Activity-Based Costing Approach to Measure Term Paper

Excerpt from Term Paper :

Many organizations have sufficient control over their cost drivers, specifically those that work with activity-based costing; these companies can locate a sufficient amount of cost information within the company to accomplish these analyses in a timely fashion (Chatzkel, 2003). In reality, though, ABC systems are typically structurally complex and, in spite of the need for complete integration of such ABC systems, many such systems remain as stand-alone analysis tools which generally begin with resource-based, rather than activity-based, data fed from the general ledger system (Platt & Towry, 2001).

In their case study of a hypothetical bank, "Activity-Based Costing in the Service Sector: The Buckeye National Bank," Bamber and Hughes (2001) report that, "Banks, like other businesses, are under attack from all sides. Brokerage firms and mutual-fund empires in particular are trying to grab traditional bank customers, and highly profitable ones are the most attractive. To fend off the assault, banks say they need to identify the customers they should fight hardest to keep" (p. 381). To address the issue of declining profits at "Buckeye National Bank" (the hypothetical bank in the case study), an ABC team was assembled consisting of the managers of each of the three bank branches, a bank teller, and a representative from the customer service call center; the ABC team began their analysis by identifying the activities Buckeye National Bank performed (Bamber & Hughes, 2001). The team identified the three most important activities as part of their pilot ABC project:

Paying checks;

Providing teller services; and,

Responding to customer account inquiries at the customer service call center.

The ABC team began by identifying the actual costs that were associated with each of these three banking activities and determined that, as is common in service industries such as banking, labor (personnel) costs dominate (Bamber & Hughes, 2001). Thereafter, the ABC team requested that every bank employee complete a short survey to determine how the employees actually spent their time on the job; the team then administered a series of one-on-one in-depth interviews with each employee and used this combined information to estimate the percentage of time each employee spent on each of the three activities: (a) paying checks, (b) providing teller services, and - responding to customer account inquiries (Bamber & Hughes, 2001).

The ABC team subsequently estimated the other (nonlabor) resources that each of the above-mentioned activities required. For instance, the ABC team at the case study bank linked the "responding to customer account inquiry" activity to the following cost drivers:

The cost of toll-free telephone lines at the customer service call center; and,

Depreciation on other equipment and facilities the call center personnel use.

According to Bamber and Hughes (2001), "A cost driver is a factor, such as the number of checks processed, that causally affects costs. For example, the costs associated with the activity 'paying checks' rise and fall as the quantity of the cost driver (the number of checks processed) rises and falls" (p. 381). In addition, the ABC team at Buckeye estimated the percentage of time the bank's information system was used for check processing and providing teller services (vs. other uses such as compiling periodic financial statements), to determine how much of the equipment's depreciation to assign to the activities "paying checks" and "providing teller services."

To complete the pilot study in a timely fashion, the ABC team based their estimated activity costs on last year's actual data, which were already available. If the pilot study succeeded, then the ABC team planned to develop budgeted indirect cost rates for each activity the following year. The advantage of budgeted rates over actual rates based on the prior year's data is that budgeted rates (budgeted cost associated with the activity divided by the budgeted quantity of the activity's cost driver) can incorporate expected changes in costs and operations. After examining the three branch banks' indirect costs (that is, the cost items making up the branch banks' noninterest operating expenses), the ABC team classified the annual costs in each activity's cost pool. The team identified the following cost drivers for each activity cost pool as shown in Table 1 below.

Table 1.

Cost Drivers for Each Activity Cost Pool at Buckeye National Bank.

Activity Cost Pool

Activity Cost Driver

Paying checks

Number of checks processed

Providing teller services

Number of teller transactions

Responding to customer account inquiries

Number of account inquiry calls to customer service call center

Source: Bamber & Hughes, 2001 p. 381.

The Buckeye ABC team estimated the annual activity retail and business customer line levels for the three pilot-test bank branches and found that retail customers used much more than 10% of the three activities: (a) paying checks, (b) teller services, and - responding to customer account inquiry calls. The ABC team then analyzed these three activities in relation to the four-level activity-cost hierarchy developed by Horngren at al. (1999):

Unit-level activities are performed for each unit of product or service; in Buckeye Bank's case, these were considered to be "paying checks" and "providing teller services" as unit-level activities.

Batch-level activities are performed for groups of products or services rather than for individual units. For example, setting up machines to produce a batch of a specific product is a batch-level activity; however, simplicity's sake, the Buckeye ABC pilot study does not include any batch-level costs, but these costs exist as well in service firms such as banks (particularly where each service represents a unique demand on resources, such as in this case).

Product-sustaining activities, service-sustaining activities, and customer-sustaining activities support individual products, services, or customers. The ABC team at Buckeye regarded "responding to customer account inquiries at the customer service call center" to be a customer-sustaining activity.

Facility-sustaining activities are general activities that support the organization as a whole, but that cannot be traced to individual products or services, such as the CEO's activities. Because it is not possible to identify cost drivers for facility-sustaining costs, many ABC systems exclude these costs, or allocate them using a general allocation base. Again, for simplicity, the Buckeye ABC team did not consider this type of activity from the pilot study (Bamber & Hughes, 2001).

The results of this analysis showed that ABC customer cost data could assist Buckeye's managers in identifying more effective marketing strategies by more appropriately pricing their services and assessing the profitability of different mixes of customers and/or services. "For example," Bamber and Hughes conclude, "after recognizing that attracting and retaining business accounts is the key to profitability (given the existing cost and revenue structure), Buckeye may want to add special services for business customers" (p. 381). Given the complexity and costs associated with a transition to an ABC methodology, though, it is vitally important for any type of organization to take into account the impact of such processes on their community relations activities and what these initiatives can do to help them improve their corporate responsibility. This requirement appears especially important for banks today because of their already poor image in the minds of many consumers, and these issues are discussed further below.

Banks and Corporate Responsibility.

While the experts continue to debate precisely why, the fact remains that many people dislike banks in the first place and making the decision to patronize one over another may simply be a matter of choosing between the lesser of two evils in terms of convenience and costs. According to Barclays' Corporate Responsibility Report for 2005, "The UK banking sector as a whole has often been taken to task for not giving customers good enough service, and some of this criticism has been justified. But in recent years the picture has changed quite significantly. A great deal of effort and investment has gone into improving our products, and giving our customers better service, but more still remains to be done" (p. 4). Barclays is not alone in these initiatives, either. For example, Blanden (2000) reports that, "In the past year, UK banks have spent around 300 million pounds trying to persuade the public that they are not so bad after all. But they know they are on to a loser, and much of the money spent on advertising is wasted. The simple truth is that people do not have good feelings towards banks" (p. 37). Given this environment, it is little wonder that many banks would be concerned about their public relations image and would seek to take advantage of the opportunities to improve it through various corporate socially responsible initiatives; these initiatives also serve to improve employee morale (Blanden, 2000). This author adds that community sponsorship initiatives have become commonplace among large banks today: "Not only does it associate the banks with people's favourite sports -- and they are big sponsors of yuppie sports such as rugby, cricket and golf -- but it also provides great opportunities for entertaining their own staff…

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