The Gibraltar Insurance Co. (GIC) established a systems department to implement and operate its own data processing systems. GIC believed that its own system would be more cost-effective than the service bureau it had been using.

GIC’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 needs. In addition, the system was designed to meet GIC’s long-term capacity needs. The excess capacity designed into the system would be sold to outside users until needed by GIC. The estimated resource requirements used to design and implement the system are shown in the following schedule:

GIC 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 on actual computer time used. The actual costs for the first quarter of the current fiscal year were distributed to the user departments as follows:

The three user departments have complained about the cost-distribution method 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 because these allocated costs form the basis for the fees billed to the outside clients. Mostafa Al Rashed, GIC’s controller, decided to review the cost-allocation method. The additional information he gathered for his review is reported in Tables 1, 2, and 3 in Exhibit 12-27.

Al Rashed has concluded that the method of cost allocation should be changed. He 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 would remain with the systems department.

The costs for software development and operations would be charged to the user departments based on actual hours used. A predetermined hourly rate based on the annual budget data would be used. The hourly rates that would be used for the current fiscal year are as follows:

Function …………………………….. Hourly Rate

Software development operations … $ 30

Computer related ………………….. 200

Input/output related ………………… 10

Al Rasheed plans to use first-quarter activity and cost data to illustrate his recommendations. The recommendations will be presented to the systems department and the user departments for their comments and reactions. He then expects to present his recommendations to management for approval.

1. Calculate the amount of data-processing costs that would be included in the claims department’s first-quarter budget according to the method Al Rashed has recommended.

2. Prepare a schedule to show how the actual first-quarter costs of the systems department would be charged to the users if GIC adopts Al Rashed’s recommended method.

3. Explain whether Al Rasheed’s recommended system for charging costs to the user departments will

a. improves cost control in the systems department.

b. improves planning and cost control in the user departments.

Transcribed Image Text:

Records Claims Finance Expansion (outside use) Total Hardware and Other Capacity-Related Resources 25% 50 20 Operating Resources 60% 15 20 100% 1 00% Percentage Utilization 60% 15 20 Amount S330,000 82,500 110,000 27.500 5550 0O Department Records Claims Finance Outside Total 100%