Compute the profit (loss) per customer for the retail customer and business customer first using original cost system then using the ABC System. For this purpose, use the cost data in Exhibit B. Show all your calculations in good form.

2. Based on the case, do you think the original cost system is "broken"? And if your answer is yes, explain why.

3. How can ABC data be used to develop marketing strategies that increase profits? How can the branch manager use ABC data to identify opportunities to trim cost while maintaining or increasing customer satisfaction?

4. Do you think bank's incentive bonus plan to increase the number of customers is wise? Explain your reasoning. What changes in the existing incentive plan, if any, would you recommend? Justify your answe

2 The ABC Bank CEO, Rob Garrison, believes that this staffing arrangement allows the The ABC Bank began operations in the mid-1980s. The bank bank to provide speedy customer service, while operating at practical quickly grew by providing checking account services to many small capacity. (That is, the bank's staff is fully utilized in efficient operations, businesses. Although ABC initially offered checking account after allowing for bank holidays and other scheduled staff activities such services for individual accounts (retail customers), the bank as training.) primarily focused on serving its business customers. During the To counter falling profits, ABC's directors took two actions last economic slowdown of the carly 1990s that weakened the local year, both aimed at increasing the bank's retail customer base. First, economy, growth in business customer accounts began to decline. ABC established a service call center to respond to customer inquiries In response, ABC's senior management adopted a new strategy, about account balances, checks cleared, fees charged, and other focusing on increasing the number of retail customer accounts. By banking concerns. Second, ABC's directors authorized year-end aggressively marketing individual retail accounts, the ABC Bank bonuses to branch managers who met their branch's target increase continued to grow. Today, the ABC Bank strives to maintain a in the number of customers. However, even though 80 percent of stable base of business customers, while actively competing for an the branch managers met the targeted increase in customer accounts, increased market share of retail customers. the Bank's profits continued to decline. CEO Rob Garrison does not Recent income statements (Exhibit A) reveal a decline in the understand why profits are declining, given that the Bank is serving bank's profits. The bank's primary (noninterest) expense consists of more customers. ABC's southeast regional manager, Erik Larsen, salaries and employee benefits. Most full-time employees' first priority is has also noticed that while small retail customers flock to the bank, providing services to customers; these employees conduct their the number of business customers is barely stable. administrative responsibilities during slack times. The Bank schedules Erik Larsen suspects that ABC's costing system may be part additional part-time employees to work during peak demand times, from of the problem. ABC developed its simple costing system when the 1 1AM- 2PM and Friday afternoons. Flexibility in scheduling part-time bank began operations in 1985. The bank does not trace any costs employees means that the bank's staff is lean and fully utilized. ABC's directly to individual customers. It simply treats all (noninterest Reproduced with permission of the copyright owner. Further reproduction prohibited without Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. permission.expense) operating costs identified in the Income Statement in of the three bank branches, a bank teller, and a representative from the Exhibit A as indirect with respect to the customer line. The bank customer service call center. The team began by identifying the activities allocates these indirect costs to either the retail customer line or ABC Bank performed. To start a simple pilot study, the team identified the business customer line, based on the total dollar value of checks the three most important activities: processed (which is readily available because each branch must 1. Paying checks provide the dollar values of daily transactions for internal control). 2. Providing teller services For the current period, ABC processed a total of $95 million in 3. Responding to customer account inquiries at the customer service call checks, of which $9.5 million was written by retail customers, and center $85.5 million was written by business customers. This costing If this pilot study turned out to be successful, then the team approach was fairly typical of banks and other financial institutions planned to refine the system by conducting a more detailed at the time ABC developed its cost system. activity analysis the following year. In college, Erik learned about an alternative costing approach The ABC team began by determining the costs that are associated called activity-based costing (ABC). However, the examples he with each of the three activities. The team quickly discovered that, as remembered involved manufacturing firms. He wondered whether ABC is typical in service industries like banking, labor (personnel) costs could develop an ABC system, with the business account customer line dominate. The ABC team asked each employee to fill out a short and the retail account customer line as the two primary cost objects. questionnaire to find out how the employee spends his or her time. Erik approached Rob Garrison with this suggestion. Rob was skeptical, The team then followed up with an in-depth personal interview with exclaiming, "Our profits are going down the tubes and you want me to each employee. The ABC team used this combined information to spend money developing a new accounting system?" However, Erik estimate the percentage of time each employee spent on each of the persisted, and Rob eventually authorized a pilot ABC study using three activities: (1) paying checks, (2) providing teller services, and (3) three local branches of the bank. responding to customer account inquiries. The ABC implementation team included Erik, the managers of each The team then estimated the other (non-labor) resources that5 each of the three activities consumed. For example, they traced to the cost pool (hereafter, all numbers are in thousands) as shown in "responding to customer account inquiry" activity: (1) the cost of Exhibit B. toll-free telephone lines at the customer service call center, and (2) The team identified the following cost drivers for each depreciation on other equipment and facilities the call center activity cost pool: personnel use. Similarly, the ABC team estimated the percentage of time the bank's information system was used for check processing and Activity Cost Pool Activity Cost Driver providing teller services (vs. other uses such as compiling periodic Paying checks Number of checks Providing teller services Number of teller transactions financial statements), to determine how much of the equipment's Responding to customer account Number of account inquiry calls inquiries to customer service call center depreciation to assign to the activities "paying checks" and "providing teller services." The ABC team estimated that for the three pilot-test To complete the pilot study in a timely fashion, the ABC bank branches, the retail and business customer lines team based their estimated activity costs on last year's actual data, experienced the annual activity levels (in thousands) as shown which were already available. If the pilot study succeeded, then the in Exhibit C. For example, Exhibit C reveals that retail customers had ABC team planned to develop budgeted indirect cost rates for each 160,000 teller transactions and made 95,000 account inquiry calls to activity the following year. The advantage of budgeted rates over actual the customer service call center. rates based on the prior year's data is that budgeted rates (budgeted ABC Bank currently services 150,000 retail customer checking cost associated with the activity divided by the budgeted quantity of accounts and 50,000 business customer checking accounts. The bank the activity's cost driver) can incorporate expected changes in costs carns net interest revenue on the balances that customers keep in their and operations. An activity's cost pool is simply a grouping, or aggregation, of all the individual costs associated with that activity. The bank's ABC team created separate activity cost pools for After examining the three branch banks' indirect costs (that is, the costs associated with each of the three activities: (1) paying checks, (2) providing teller services, and (3) responding to customer account inquiries. the cost items making up the branch banks' noninterest operating A cost driver is a factor, such as the number of checks processed, that causally affects posts. 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 falls. expenses), the ABC team classified the annual costs in each activity'schecking accounts." On average, the bank earns the following annual Required: Answer the following questions. revenue from each type of account: Avg. annual revenue per retail customer account $10 1. Compute the profit (loss) per customer for the retail customer and business customer first using original cost system then using the ABC System. Avg. annual revenue per business customer $40 For this purpose, use the cost data in Exhibit B. Show all your calculations in account good form. 2. Based on the case, do you think the original cost system is "broken"? And if your answer is yes, explain why. 3. How can ABC data be used to develop marketing strategies that increase profits? How can the branch manager use ABC data to identify opportunities to trim cost while maintaining or increasing customer satisfaction? 4. Do you think bank's incentive bonus plan to increase the number of customers is wise? Explain your reasoning. What changes in the existing incentive plan, if any, would you recommend? Justify your answer.10 EXHIBIT A Consolidated Income Statement EXHIBIT B For the three years ending December 31, 20x5 Assignment of Indirect (Noninterest Expense) Costs to Activity Cost Pools" 20x5 20x4 20x3 Estimated Annual (8000) (8000) (3000) Activity Cost Pool to which Total Costs Net interest income' $3,486 $3,417 $3.349 Indirect Cost Indirect Cost is Assigned (in $1,000s) Provision for credit losses 484 475 165 Salaries of check-processing Net interest income after personnel Paying checks $ 700 provision for credit losses 3,002 2,942 2,884 Depreciation of equipment Noninterest income 1,207 1.199 1,190 and facilities used in Income prior to noninterest check processing Paying checks 440 expenses and income tax 4.209 4,141 4,074 3.805 3.539 3,362 Teller salaries Providing teller services 1,000 Noninterest expenses Income before income taxes 404 602 712 Depreciation of equipment Income tax expense 130 194 230 and facilities used in teller operations Providing teller services 200 Net income 27 $ 406 482 Salaries of customer " Net interest income equals interest income less interest expense. The bank's primary income is from representatives at call Responding to customer account interest bearing checking accounts. Noninterest income includes fors charged for various services, such center inquiries 450 as checking account fees charged if the account balance falls below the required minimum level. Nominterest expenses are all of the bank's operating costs, including those associated with paying checks, providing Toll-free phone lines plus teller services, and responding to customer account inquires. 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 $3,906 "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.)