1. What are the current problems, if any, that Buckeye National Bank (BNB) appears to be facing?

2. Based on your understanding of cost system failure, do you think that the problems that BNB is facing are due to the cost systems feedback? If yes, explain clearly why that is the case

3.(a) Using the traditional (current) accounting system, what are the costs of servicing an average retail and business customer? Also, determine the profit per customer in each of the two groups. (b) What business strategy would a manager using the original cost allocation system likely adopt?

4. What are the major cost pools the Bank has identified under the new Activity-based costing system? What transactions are used to absorb the cost of each activity at a given customer group level?

5. (a) Using the Activity-based costing (ABC) system, what are the costs of servicing an average retail and business customer? Also, determine the profit per customer in each of the two groups.

6. Clearly explain the reason for the differences, if any, between the ABC and the traditional views of profitability of an average customer in the two groups.

7. Activity-based management (ABM) refers to managers' use of ABC data in making business decisions. How can Buckeye's managers use the ABC data to plan more profitable marketing strategies? How can Buckeye's managers use ABC information to identify opportunities to trim costs while still satisfying customers' needs?

8. Assume that the depreciation expense on the customer call center equipment is $40,000. An outsourcing company offers to provide the same level (i.e., attending 100,000 calls a year) and quality of service for $480,000. Should the bank outsource its call center service based on just these numbers and the other data given in the case? You may ignore the qualitative and long-term concerns related to outsourcing and view this as a single-shot decision.

9. Suppose that the variable portion of servicing one retail customer is $4 (under the new Activity-Based-Costing system). If the bank responds to the new customer profitability numbers by letting one retail customer go, by how much would its total income for the year change?

Issues in Accounting Education Vol. 16, No. 3 August 2001 Activity-Based Costing in the Service Sector: The Buckeye National Bank Linda Smith Bamber and K. E. Hughes II T: INTRODUCTION he Buckeye National Bank began operations in the mid-1980s. The bank quickly grew by providing checking account services to many small busi- nesses that preferred to do business with a local bank. Although Buckeye initially offered checking account services for individual accounts (retail custom- ers), the bank primarily focused on serving its business customers. During the economic slowdown of the early 1990s that weakened the local economy, growth in business customer accounts began to decline. In response, Buckeye's senior management adopted a new strategy, focusing on increasing the number of retail customer accounts. By aggressively marketing individual retail accounts, Buck- eye continued to grow, Today, the Buckeye National Bank strives to maintain a stable base of business customers, while actively competing for an increased mar- ket share of retail customers. Recent income statements (Exhibit A) reveal a decline in the bank's profits. The bank's primary (noninterest) expense consists of salaries and employee ben- efits. Most full-time employees' first priority is providing services to customers; these employees conduct their administrative responsibilities during slack times. The Bank schedules additional part-time employees to work during peak demand times, from 11 AM-2 PM and Friday afternoons. Flexibility in scheduling part-time employees means that the bank's staff is lean and fully utilized. Buckeye's CEO, Rob Garrison, believes that this staffing arrangement allows the bank to provide speedy customer service, while operating at practical capacity. (That is, the bank's staff is fully utilized in efficient operations, after allowing for bank holidays and other scheduled staff activities such as training.) To counter falling profits, Buckeye's directors took two actions last year, both aimed at increasing the bank's retail customer base. First, Buckeye established a service call center to respond to customer inquiries about account balances, checks cleared, fees charged, and other banking concerns. Second, Buckeye's directors authorized year-end bonuses to branch managers who met their branch's target increase in the number of customers. However, even though 80 percent of the branch managers met the targeted increase in customer accounts, the Bank's prof- its continued to decline. CEO Rob Garrison does not understand why profits are declining, given that the Bank is serving more customers. Buckeye's southeast regional manager, Erik Larsen, has also noticed that while small retail custom- ers flock to the bank, the number of business customers is barely stable. Erik Larsen suspects that Buckeye's costing system may be part of the prob- lem. Buckeye developed its simple costing system when the bank began opera- tions in 1985. The bank does not trace any costs directly to individual customers. It simply treats all (noninterest expense) operating costs identified in the Income Statement in Exhibit A as indirect with respect to the customer line. The bank allocates these indirect costs to either the retail customer line or the business customer line, based on the total dollar value of checks processed (which is readily available because each branch must provide the dollar values of daily transac- tions for internal control). For the current period, Buckeye processed a total of $95 million in checks, of which $9.5 million was written by retail customers, and $85.5 million was written by business customers. This costing approach was fairly typical of banks and other financial institutions at the time Buckeye developed its cost system. In college, Erik learned about an alternative costing approach called activity- based costing (ABC). However, the examples he remembered involved manufac- turing firms. He wondered whether Buckeye could develop an ABC system, with the business account customer line and the retail account customer line as the two primary cost objects. Erik approached Rob Garrison with this suggestion. Rob was skeptical, exclaiming, "Our profits are going down the tubes and you want me to spend money developing a new accounting system?" However, Erik persisted, and Rob eventually authorized a pilot ABC study using three local branches of the bank. The ABC implementation team included Erik, the managers of each of the three bank branches, a bank teller, and a representative from the customer service call EXHIBIT A Buckeye National Bank Consolidated Income Statement For the three years ending December 31, 2045 20x5 20x4 20x3 (5000) ($000) ($000) Net interest income $3,486 $3,417 $3,349 Provision for credit losses 484 475 465 Net interest income after provision for credit losses 3,002 2,942 2,884 Noninterest income 1,207 1,199 1,190 Income prior to noninterest expenses and income tax 4,209 4,141 4,074 Noninterest expenses 3,805 3,599 3,362 Income before income taxes 404 602 712 Income tax expense 130 194 230 Net income 274 482 Net interest income equals interest income less interest expense. The bank's primary income is from interest-bearing checking accounts. Noninterest income includes fees charged for various services, such as checking account fees charged if the account balance falls below the required minimum level. Noninterest expenses are all of the bank's operating costs, including those associated with paying checks, providing teller services, and responding to customer account inquires. 408 center. The team began by identifying the activities Buckeye National Bank per- formed. To start a simple pilot study, the team identified the three most impor- tant activities: 1. Paying checks 2. Providing teller services 3. Responding to customer account inquiries at the customer service call center If this pilot study turned out to be successful, then the team planned to refine the system by conducting a more detailed activity analysis the following year. The ABC team began by determining the costs that are associated with each of the three activities. The team quickly discovered that, as is typical in service indus- tries like banking, labor (personnel) costs dominate. The ABC team asked each em- ployee to fill out a short questionnaire to find out how the employee spends his or her time. The team then followed up with an in-depth personal interview with each employee. The ABC team used this combined information to estimate the percent- age of time each employee spent on each of the three activities: (1) paying checks, (2) providing teller services, and (3) responding to customer account inquiries. The team then estimated the other (nonlabor) resources that each of the three activities consumed. For example, they traced to the responding to customer account inquiry activity: (1) the cost of toll-free telephone lines at the customer service call center, and (2) depreciation on other equipment and facilities the call center personnel use. Similarly, the ABC team estimated the percentage of time the bank's information system was used for check processing and providing teller services (vs. other uses such as compiling periodic financial statements), to determine how much of the equipment's depreciation to assign to the activities "paying checks" and providing teller services." To complete the pilot study in a timely fashion, the ABC team based their estimated activity costs on last year's actual data, which were already available. If the pilot study succeeded, then the ABC team planned to develop budgeted indirect cost rates for each activity the following year. The advantage of budgeted rates over actual rates based on the prior year's data is that budgeted rates (bud- geted cost associated with the activity divided by the budgeted quantity of the activity's cost driver) can incorporate expected changes in costs and operations. After examining the three branch banks' indirect costs (that is, the cost items making up the branch banks'noninterest operating expenses), the ABC team clas- sified the annual costs in each activity's cost pool Chereafter, all numbers are in thousands) as shown in Exhibit B. An activity's cost pool is simply a grouping, er aggregation of all the individual costs associated with that activ- ity. The bank's ABC team created separate activity cost pools for the costs associated with each of the three activities: (1) paying checks, (2) providing teller services, and (3) responding to customer account inquiries. EXHIBIT B Assignment of Indirect (Noninterest Expense) Costs to Activity Cost Pools Estimated Annual Activity Cost Pool to which Total Costs Indirect Cost Indirect Cost is Assigned (in $1,000s) Salaries of check-processing personnel Paying checks $ 700 Depreciation of equipment and facilities used in check processing Paying checks 440 Teller salaries Providing teller services 1,000 Depreciation of equipment and facilities used in teller operations Providing teller services 200 Salaries of customer representatives at call Responding to customer account center inquiries Toll-free phone lines plus depreciation of equipment and facilities in customer Responding to customer account call center inquiries Total indirect costs $2,850 . These indirect costs are part of the $8,806 "noninterest expenses in the bank's 20x5 Income Statement in Exhibit A. The rest of the noninterest expenses in the Income Statement shown in Exhibit A pertain to other operating costs that are excluded from the pilot ABC study, such as the CEO's salary. (The costs listed in Exhibit B are indirect with respect to the retail customers and business account customers.) 450 60 The team identified the following cost drivers for each activity cost pool: Activity Cost Pool Activity Cost Driver Paying checks Number of checks processed Providing teller services Number of teller transactions Responding to customer account Number of account inquiry calls to inquiries customer service call center The ABC team estimated that for the three pilot-test bank branches, the re- tail and business customer lines experienced the annual activity levels in thou- sands) as shown in Exhibit C. For example, Exhibit C reveals that retail customers had 160,000 teller transactions and made 95,000 account inquiry calls to the cus- tomer service call center. Buckeye National Bank currently services 150,000 retail customer checking accounts and 50,000 business customer checking accounts. The bank earns net interest revenue on the balances that customers keep in their checking accounts. On average, the bank earns the following annual revenue from each type of account: Average annual revenue per retail customer account $10 Average annual revenue per business customer account $40 Required: Your task is to assist Erik Larsen and his ABC team by providing the follow- ing information: 1) Under the original (old) cost system: A) Compute the single indirect cost allocation rate that the bank would use to allocate the total indirect costs presented in Exhibit B. A cost driver is a factor, such as the number of checks processed, that causally affects costs. For example, the costs associated with the activity, paying checks" rise and fall as the quantity of the cost driver (the number of checks processed) rises and fails. The bank earns net interest revenue by managing the interest rate spread." This spread is the difference between the interest rate the bank earns on customer deposits (say 8 percent), less the interest rate the bank pays the customer on the average checking account balance say 4 percent). EXHIBIT C Activity Cost Drivers by Customer Line Annual Number of Units Annual Number of Units of Activity-Cost Driver of Activity-Cost Driver Used by Retail Customers Used by Business Customers in 1,000s) (in 1,000s) 570 2,280 160 40 Total 2,850 Activity Cost Driver Checks processed Teller transactions Account inquiry calls to customer service call center 200 95 5 100 Issues in Accounting Education Vol. 16, No. 3 August 2001 Activity-Based Costing in the Service Sector: The Buckeye National Bank Linda Smith Bamber and K. E. Hughes II T: INTRODUCTION he Buckeye National Bank began operations in the mid-1980s. The bank quickly grew by providing checking account services to many small busi- nesses that preferred to do business with a local bank. Although Buckeye initially offered checking account services for individual accounts (retail custom- ers), the bank primarily focused on serving its business customers. During the economic slowdown of the early 1990s that weakened the local economy, growth in business customer accounts began to decline. In response, Buckeye's senior management adopted a new strategy, focusing on increasing the number of retail customer accounts. By aggressively marketing individual retail accounts, Buck- eye continued to grow, Today, the Buckeye National Bank strives to maintain a stable base of business customers, while actively competing for an increased mar- ket share of retail customers. Recent income statements (Exhibit A) reveal a decline in the bank's profits. The bank's primary (noninterest) expense consists of salaries and employee ben- efits. Most full-time employees' first priority is providing services to customers; these employees conduct their administrative responsibilities during slack times. The Bank schedules additional part-time employees to work during peak demand times, from 11 AM-2 PM and Friday afternoons. Flexibility in scheduling part-time employees means that the bank's staff is lean and fully utilized. Buckeye's CEO, Rob Garrison, believes that this staffing arrangement allows the bank to provide speedy customer service, while operating at practical capacity. (That is, the bank's staff is fully utilized in efficient operations, after allowing for bank holidays and other scheduled staff activities such as training.) To counter falling profits, Buckeye's directors took two actions last year, both aimed at increasing the bank's retail customer base. First, Buckeye established a service call center to respond to customer inquiries about account balances, checks cleared, fees charged, and other banking concerns. Second, Buckeye's directors authorized year-end bonuses to branch managers who met their branch's target increase in the number of customers. However, even though 80 percent of the branch managers met the targeted increase in customer accounts, the Bank's prof- its continued to decline. CEO Rob Garrison does not understand why profits are declining, given that the Bank is serving more customers. Buckeye's southeast regional manager, Erik Larsen, has also noticed that while small retail custom- ers flock to the bank, the number of business customers is barely stable. Erik Larsen suspects that Buckeye's costing system may be part of the prob- lem. Buckeye developed its simple costing system when the bank began opera- tions in 1985. The bank does not trace any costs directly to individual customers. It simply treats all (noninterest expense) operating costs identified in the Income Statement in Exhibit A as indirect with respect to the customer line. The bank allocates these indirect costs to either the retail customer line or the business customer line, based on the total dollar value of checks processed (which is readily available because each branch must provide the dollar values of daily transac- tions for internal control). For the current period, Buckeye processed a total of $95 million in checks, of which $9.5 million was written by retail customers, and $85.5 million was written by business customers. This costing approach was fairly typical of banks and other financial institutions at the time Buckeye developed its cost system. In college, Erik learned about an alternative costing approach called activity- based costing (ABC). However, the examples he remembered involved manufac- turing firms. He wondered whether Buckeye could develop an ABC system, with the business account customer line and the retail account customer line as the two primary cost objects. Erik approached Rob Garrison with this suggestion. Rob was skeptical, exclaiming, "Our profits are going down the tubes and you want me to spend money developing a new accounting system?" However, Erik persisted, and Rob eventually authorized a pilot ABC study using three local branches of the bank. The ABC implementation team included Erik, the managers of each of the three bank branches, a bank teller, and a representative from the customer service call EXHIBIT A Buckeye National Bank Consolidated Income Statement For the three years ending December 31, 2045 20x5 20x4 20x3 (5000) ($000) ($000) Net interest income $3,486 $3,417 $3,349 Provision for credit losses 484 475 465 Net interest income after provision for credit losses 3,002 2,942 2,884 Noninterest income 1,207 1,199 1,190 Income prior to noninterest expenses and income tax 4,209 4,141 4,074 Noninterest expenses 3,805 3,599 3,362 Income before income taxes 404 602 712 Income tax expense 130 194 230 Net income 274 482 Net interest income equals interest income less interest expense. The bank's primary income is from interest-bearing checking accounts. Noninterest income includes fees charged for various services, such as checking account fees charged if the account balance falls below the required minimum level. Noninterest expenses are all of the bank's operating costs, including those associated with paying checks, providing teller services, and responding to customer account inquires. 408 center. The team began by identifying the activities Buckeye National Bank per- formed. To start a simple pilot study, the team identified the three most impor- tant activities: 1. Paying checks 2. Providing teller services 3. Responding to customer account inquiries at the customer service call center If this pilot study turned out to be successful, then the team planned to refine the system by conducting a more detailed activity analysis the following year. The ABC team began by determining the costs that are associated with each of the three activities. The team quickly discovered that, as is typical in service indus- tries like banking, labor (personnel) costs dominate. The ABC team asked each em- ployee to fill out a short questionnaire to find out how the employee spends his or her time. The team then followed up with an in-depth personal interview with each employee. The ABC team used this combined information to estimate the percent- age of time each employee spent on each of the three activities: (1) paying checks, (2) providing teller services, and (3) responding to customer account inquiries. The team then estimated the other (nonlabor) resources that each of the three activities consumed. For example, they traced to the responding to customer account inquiry activity: (1) the cost of toll-free telephone lines at the customer service call center, and (2) depreciation on other equipment and facilities the call center personnel use. Similarly, the ABC team estimated the percentage of time the bank's information system was used for check processing and providing teller services (vs. other uses such as compiling periodic financial statements), to determine how much of the equipment's depreciation to assign to the activities "paying checks" and providing teller services." To complete the pilot study in a timely fashion, the ABC team based their estimated activity costs on last year's actual data, which were already available. If the pilot study succeeded, then the ABC team planned to develop budgeted indirect cost rates for each activity the following year. The advantage of budgeted rates over actual rates based on the prior year's data is that budgeted rates (bud- geted cost associated with the activity divided by the budgeted quantity of the activity's cost driver) can incorporate expected changes in costs and operations. After examining the three branch banks' indirect costs (that is, the cost items making up the branch banks'noninterest operating expenses), the ABC team clas- sified the annual costs in each activity's cost pool Chereafter, all numbers are in thousands) as shown in Exhibit B. An activity's cost pool is simply a grouping, er aggregation of all the individual costs associated with that activ- ity. The bank's ABC team created separate activity cost pools for the costs associated with each of the three activities: (1) paying checks, (2) providing teller services, and (3) responding to customer account inquiries. EXHIBIT B Assignment of Indirect (Noninterest Expense) Costs to Activity Cost Pools Estimated Annual Activity Cost Pool to which Total Costs Indirect Cost Indirect Cost is Assigned (in $1,000s) Salaries of check-processing personnel Paying checks $ 700 Depreciation of equipment and facilities used in check processing Paying checks 440 Teller salaries Providing teller services 1,000 Depreciation of equipment and facilities used in teller operations Providing teller services 200 Salaries of customer representatives at call Responding to customer account center inquiries Toll-free phone lines plus depreciation of equipment and facilities in customer Responding to customer account call center inquiries Total indirect costs $2,850 . These indirect costs are part of the $8,806 "noninterest expenses in the bank's 20x5 Income Statement in Exhibit A. The rest of the noninterest expenses in the Income Statement shown in Exhibit A pertain to other operating costs that are excluded from the pilot ABC study, such as the CEO's salary. (The costs listed in Exhibit B are indirect with respect to the retail customers and business account customers.) 450 60 The team identified the following cost drivers for each activity cost pool: Activity Cost Pool Activity Cost Driver Paying checks Number of checks processed Providing teller services Number of teller transactions Responding to customer account Number of account inquiry calls to inquiries customer service call center The ABC team estimated that for the three pilot-test bank branches, the re- tail and business customer lines experienced the annual activity levels in thou- sands) as shown in Exhibit C. For example, Exhibit C reveals that retail customers had 160,000 teller transactions and made 95,000 account inquiry calls to the cus- tomer service call center. Buckeye National Bank currently services 150,000 retail customer checking accounts and 50,000 business customer checking accounts. The bank earns net interest revenue on the balances that customers keep in their checking accounts. On average, the bank earns the following annual revenue from each type of account: Average annual revenue per retail customer account $10 Average annual revenue per business customer account $40 Required: Your task is to assist Erik Larsen and his ABC team by providing the follow- ing information: 1) Under the original (old) cost system: A) Compute the single indirect cost allocation rate that the bank would use to allocate the total indirect costs presented in Exhibit B. A cost driver is a factor, such as the number of checks processed, that causally affects costs. For example, the costs associated with the activity, paying checks" rise and fall as the quantity of the cost driver (the number of checks processed) rises and fails. The bank earns net interest revenue by managing the interest rate spread." This spread is the difference between the interest rate the bank earns on customer deposits (say 8 percent), less the interest rate the bank pays the customer on the average checking account balance say 4 percent). EXHIBIT C Activity Cost Drivers by Customer Line Annual Number of Units Annual Number of Units of Activity-Cost Driver of Activity-Cost Driver Used by Retail Customers Used by Business Customers in 1,000s) (in 1,000s) 570 2,280 160 40 Total 2,850 Activity Cost Driver Checks processed Teller transactions Account inquiry calls to customer service call center 200 95 5 100