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Financial Services Industry

AMIfs Bank Cost Analysis Model (BCAM) implementing activity-based cost management in a financial institution

Journal of Bank Cost & Management Accounting, The, 2001 by Smith, J Timothy, Harper, Charlene

ABSTRACT

Over the past several years, much has been written about the application of Activity-Based Costing/Management (ABC/M) in both manufacturing and service business sectors. This paper is intended to specifically address the implementation of ABC/M in financial institutions, primarily banks. This paper provides guidelines for creating and maintaining an ABC/M solution in these environments.

In addition, AMIfs is interested in providing benchmark information to members if there is an interest and if members can reach a consensus on a method of cost development.

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One of the objectives of this article, besides providing information on Activity-Based Costing, is for members to review the detail functions, activities, drivers, etc., to determine if they provide the right level of consensus amongst member banks and the basis for understanding of costs through benchmarking.

From the answers to the above question, AMIfs will determine whether it is feasible to begin a cost benchmarking exercise.

This set of guidelines is divided into the following sections:

1. Introduction - Basic information on ABC/M and uses of ABC/M to solve business problems.

2. The Case for ABC/M in Banks - What created interest in ABC/M and why should it be applied to banks?

3. The AMIfs Bank Cost Analysis Model (SCAM) - Definition of banking activities, cost drivers, and cost objects designed to cover the traditional banking costs of a community or regional bank.

4. BCAM Implementation - Basic process for the implementation of BCAM in a bank.

5. Implementing ABC/M Is More Feasible Once the Misconceptions Are Disproved - Tips for success for implementing ABC/M.

1. INTRODUCTION

ABC/M implementation is frequently an intimidating proposition, potentially in conflict with an organization's current management accounting practices. The implementation effort can be resource-intensive, fraught with data challenges, and subject to frustrating delays. A poorly or slowly executed ABC/M study can result in loss of credibility, cost factors becoming obsolete before they are finalized, and no better management decision-making ability. So why bother to take on what appears to be an awesome task with high risks and potential failure?

Simply stated, the rewards are great. Properly implemented ABC/M systems in banks provide the cornerstone for product pricing, product/ customer/organization profitability measurement, staffing models, reengineering efforts, aligning workload with the organization's strategies, and cost reduction.

Because the management information resulting from ABC/M systems can be so rich, it is imperative at the outset to determine the primary business uses) for the data prior to starting any ABC/M study. That is, begin by working backwards with the end in mind. Strong executive sponsorship is also essential, accompanied by a clear definition of the business problem to be addressed through an ABC/M implementation. The level of detail employed in an ABC/M implementation will be directly affected by the ultimate use of the data. Ideally, it is advisable to start with a more summarized ABC/M structure, and then later selectively build in more detail in places that need greater visibility. ABC/M is scalable. See the section on leveling and right-sizing an ABC/M system in the introduction of BCAM (Bank Cost Analysis Model).

How Does Traditional Accounting Distort Reality?

The ABC/M logical assignment of expenses and costs obliterates the use of simple averages as the basis for tracing costs. Figure 1 illustrates the impact of applying ABC/M versus the traditional allocation of resource expenses into costs. The diagram reveals ABC/M's "S-curve." The horizontal line represents the flawed costs that are calculated by a traditional standard costing system that forms the organization's belief system.

In practice, one discovers the under-costed products are substantially under-costed because these products may be low-volume with small batch sizes, require more technical attention, consume more or special handling, or need extra inspection. ABC/M removes the distortions from simplistic cost allocations.

ABC/M corrects for these flaws by identifying the work activities that are responsible for costs. ABC/M provides a cost flow assignment network, which allows the work activity costs and their output costs to be continuously re-assigned, or passed on only if the products, services, or customers, (or in some cases, other work activities) actually use the activity. This condition of consumption and use is what sets ABC/M apart from traditional cost allocation schemes. See also section 2 of BCAM regarding the case for ABC/M in Banks.

From General Ledger to ABC Database

How can traditional accounting that has been around for so many years all of a sudden become considered so bad? The answer is the existing data is not necessarily bad as much as it is somewhat distorted, incomplete and unprocessed. The left side of Figure 2 shows the classic responsibility-center statement report that managers receive each month. When you translate those "chart-of-accounts" expenses on the left into the "chart of activities" on the right that consume the financial general ledger's expenses, a manager's insights from viewing the activity costs begin to increase. The right side of Figure 2 is the ABC/M view that is used for analysis and as the starting point for calculating the costs for both processes and for diverse outputs such as products and customers. In effect, the right side ABC/M view resolves the deficiencies of traditional financial accounting by focusing on work activities. ABC/M is very work-centric, whereas the General Ledger is transaction-centric.

Financial Services Industry

AMIfs Bank Cost Analysis Model (BCAM) implementing activity-based cost management in a financial institution

Journal of Bank Cost & Management Accounting, The, 2001 by Smith, J Timothy, Harper, Charlene

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