Activity Activity Cost Activity Driver Activity Capacity S 100,000 1,000,000 Providing ATM service Computer processing Issuing statements Customer inquiries No. of transactions 200,000 No. of transactions 2,500,000 800,000 360,000 No. of statements 500,000 600,000 Telephone minutes The following annual information on the three products was also made available: Checking Accounts Personal Loans Gold VISA Units of product ATM transactions Computer transactions 30,000 180,000 2,000,000 5,000 10,000 20,000 300,000 200,000 Number of statements 300,000 50,000 90,000 150,000 160,000 Telephone minutes 350,000
Activity-Based Costing: Service Firm Glencoe First National Bank operated for years under the assumption that profitability can be
increased by increasing dollar volumes. Historically, First National’s efforts were directed toward increasing total dollars of sales and total dollars of account balances. In recent years, however,
First National’s profits have been eroding. Increased competition, particularly from savings and loan institutions, was the cause of the difficulties. As key managers discussed the bank’s problems, it became apparent that they had no idea what their products were costing. Upon reflection, they realized that they had often made decisions to offer a new product which promised to increase dol-
lar balances without any consideration of what it cost to provide the service. After some discussion, the bank decided to hire a consultant to compute the costs of three products: checking accounts, personal loans, and the gold VISA. The consultant identified the following activities, costs, and activity drivers (annual data):
In light of the new cost information, Larry Roberts, the bank president, wanted to know whether
a decision made two years ago to modify the bank’s checking account product was sound. At that
time, the service charge was eliminated on accounts with an average annual balance greater than
$1,000. Based on increases in the total dollars in checking, Larry was pleased with the new prod-
uct. The checking account product is described as follows: (1) checking account balances greater
than $500 earn interest of 2 percent per year, and (2) a service charge of $5 per month is charged
for balances less than $1,000. The bank earns 4 percent on checking account deposits. Fifty per-
cent of the accounts are less than $500 and have an average balance of $400 per account. Ten per-
cent of the accounts are between $500 and $1,000 and average $750 per account. Twenty-five
percent of the accounts are between $1,000 and $2,767; the average balance is $2,000. The remain-
ing accounts carry a balance greater than $2,767. The average balance for these accounts is
$5,000. Research indicates that the $2,000 category was by far the greatest contributor to the
increase in dollar volume when the checking account product was modified two years ago.
Required:
1. Calculate rates for each activity.
2. Using the rates computed in Requirement 1, calculate the cost of each product.
3. Evaluate the checking account product. Are all accounts profitable? Compute the average
annual profitability per account for the four categories of accounts described in the problem.
What recommendations would you make to increase the profitability of the checking
account product? (Break-even analysis for the unprofitable categories may be helpful.)
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