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巴黎银行-2013-C5


Case 5 - Solution / expected answers
Note: For extreme precision, all intermediate computations have been carried out with exact values. Figures of intermediate results in this solution may be rounded for simplicity of notation only. Final results are the only ones to be rounded according to the rules of the game. Part 1: Question 1: The correct text is as follows: Suppose that A, B, and C are three bank customers. They require different activities from the bank: ? A uses exclusively internet banking; ? B visits the teller daily to make deposits, withdrawals; ? C deposits foreign currency as well as calls the branch frequently to ask for information about currency rates. Using actual allocation bases, the customer A will be overcosted and appear less profitable than he should. Customer B may be undercosted and appear More profitable than he should. Customer C may be undercosted and appear More profitable than he should. A common mistake in such cost accounting systems is that high-volume services produce losses and low-volume services produce significant profits. This was the case at the bank. The expenses that were required to support low-volume services were often not accurately assigned to these services but instead spread to high-volume services. These low-volume, unique services were generally provided to fulfill the requests of wealthy customers. To avoid these problems, the final report by the management control department concludes that the most appropriate method to meet BNP Paribas new needs is Activity-based costing, because it allows to better analyze the working processes and to determine which services are unprofitable and uncompetitive and which products are profitable and underdeveloped. Without this knowledge, the bank was not able to compete successfully against larger rivals in the retail banking sector.

Activity-based costing (“ABC”) is widely recognized as a better method for allocating overhead costs. For banks, in particular, the potential benefits of ABC implementation can be numerous. These include the proper costing of transactions, the ability to trace specific costs to bank customers and the ability to measure customer and product profitability. The end result of these benefits is the ability to improve decision-making and help organizations meet their strategic objectives. Explanations These answers simply rephrase the definitions stated in technical document 1. Here are some additional explanations: ? The current allocation bases divides up branch overheads to accounts based on account balances or equal amounts per account. A (who never makes any demands on the branch and deals with everything online) is thus overcosted and appears less profitable than (s)he should. B and C (who require personal contact with branch employees) may be undercosted and appear more profitable than they really are. ? The current costing system is not suitable for the bank. Low-volume services are allocated with a relatively small amount of costs (undercosted). On the contrary, highvolume services are overcosted. o Product undercosting: a product consumes a relatively high level of resources but is reported to have a relatively low total cost. o Product overcosting: a product consumes a relatively low level of resources but is reported to have a relatively high total cost. ? The products that are unprofitable are also uncompetitive compared to other products which earn profits; the profitable products may generate even more earnings to the bank, thus should be developed further to increase the margins and demand. ? Direct tracing requires that a cost is easily and accurately related to a cost object. The difference between allocation and tracing is that allocation is arbitrary whereas tracing is based on 'cause and effect' relations. Question 2: The four steps of ABC implementation are: 1- Identify and classify the activities related to the bank operations 2- Estimate the cost of activities 3- Calculate a cost-driver rate for each activity 4- Assign activity costs to products or customers Explanation:

1- Identify the activities which are at the groundings of the system. Activities should be grouped according to whether they are performed by unit, batch, product, customer, or for the organization as a whole. Different types of activities have to clearly be separated. 2- Assign total overhead costs to the identified activities (it is called a “first stage allocation”) 3- Determine the activity measure (allocation base) for each activity according to what is driving its costs. Determine also the number of units of the activity base which are expected to be used for each activity over the period. To determine the activity rate of each activity, divide the total cost of each activity by the total expected activity units to get an overall per unit rate for the activity. 4- Assign costs to Cost Objects (products or customers) using the Activity Rates and Actual Activity Units (units of activity that the cost object consumes) for a given Cost Object (called “Second Stage Allocation”).

Question 3: The correct answers are:
Unit level costs ? ? ? ? ? ? ? Open/close customer accounts Process visa transactions Accept checks Issue checkbooks Make money transfers Process loan applications Advice on investments and insurance ? ? Batch level costs Provide ATM service Market and sell products Product level costs ? Design a new product / service ? ? ? Facility level costs Train personnel Prepare management reports Prepare financial statements Customer level costs ? Handle customer queries

Explanation: ? ? ? ? Unit level costs are resources required for activities performed on each individual unit of product or service. Batch level costs are resources required for activities that are related to a group of units of product or service. Product level costs: are resources required for activities to support individual products or services. Facility level costs are resources required for activities that cannot be traced to individual products or services but support the organization as a whole.

?

Customer level costs are costs that are incurred for activities which are not related to any specific product or service.

Question 4: The correct answers are in the following table:
Activity Open/close customer accounts Provide ATM service Process visa transactions Handle customer queries Accept checks Issue checkbooks Market and sell products Make money transfers Train personnel Process loan applications Advice on investments and insurance Prepare management reports Prepare financial statements Design a new product / service Cost driver Number of accounts opened/closed Number of (ATM) transactions Amount of (visa) transactions Duration of telephone calls, mail answering Number of checks Number of checkbooks issued Number of products (sold) Number of transfer Revenue generated by each cost object Number of applications Duration of advice provided Revenue generated by each cost object Revenue generated by each cost object Number of (new) products /services

Explanation: This question is directly linked to the previous one. The choice of the driver depends on the previous classification.
?

?

?

stem from the very existence of the customer service, here, the duration of telephone calls, or mail answering is the appropriate driver e.g. The more time consuming customer queries are, the higher are the costs associated to the customer. The number of queries may be a misleading driver because some problems can be solved quickly and some take a long time. Batch level drivers are triggered for every batch produced.

Unit level drivers are triggered for every unit service. 2 special cases are to be considered : o Provide visa transactions ? the appropriate cost driver is the amount and not the number of transactions: the fees in this kind of transactions are based on the amount of the transaction. o Advice on investments and insurance ? the cost driver is the duration and not the number of advice as the time spent on providing advice may differ significantly per customer. Customer level drivers are triggered for each customer service incident. These drivers

? ?

Product level drivers are triggered for every product regardless of the number of units and batches produced. These drivers occur by the sole existence of a product. Facility level drivers are drivers that are not related to the products at all. Costs that are traced by such drivers will therefore be allocated to products and not traced. As stated in instructions, the revenue generated by each cost object is the used driver for all facility level costs.

Part 2: Question 1:
Correct answers are in the tables below:

Using traditional system
Cost of Current accounts Cost of Personal loans Indirect costs Number of units Cost per unit Unit selling price (average) Unit profit 72 318.012 4 253 17.004 120 102.996 239 543.85 3 450 69.433 490 420.567 Cost of Visa card 135 493.54 9 562 14.170 100 85.83

Explanations:
As the traditional allocation bases of the bank assigns branch overheads to products based on the revenues generated by each product:

?

The indirect costs for a product = Total resources used by the bank/ Revenue generated

? ?

by all bank products*Revenue generated by the concerned product o Indirect costs for Current accounts is thus (11 336 000 / 80 000 000 * 510360) = 72 318.012 o For Personal loans (11 336 000 / 80 000 000 * 1 690 500) = 239 543.85 o For Visa card (11 336 000 / 80 000 000 * 956 200) = 135 493.54 Cost per unit = Indirect costs / Number of units Unit profit = Unit selling price – Cost per unit

Using ABC system
Activity Open/close customer accounts Provide ATM service Process visa transactions Cost of Current accounts Cost of Personal loans 140 000 93 600 125 000 10 000 0 100 000 Cost of Visa card 0 43 200 550 000

Handle customer queries Accept checks Issue checkbooks Market and sell products Make money market transfers Process loan applications Advice on investments and insurance Design a new product / service Facility costs: Prepare management reports Train personnel Prepare financial statements Total cost Number of units Cost per unit Unit selling price (average) Unit profit

1 736 500 183 750 82 000 22 953.125 26 800 0 51 200 73 666.66667

120 750 750 0 37 070.3125 0 690 000 768 000 294 666.6667

100 050 0 0 41 335.9375 0 0 1 139.2 147 333.3333

8 293.35

27 470.625

15 538.25

2 543 763.142 4 253 598.110 120 -478.110

2 048 707.604 3 450 593.828 490 -103.828

898 596.7208 9 562 93.976 100 6.024

Explanations: ? Cost of the activity X for each product = Total resources used by the activity X for the bank / Total number of drivers X for all the bank products * Number of drivers X related to the product) o The cost of the activity “Open/close customer accounts” for Current accounts is thus 300 000 / 3 000 * 1 400 = 140 000 o Etc. for each activity and each product Total cost is the sum of all activity costs for the given product Cost per unit = Total cost / number of units sold Unit profit = Unit selling price – Cost per unit

? ? ?

Question 2: The correct text is as follows:

The three products, previously thought to be strong profit contributors, turned out to be unprofitable. Naturally, the results caused a change in the strategic thinking about product promotion, product deletion and even some process improvements. The next logical step in the ABC analysis was then taken: segmenting the customer base and determining the profits earned by each customer segment with each product or natural grouping of products. This study revealed that up to half of all current accounts, particularly those with low balances, were unprofitable. The marketing team now has to redirect its resources to attract more customers whose behavior would be profitable for the bank and to deepen relationships even further with already profitable customers. In summary, the bank’s ABC model stimulated a full range of activity based management actions, once the senior managers had a clear understandable and defensible picture of the economics of their operations. This opened unexpected opportunities for the branch managers who could now analyse the impact of their decisions at the customer level, not just at gross profit level. They are able to look at client profitability at the transaction and account level, not using averages. This allows them to disaggregate the financial data into meaningful values at the customer level and, therefore, to overcome the difficulties initially encountered in determining profitability products such as customer loans. The system has also made it possible to develop improved activity-based cost drivers and assign these to individuals and events.

Question 3: It is significant to consider an ABC system implementation when we have: ? High amounts of overhead costs: YES Explanation: the traditional costing system assumes that all overheads are volume-related; in reality, economies of scale may apply for high volume products and they may take significantly less overheads per unit while specific customized low volume products may consume a lot more resources. ? Complex products and services: YES Explanation: If a certain product uses a small number of labor hours (because it is a complicated, sophisticated and automated product) it will be allocated with a relatively small

amount of costs, it is thus UNDERCOSTED. On the contrary, a product that is “low tech” and uses a lot of labor hours will be OVERCOSTED. ? Significant variable costs: NO Explanation: it’s not the distribution “variable / fixed” costs which is important to consider for choosing a costing method but the “direct / indirect” one. ? Losses on high-volume products and profits on low-volume products: YES Explanation: this could be linked to the fact that traditional costing system assumes that all overheads are volume-related. The traditional costing method thus underestimates the costs related to developing and offering low-volume customized products; similarly, it overestimates the costs related to high-volume products which often produce economies of scale as the volume increases. ? Disagreement by managers over cost allocations: YES Explanation: ABC system provides better cost allocation information and promotes understanding of why and where costs are incurred. ? Constancy in volume between high and low volume products: NO Explanation: As traditional costing system assumes that all overheads are volume-related, significant variation in volume between high and low volume products could generate inaccurate product cost and profitability. ? Bid results: YES Explanation: ABC system provides better cost allocation information and thus promotes understanding the profitability of the company’s different products and customer segments. ? Different products place different demands on resources: YES Explanation: ABC method aids in recognizing, measuring and controlling complexity. The more complex and customized low volume products may consume much more resources than would be allocated to them using the traditional costing system based on volume alone. Question 4: The precautions to be taken when implementing the ABC system are: ? ABC unit costs can generate an inappropriate degree of variability: YES ? Identifying the cost drivers may be very difficult: YES

? The concept of unused capacity within the resource consumption model is only valid for physical resources: NO ? Some activities may be costly in the short run but very profitable in the long run, for example building relationships with suppliers: YES Explanations: ? ABC system may suffer from the same weaknesses as the traditional costing systems by suggesting an inappropriate degree of variability. For example, to calculate unit product cost, batch level of activity costs are divided by the number of products produced. There is a danger for decision making because non volume related activity cost would be translated into a cost which varies with production volume. Identifying the relevant drivers and allocating them to the appropriate activities is a difficult task. The concept of unused capacity within the resource consumption model is questionable for physical resources. The reported costs may not significantly differ from a less costly traditional system if indirect costs are a low proportion of total costs. ABC method may conclude that some products are unprofitable but it doesn’t take into account the value of building customer relationships. If some of the products are unprofitable for the bank, it may be still crucial to provide them to the customers in order to offer a full range of products and retain the customers who buy the profitable products.

? ? ?


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