Question

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):

Cost	Activity Cost Pool to Which Cost is Assigned	Estimated Total Costs for Tacoma Branches
Salaries of check processing personnel	Check payments	$    440
Depreciation on check processing equipment	Check payments	700
Teller salaries	Teller withdrawals and deposits	1,200
Salaries of customer representatives at call center	Customer service call center	450
Toll-free phone lines at customer call center	Customer service call center	60
Total indirect costs		$2,850

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):

Activity Cost Driver	# of Units of Activity Cost Driver Used by Retail Customers	# of Units of Activity Cost Driver Used by Business Customers	Total
Checks processed	1,140	4,560	5,700
Teller transactions	320	80	400
Customer calls to call center	95	5	100
Checking accounts	150	50	200

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

Questions:

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:

Activity	Total Indirect Cost Assigned to Retail Customer Line	Total Indirect Cost Assigned to Business Customer Line
Check payments
Teller withdrawals and deposits
Customer call center
Total indirect costs

                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?

Answer 1

1.
a.
Total indrect costs for Tachoma brances					2,850,000.00
Total number of cheques processed					5,700,000.00
Cost per cheque = Total indirect cost / Total cheques processed
= $ 2850000/5700000
= $ 0.50
b.			Activity Base	Rate	Cost Allocated
Retail customer			1,140,000.00	0.50	570,000.00
Business customer			4,560,000.00	0.50	2,280,000.00
c.			Cost Allocated	Total Cost	Proportion
Retail customer			570,000.00	2,850,000.00	20%
Business customer			2,280,000.00	2,850,000.00	80%
d.			Cost Allocated	No.of accounts	Cost per A/c
Retail customer			570,000.00	150,000.00	3.80
Business customer			2,280,000.00	50,000.00	45.60
e.
			Revenue	Cost	Profit/(Loss)
Retail customer			10.00	3.80	6.20
Business customer			40.00	45.60	(5.60)
f.
The traditional costing analysis shows that the Tachoma is earning profits on retail customer accounts and incurring loss
on business customer account.Hence,
(i) profitability would increase by adding retail customer
(ii) profitability would decrease by adding business customer
Based on the traditional costing system it would be advisable to add retail customers and reduce the business customers
if the company wants to increase its profitability
2.Since,the results as per traditional costing system show that the business customer line is incurring loss,it means
that the costing system used by the Bank is not giving the desired results and needs to be mosified
3.
a.
Activity		Activity Cost Driver	Total	Cost	Indirect Cost Rates
Salaries of check processing team		Check Payments	5700000	440000	0.08
Depreciation		Check Payments	5700000	700000	0.12
Teller Salaries		Teller withdrawal and deposits	400000	1200000	3.00
Salaries of customer call center		Customer call center	100000	450000	4.50
Toll free phone lines		Customer call center	100000	60000	0.60
b.
Activity		Activity Cost Driver	Indirect Cost Rates	Units of Activity Cost Drivers Retail Customers	Units of Activity Cost Drivers Business Customers	Total Indirect Cost Assigned to Retail Customer Line	Total Indirect Cost Assigned to Business Customer Line
Salaries of check processing team		Check Payments	0.08	1140000	4560000	88,000.00	352,000.00
Depreciation		Check Payments	0.12	1140000	4560000	140,000.00	560,000.00
Teller Salaries		Teller withdrawal and deposits	3.00	320000	80000	960,000.00	240,000.00
Salaries of customer call center		Customer call center	4.50	95000	5000	427,500.00	22,500.00
Toll free phone lines		Customer call center	0.60	95000	5000	57,000.00	3,000.00
						1,672,500.00	1,177,500.00
Activity				Total Indirect Cost Assigned to Retail Customer Line	Total Indirect Cost Assigned to Business Customer Line
Check Payment				228,000.00	912,000.00
Teller withdrawal and deposits				960,000.00	240,000.00
Customer call center				484,500.00	25,500.00
Total				1,672,500.00	1,177,500.00
c.
Activity				Total Indirect Cost Assigned to Retail Customer Line	Total Indirect Cost Assigned to Business Customer Line	Proportion used by Retail Customer Line	Proportion used by Business Customer Line
Check Payment				228,000.00	912,000.00	20%	80%
Teller withdrawal and deposits				960,000.00	240,000.00	80%	20%
Customer call center				484,500.00	25,500.00	95%	5%
Total				1,672,500.00	1,177,500.00	59%	41%
d.
Total Indirect Cost Assigned				1,672,500.00	1,177,500.00
Total number of customers				150,000.00	50,000.00
Cost per customer account				11.15	23.55
The indirect cost per customer computed in ABC system is different from the costs computed in traditional costing as
in traditional costing system all indirect costs were pooled together and rates were applied based on the total volume.
In ABC system each distinct activity was a different cost pool and the rates were applied on the basis of the activity.
e.
Revenue per customer account				10.00	40.00
Cost per customer account				11.15	23.55
Profit/(Loss) per customer account				(1.15)	16.45
f.
Since, the profit is being earned through business customers account,the strategy to increase profitabilty should focus
on increasing the number of business customers accounts.
The branch - managers bonus plan should be modified so that bonus is paid when the branch achieves the target for
increasing the number of business custimer accounts only and not the total number of accounts.
4.
a.
Salaries of customer representatives at call center				450,000.00
Toll free phone lines at call center				60,000.00
Total costs at call center				510,000.00
Number of customer calls to call center				100,000.00
Cost per customer call				5.10
Assuming all call ceter costs are variable
Calls reduced by printing brochures				1000
Cost of calls reduced ( 1000 * 5.10)				5100
Cost of printing brochure				3000
Since,cost saved on call center is higher than the cost of printing the brochure,Belltown should print and distribute the
brochure.
b.
Although it appears that the company would save $ 510,000 by closing the call center as it is not involved in aby direct
function,it is not advisable to close it.
As shown in the data, 100,000 customers use this service and if it is discontinued,they would use the services of the
employees involved in direct functions and hence the workload would increase and the company would have to deploy
additional personnel there thereby increasing the costs there which would offset the savings generated by the closure.
c. As stated above, the suggestion is not advisable as it would reduce the teller's efficiency as they would be doing
additional work.This can result in the company to deploy more tellers without any increase in the number of transactions
which would increase the total costs per transaction.
d. Current revenues as shown only show the income from interest earned on checking account balances.The company
does not have a pricing policy at present.This is the reason for the loss incurred o retail customer line.
The Belltown Bank should design a pricing policy in such a way that the customer pays only for the services utilized by
the customer. The cost of each activity has been derived by the ABC method and Bank should design a pricing policy
so that customer pays for the facility used by him.