Question

Discuss how cost allocation or transfer pricing and activity-base cost applies to banking industry and financial institution. Once you have identified the subject of interest, your post should focus on an assessment of the situation. What do you believe are the key issues? If there are problems, what solutions do you see? If this is a post that illustrates a successful resolution of a challenge, how was this success achieved?

Answer 1

Transfer pricing in banking industry is used to measure profitbility of different services, several branches, their management and economic performance of different banking units. Through transfer pricing, net interest income is allocated in different organisational units of a bank. If one unit lacks funds to run business, other profitable unit provides supply funds. The rate of transfer funds between units of bank is determined by the transfer pricing mechanism.

Activity based costing considers a single service instead of looking entire department to evaluate the profitability of the institution. Banks provide different types of savings account, current account, various types of loans and insurance products. Different direct and indirect costs are measured in ach unit of a banking institutuon. Identification of overhead expenses so that certain costs cannot be allocated to several activities.

Disadvantage of activity-based-costing is that this method requires lots of information and thus this process is relatively costlier and complex.

Some serious problems and dillemas that banking sector faces in transfer pricing mechanism is

• wrong allocation of resources
• use of different methods for calculating margins, which cannot be compared between two different products or services
• incorrect measurement of overall interest rate risk of ant banking institution
• Inappropriate deternination regarding credit risk and interest rate.