IT costs are now highly visible and containing them is high on executive agendas.

Business units must be cost effective in their use of IT. IS organisations must be seen to deliver value for money. Bringing these together is a challenge. That's where chargeback comes in.

Whether or not to charge back and how to charge back is a top-level enterprise decision. Part of the IT governance process is setting out what behaviours are sought and how chargeback will encourage them. This may call for the allocation of costs to business units - or it might not. And that decision can't be made by IS alone.

Charging back for IT services is controversial. It can lead to political tensions, investment setbacks and wasted arguments that lead straight into the debate that IT services can be bought elsewhere. It's costly to agree and administer, taking up time that could be focused on delivery. It's not surprising then that CIOs have very different opinions about it

To Charge or Not to Charge . . .

As CIO at National Wealth Management (and formerly MLC), Michelle Tredenick was a strong proponent of "no chargeback". "We have a real partnership and integration of business and technology," Tredenick said at a recent EXP meeting exploring chargeback issues. "Chargeback plays into the 'provider' rather than the 'partner' way of thinking." However, costs are always clearly identified and transparent.

Doug Wisdorf, senior vice president at Washington Mutual, a financial services firm based in Seattle, takes a different view. "Charging for IT services creates a discipline that nothing's free. If the cost of technology isn't charged back to customers, they will not consider it valuable or use it wisely," Wisdorf says.

To take the heat out of chargeback, think about it in three phases. First make IT service costs visible, which is the initial step in responsible financial management - no matter what you do about chargeback. Second, if appropriate, allocate costs equitably, according to the needs of the business units. The third and final stage is to recover these costs - again if appropriate.

Phase 1: Identifying your IT service costs is essential for all. Whether or not you decide to charge back for IT services, identifying IT service costs is mandatory. It is best done as a three-phase process: create a standardised chart of accounts, decide which accounting treatment to use, and draw up an accounting policy to be used consistently.

Creating a chart of accounts begins with an IT services directory that shows what IT services exist, who uses them and what cost treatments apply to each. Costs can be accounted for in different ways, taking into account fixed and variable components.

To fairly charge users based on average cost, IS must accurately predict usage. The cost of a service depends on its service level. Upgrading service levels often requires investments in new equipment or capacity, increasing the fixed costs. For example, decreasing help desk response time from a day to an hour greatly increases cost, because it requires more support staff.

Marginal cost is another way to account for costs. Marginal cost is the cost of an increment of service usage. It assumes that the fixed cost element of a shared IT service is already being paid for by other users. The marginal cost is always less, and often substantially less, than the average cost of a service.

Capitalisation (recording an expense on the enterprise's balance sheet as an asset) or depreciation (reducing its expense to zero over its life) are still further accounting treatments. Traditionally, capitalisation has been reserved for physical assets, such as hardware and equipment. But recently there's been a trend towards capitalising soft assets, such as software.

Activity-based costing traces costs to activities, then to services. Traditional accounting traces costs to departments, then to services. The principal difference between the two approaches is the number of cost drivers that are used. Activity-based costing uses more cost drivers. As a result it has greater accuracy and complexity.

Whatever approach you use, IT service costs need to be consistently identified throughout the enterprise.

The next stage is to allocate them equitably, according to the needs of the business units.