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 usiness 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 Linda Smith Bamber is a Professor at the University of Georgia and K. E. Hughes Il is an Assistant Professor at Louisiana State University. We appreciate the helpful suggestions and comments from Barbara Apostolou, Michael Bamber, Tom Harrison, Charlene Henderson, Sue Ravenscroft (associate editor), David E. Stout (editor), and two anonymous reviewers. 382 Issues in Accounting Education 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 AM2 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 Bamber and Hughes 383 EXHIBITA Buckeye National Bank Consolidated Income Statement For the three years ending December 31, 20x5 20x5 ($000) $3,486 484 20x4 ($000) $3,417 475 20x3 ($000) $3,349 465 3,002 1,207 2,942 1,199 2,884 1,190 Net interest income Provision for credit losses Net interest income after provision for credit losses Noninterest income Income prior to noninterest expenses and income tax Noninterest expenses Income before income taxes Income tax expense Net income 4,209 3,805 404 130 $ 274 4,141 3,539 602 194 $ 408 4,074 3,362 712 230 $ 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 telier services, and responding to customer account inquires. 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 384 Issues in Accounting Education 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 (hereafter, all numbers are in thousands) as shown in Exhibit B. 1 An activity's cost pool is simply a grouping, or 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 (Nopinterest Expense) Costs Activity Cost Pools Activity Cost Pool to which Indirect Cost is Assigned Estimated Annual Total Costs (in $1,000s) Paying checks $ 700 Paying checks Providing teller services 440 1,000 Indirect Cost Salaries of check-processing personnel Depreciation of equipment and facilities used in check processing Teller salaries Depreciation of equipment and facilities used in teller operations Salaries of customer representatives at call center Toll-free phone lines plus depreciation of equipment and facilities in customer call cent Providing teller services 200 Responding to customer account inquiries 450 Responding to customer account inquiries 60 Total indirect costs $2,850 These indirect costs are part of the $3,805 *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.) Bamber and Hughes 385 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.3 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 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 usiness 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 Linda Smith Bamber is a Professor at the University of Georgia and K. E. Hughes Il is an Assistant Professor at Louisiana State University. We appreciate the helpful suggestions and comments from Barbara Apostolou, Michael Bamber, Tom Harrison, Charlene Henderson, Sue Ravenscroft (associate editor), David E. Stout (editor), and two anonymous reviewers. 382 Issues in Accounting Education 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 AM2 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 Bamber and Hughes 383 EXHIBITA Buckeye National Bank Consolidated Income Statement For the three years ending December 31, 20x5 20x5 ($000) $3,486 484 20x4 ($000) $3,417 475 20x3 ($000) $3,349 465 3,002 1,207 2,942 1,199 2,884 1,190 Net interest income Provision for credit losses Net interest income after provision for credit losses Noninterest income Income prior to noninterest expenses and income tax Noninterest expenses Income before income taxes Income tax expense Net income 4,209 3,805 404 130 $ 274 4,141 3,539 602 194 $ 408 4,074 3,362 712 230 $ 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 telier services, and responding to customer account inquires. 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 384 Issues in Accounting Education 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 (hereafter, all numbers are in thousands) as shown in Exhibit B. 1 An activity's cost pool is simply a grouping, or 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 (Nopinterest Expense) Costs Activity Cost Pools Activity Cost Pool to which Indirect Cost is Assigned Estimated Annual Total Costs (in $1,000s) Paying checks $ 700 Paying checks Providing teller services 440 1,000 Indirect Cost Salaries of check-processing personnel Depreciation of equipment and facilities used in check processing Teller salaries Depreciation of equipment and facilities used in teller operations Salaries of customer representatives at call center Toll-free phone lines plus depreciation of equipment and facilities in customer call cent Providing teller services 200 Responding to customer account inquiries 450 Responding to customer account inquiries 60 Total indirect costs $2,850 These indirect costs are part of the $3,805 *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.) Bamber and Hughes 385 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.3 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