Cost Allocation and Information Technology

Abstract

A central question in management accounting is the allocation of support department costs. Support departments provide services to operating departments that directly add value to a product or service in the firm. The increasing use of information technology (IT) has resulted in the creation of another important cost category that contributes to overhead costs. Although increases in IT spending are expected to increase productivity and profitability, the results were typically mixed. This phenomenon has historically been labeled “the productivity paradox.” Recently, IT has more rapidly increased productivity and profitability in various organizations, but the productivity increase has been erratic and inconsistent. To remain competitive, managers have had to respond to these technological changes by investing heavily in IT. Hence, justifying IT expenses has been an increasing conundrum for CIOs of most organizations. The paper provides insight into cost allocation methods that can be used to distribute IT costs. An illustrative case study provides additional insights. Three methods of varying complexity and accuracy are utilized by most organizations. From the case analysis, the reciprocal method is shown to allocate IT costs better than the direct and step-down methods. Managerial insights are provided to technology managers.