000 750,000 300,000 945 7,560 189,000 75,600 920 7.900 187,000 78,000 Exhibit 2 Historical Utilization by Users (percentage figures) Hardware and Software Operations Other Capacity Development Computer Related Input/Output Related Needs Range Average Range Average Range Average Records 30% 0-30% 12% 55-65% 60% 10-30% 20% Claims 50 15-60 35 10-25 20 60-80 70 Finance 15 25-75 45 10-25 15 3-10 6 Outside 5 0-25 8 3-8 5 3-10 4 100% 100% 100% 100% Exhibit 3 Records Claims Finance Outside Total Utilization of Systems Department's Services (in hours) First Quarter Operations Software Computer- Input/Output Development Related Related 425 552 1,580 1,700 184 5,530 1,700 138 395 425 46 395 4,250 920 7,900 30 Exhibit 4 Function Hourly Rate (5) Software development Operations Computer-related 200 Input/output-related Melinda plans to use first-quarter activity and cost data to illustrate her recommendations. The recommendations will be presented to the Systems Department 10 392 and the user departments for their comments and reactions. She then expects to present her recommendations to management for approval. a. Prepare a schedule to show how the actual first-quarter costs of the Systems Department would be charged to the users, if Melinda Poon's recommended method were adopted. b. Explain whether Melinda Poon's recommended system for charging costs to the user departments would: i. improve cost control in the Systems Department, ii. improve planning and cost control in the user departments, and iii. be a more equitable basis for charging costs to user departments