To increase its share of the checking account market, Belltown National Bank in Seattle took two actions: (1)
established a customer call center to respond to customer inquiries about account balances, checks cleared, fees charged, etc., and (2) paid year-end bonuses to branch managers who met their branch's target increase in the number of customers. While 80% of the branch managers met the target increase in the number of customers, Belltown National's profits continued to decline. Roger Welton, the CEO, didn't understand why profits were declining, even though the bank was serving more customers. The Pierce County branch manager, Rose Martinez, noticed that while small retail customers flocked to the bank, the number of business customers was declining.
Belltown National's existing costing system, developed back in 1990, is straightforward. No costs are traced directly to customers. The bank assigns the total indirect costs to customer lines (retail customer line or business customer line) by dividing the total indirect costs by the total number of checks processed to compute a cost per check processed. The cost by customer line is then the number of checks processed for the customer line multiplied by the cost per check.
Martinez suspected that Belltown National's cost system might be part of the problem. Martinez learned about activity-based costing (ABC) in school, but the applications she studied involved manufacturing firms. She wonders whether Belltown National could develop an ABC system, with the customer-line as the primary cost object.
Rose's boss was skeptical. ("Our profits are going down the tubes and you want me to spend money developing a new accounting system???") However, Rose persuaded her boss to allow a pilot ABC study, using the three Tacoma branches for the pilot test.
The ABC implementation team included Martinez, the managers of each of the three Tacoma branches, a bank teller, and a customer service representative from the customer call center. The team began by identifying the following three activities:
● Check payments
● Teller withdrawals and deposits
● Customer service call center
The ABC team then scrutinized the Tacoma branches' total indirect cost of $2,850,000. They classified the components of this total indirect cost into the appropriate activity pool, coming up with the following estimates (in thousands of dollars):
The team then identified the following cost drivers for each activity cost pool:
Activity Cost Pool Activity Cost Driver
Check payments # checks processed
Teller withdrawals and deposits # teller transactions
Customer service call center # calls
The ABC team estimated that for the Tacoma branches, the retail customer line and the business customer line would require the following total resources (in thousands):
That is, the retail customers have 320,000 teller transactions, make 95,000 calls to the customer service center, etc.
On average, Belltown National Bank earns revenue from each type of account (from interest earned on checking account balances) as follows:
Average annual revenue per retail customer account $10
Average annual revenue per business customer account $40
1. Using the original (traditional) cost system:
a) Compute the indirect cost allocation rate per check processed.
b) Determine the total indirect cost assigned to (1) the retail customer line and (2) the business customer line.
c) Compute the proportion of the total indirect cost assigned to (1) the retail customer line and (2) the business customer line.
d) Determine (1) the indirect cost per retail account and (2) the indirect cost per business account.
e) Assuming that there are only indirect costs and no direct costs, compute the average profit per account for retail customers and for business customers.
f) Using only the cost and profitability information from the traditional costing system, how would you expect profitability to change as you add i) retail customers, or ii) business customers? What business strategy (or strategies) would you suggest based on this traditional system?
2. Are there any signs that Belltown National's original cost system is broken or in need of refinement?
3. Using the new activity-based costing (ABC) system,
a) compute the indirect cost allocation rates for each of the three activities:
● Check payments
● Teller withdrawals and deposits
● Customer call center
b) Use the schedule below to compute the total indirect cost allocated to each customer line:
c) What proportion of each activity's resources are used by (1) the retail customer line and (2) the business customer line?
d) Using the ABC data, compute the indirect cost per retail customer account and the indirect cost per business customer account.
Explain specifically why the results in part 1d and part 3d differ in the direction they do.
e) Using the new ABC data, compute the average profit per account for both retail and business customers.
f) Using the cost and profitability information from the ABC system, what business strategy would you suggest? Would you modify the branch-manager bonus plan and, if so, how?
4. Use the ABC information you generated above to make the following decisions:
a) Belltown is considering distribution of a brochure that explains bank policy on withdrawal of recently deposited amounts, which is the topic of about 2% of calls to the call center (or 2,000 calls). Belltown estimates that once the brochure is distributed, about half these calls will be eliminated because customers will refer to the brochure. Thus, the brochure is expected to eliminate about 1,000 calls to the call center. The brochure will cost $3,000 per year to print and distribute. Should Belltown print the brochure?
b) Belltown is considering closing the call center. How much cost savings would you expect from closing the call center? Are there any opportunity costs associated with closing the call center? Any other factors you would consider in this decision?
c) Because the ABC cost per call is substantially higher than the cost per teller transaction, should Belltown design systems and policies that encourage customers to visit tellers instead of calling the call center?
d) What do the results of the ABC analysis suggest about pricing policies? What price does Belltown currently charge customers for check processing? For teller transactions? For calls to the call center? What pricing suggestions would you make to the management of Belltown Bank?
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