TheABC Bank

The ABC Bank began operations in the mid-1980s. The bank quickly grew by providing checking account services to many small businesses. Although ABC initially offered checking account services for individual accounts (retail customers), 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, ABC's senior management adopted a new strategy, focusing on increasing the number of retail customer accounts. By aggressively marketing individual retail accounts, ABC continued to grow. Today, the ABC Bank strives to maintain astable base of business customers, while actively competing for an increased market share of retail customers.

Recentincomestatements(ExhibitA)revealadeclineinthebank'sprofits. Thebank'sprimary(noninterest)expenseconsistsofsalariesandemployeebenefits.Mostfull timeemployees'firstpriorityisprovidingservicestocustomers;theseemployeesconducttheiradministrativeresponsibilitiesduringslack times.TheBankschedules additionalpart timeemployeestoworkduringpeakdemand times, from11AM- 2PMandFridayafternoons.Flexibilityinschedulingpart timeemployeesmeansthatthebank'sstaffisleanandfullyutilized.ABC'sCEO,RobGarrison,believesthatthisstaffingarrangementallowsthebanktoprovidespeedycustomerservice,whileoperatingatpracticalcapacity.(Thatis,thebank's staffisfullyutilizedinefficientoperations,afterallowingforbankholidaysandotherscheduledstaffactivitiessuchastraining.)

Tocounterfallingprofits,ABC'sdirectorstooktwoactionslastyear,bothaimedatincreasingthebank'sretailcustomerbase.First,ABCestablishedaservicecallcentertorespondtocustomerinquiriesaboutaccountbalances,checkscleared,feescharged,andotherbankingconcerns.Second,ABC'sdirectors authorizedyear-endbonusestobranchmanagerswhomettheirbranch'stargetincreaseinthenumberofcustomers.However,eventhough80percentofthebranchmanagersmetthetargetedincreaseincustomeraccounts,theBank'sprofitscontinuedtodecline.CEORobGarrisondoesnotunderstandwhyprofitsaredeclining,giventhattheBankisservingmorecustomers.ABC'ssoutheastregionalmanager,ErikLarsen,hasalsonoticedthatwhilesmallretailcustomersflocktothebank,thenumberof businesscustomersisbarelystable.

ErikLarsensuspectsthatABC'scostingsystemmaybepartoftheproblem.ABCdevelopeditssimplecostingsystemwhenthebankbeganoperationsin1985.Thebankdoesnottraceanycostsdirectlyto individualcustomers. It simplytreatsall(noninterestexpense) operatingcosts,except $955,000 of other operating expenses such as CEO salary,identifiedintheIncomeStatementinExhibitAasindirectwithrespecttothecustomerline.Thebankallocatestheseindirectcoststoeithertheretailcustomerlineorthebusiness customerline,basedonthetotaldollarvalueofchecksprocessed(whichisreadilyavailablebecauseeachbranchmustprovidethedollarvaluesofdailytransactionsforinternalcontrol).Forthecurrentperiod,ABCprocessedatotalof $95millionin checks,of which$9.5millionwaswrittenbyretailcustomers,and $85.5millionwaswrittenbybusinesscustomers.ThiscostingapproachwasfairlytypicalofbanksandotherfinancialinstitutionsatthetimeABCdeveloped itscostsystem.

Incollege,Eriklearnedaboutanalternativecostingapproachcalledactivitybased costing(ABC).However, theexamplesherememberedinvolvedmanufacturingfirms.HewonderedwhetherABCcoulddevelopanABCsystem,withthebusinessaccountcustomerlineandtheretailaccountcustomerlineasthetwoprimarycostobjects.ErikapproachedRobGarrisonwiththissuggestion.Robwasskeptical,exclaiming,"Ourprofitsaregoingdown thetubesandyouwantmetospendmoneydevelopinganewaccountingsystem?"However,Erikpersisted,andRobeventuallyauthorizedapilotABCstudyusingthreelocal branchesofthebank.

TheABCimplementationteamincludedErik,themanagersofeachofthethree bankbranches, a bankteller,andarepresentativefromthecustomerservicecall center.TheteambeganbyidentifyingtheactivitiesABC Bankperformed.Tostartasimplepilotstudy,theteamidentifiedthethreemostimportant activities:

1.Payingchecks

2.Providingtellerservices

3.Respondingtocustomeraccountinquiriesatthecustomerservicecallcenter

Ifthispilotstudyturnedouttobesuccessful,thenthe teamplannedtorefinethesystembyconductingamoredetailedactivityanalysisthefollowingyear.

TheABCteambeganbydeterminingthecoststhatareassociatedwitheachof thethreeactivities.Theteamquicklydiscoveredthat,asistypicalinserviceindustrieslikebanking,labor(personnel)costsdominate.TheABCteamaskedeachemployeetofilloutashortquestionnairetofindouthowtheemployeespendshisor hertime.Theteamthenfollowedupwithanin-depthpersonal interviewwitheachemployee.TheABCteamusedthiscombinedinformationtoestimatethepercentageoftimeeachemployeespentoneachofthethreeactivities:(1)payingchecks,(2)providingtellerservices,and(3)respondingtocustomeraccountinquiries.

Theteamthenestimatedtheother(non-labor)resourcesthateachofthethreeactivitiesconsumed.Forexample,theytracedtothe"respondingtocustomeraccountinquiry"activity:(1)thecostoftoll-freetelephonelinesatthecustomerservicecallcenter,and(2) depreciationonotherequipmentandfacilitiesthecallcenterpersonneluse.Similarly,theABCteamestimatedthepercentageoftimethebank'sinformationsystemwasusedforcheckprocessingandprovidingtellerservices(vs.otherusessuchascompilingperiodicfinancialstatements),todeterminehowmuchoftheequipment'sdepreciationtoassigntotheactivities"payingchecks"and "providingtellerservices."

Tocompletethepilotstudyinatimelyfashion,theABCteambasedtheirestimatedactivitycostsonlastyear'sactualdata,whichwerealreadyavailable.Ifthepilotstudysucceeded,thentheABCteamplannedtodevelopbudgetedindirectcostratesforeachactivitythefollowingyear.Theadvantageofbudgetedratesoveractualratesbasedontheprioryear'sdataisthatbudgetedrates(budgetedcostassociatedwiththeactivitydividedbythebudgetedquantityoftheactivity'scostdriver)canincorporateexpectedchangesin costsandoperations.

Afterexaminingthethreebranchbanks'indirectcosts (thatis,thecostitems makingupthebranchbanks'noninterestoperatingexpenses),theABC teamclassifiedtheannualcostsineachactivity'scostpool[1](hereafter,allnumbersareinthousands) asshowninExhibitB.

Theteamidentifiedthefollowingcostdrivers[2]foreachactivitycostpool:

ActivityCostPool

Activity Cost Driver

Payingchecks

Numberofchecks

Providingtellerservices

Numberoftellertransactions

Responding tocustomer accountinquiries

Numberofaccountinquirycallstocustomerservicecallcenter

TheABCteamestimatedthatforthethreepilot testbankbranches,the retailandbusinesscustomerlinesexperiencedtheannualactivitylevels(inthousands)asshowninExhibitC.Forexample,ExhibitCrevealsthatretailcustomershad160,000tellertransactionsandmade95,000 accountinquirycallstothe customerservicecallcenter.

ABC Bankcurrentlyservices150,000retailcustomerchecking accountsand50,000businesscustomercheckingaccounts.Thebankearnsnetinterestrevenueonthebalancesthatcustomerskeepintheircheckingaccounts.[3]Onaverage,thebankearnsthefollowingannualrevenue(both interest and non-interest)fromeachtypeofaccount:

Avg.annualrevenueperretailcustomeraccount$10

Avg.annualrevenueperbusinesscustomeraccount$40

Required:

1.Compute the profit (loss) per customer for the retail customer and business customer first using original cost system then using the ABC System. Use costs shown in Exhibit B for this purpose.

"IT 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 31,0008) 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 450 Toll-free phone lines plus depreciation of equipment and facilities in customer Responding to customer account call center inquiries 60 Total indirect costs $2,850 " These indirect costs are part of the $3,805 \"noninterest expenses\" in the bank's 2015 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.)