Activity-based costing (“ABC”) is widely recognized as a
superior method for allocating overhead costs. Much emphasis has
been placed on the implementation of ABC in the manufacturing
industry. However, the service industry benefi ts from this system
of cost allocation as well, due to the fact that service fi rms
usually have high overhead costs and are labor intensive. These
characteristics make ABC a logical choice for cost allocation. ABC
will help services companies identify and allocate overhead costs
and quantify labor costs associated with each activity. For
commercial banks, in particular, the potential benefi ts of ABC
implementation can be numerous. These include the proper costing of
transactions, the ability to trace specifi c costs to bank
customers and the ability to measure customer and product profi
tability. The end result of these benefi ts is the ability to
improve decision-making and help organizations meet their strategic
objectives
Benefits of ABC Implementation in Banks
A financial services company, considering an ABC system
implementation should carefully assess the following points, which
are identified by many ABC experts in determining the
appropriateness of ABC for a particular organization:
- Significant indirect costs
- Complex goods and services
- Losses on high-volume products and profits on low-volume
products
- Disagreement by managers over cost allocations
- Bid results
- Age of costing system
In the case of the bank, more than half of the bank’s expenses
were incurred by support and administrative functions and
classified as indirect costs. These functions were broken into
three major groups:
- information technology (IT—providing hardware and software
support and application development services);
- service company (providing general support services such as
check processing, wire transfer processing and ATM servicing);
- and the corporate center (providing services such as fi nance,
human resources and legal).
Another consideration in implementing an ABC system
- Compare Product Performance
- Determine Accountability Assess Competitiveness
- Recover Cost of Internal Services Provided
- Evaluate Organizational Performance Estimate and Track Costs
Assess the cost difference between item processing in different
locations Compare product profitability of wholesale lockbox vs.
retail lockbox Evaluate where competitive cost advantages may be
Identify who used services and how much they were charged Identify
the driver of certain costs
- Estimate the resources by Resource Center to meet the projected
demand of ACH transactions
Example od ABc based costing
Challenges in ABC Costing faced in a Bank
Difficulty in implementing ABC systems is often encountered when
departments within the company disagree with the costs allocated to
their cost centers.
- The biggest challenge to implementing ABC at the bank was
generating suffi cient buy-in from operational managers. The major
concern expressed by bank managers was whether the benefits of the
new costing system would justify the time and resources dedicated
to implementing the system. A few managers expressed concern that
the new cost accounting system was merely going to reshuffle the
bank’s costs and that, unless hard actions were taken to remove
costs from the bank, the project would serve no useful
purpose.
- Another concern encountered was that the project was initially
viewed as another program in a long line of special initiatives and
cost-savings programs that resulted in uncertain benefi ts. The
bank had recently completed a major restructuring initiative. While
this initiative redefi ned the support areas of the organization
and resulted in workforce reductions, it was uncertain whether this
program actually resulted in cost savings.
- During the cost center interview process, another concern
encountered was duplication of effort in collecting information.
Duplication of effort was most evident when project analysts asked
operating managers for cost accounting information that was
collected recently as part of prior cost collection activities. In
addition, duplication of effort was evident between the project and
the recently completed organizational restructuring. If the
steering committee had known earlier that much of the same
information was collected as part of the restructuring, time could
have been saved and aggravation avoided.
- A further concern was the occasional lack of creativity on the
part of the center managers. Managers were often inclined to
estimates instead of taking time to identify an appropriate cost
driver to charge dollars based on actual usage. Further, when a
suitable cost driver was defined, it was often difficult to collect
the driver information necessary to support the cost driver. If it
became evident that the driver information was not available, a new
driver would be selected or possibly a new activity or set of
activities would be used as a replacement. To support the entry and
coordination of cost-driver information into the system, three
analysts focused their attention on data management, with no cost
center interview responsibilities.
- After all the cost center allocations were created and entered
into the systems, the mostdiffi cult part of the project was
gaining approval for the cost information produced by the new
allocations. From a service provider standpoint, many managers were
dissatisfi ed with the result of the allocations and requested that
the cost center interview process for their respective center
beperformed again. While it was diffi cult to gain approval for
cost center allocations from the service providers, it proved even
more diffi cult to get approval for the allocations from the client
center managers. This challenge was especially evident for centers
whose assigned costs from a support center increased as a result of
the change in cost allocation methodology. After gaining approval
from the operating managers with specific product profi tability
responsibilities, the approval process then required approval from
the project steering committee and executive-level management.