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 dollar 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):
The following annual information on the three products was also made available:
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 product. 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 percent of the accounts are less than $500 and have an average balance of $400 per account. Ten percent 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 remaining 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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Chapter 4 Solutions
EBK CORNERSTONES OF COST MANAGEMENT
- QuickBank has decided to lower the interest rate it charges on business loans in order to attract more business. It has succeeded in boosting the number of loan applications, but it finds that many of the applicants turn out to be very poor credit risks. This illustrates the problem known as adverse selection moral hazard the principal-agent porblem diversificationarrow_forwardLetni Corporation engages in the manufacture and sale of semiconductor chips for the computing and communications industries. During the past year, operating revenues remained relatively flat compared to the prior year but management notices a big increase in accounts receivable. The increase in receivables is largely due to the recent economic slowdown in the computing and telecommunications industries. Many of the company’s customers are having financial difficulty, lengthening the period of time it takes to collect on accounts. Below are year-end amounts. Age Group OperatingRevenue AccountsReceivable AverageAge AccountsWritten Off Two years ago $1,160,000 $136,000 5 days $0 Last year 1,460,000 146,000 7 days 1,000 Current year 1,560,000 316,000 40 days 0 Paul, the CEO of Letni, notices that accounts written off over the past three years have been minimal and, therefore, suggests that no allowance for…arrow_forwardLetni Corporation engages in the manufacture and sale of semiconductor chips for the computing and communications industries. During the past year, operating revenues remained relatively flat compared to the prior year but management notices a big increase in accounts receivable. The increase in receivables is largely due to the recent economic slowdown in the computing and telecommunications industries. Many of the company’s customers are having financial difficulty, lengthening the period of time it takes to collect on accounts. Below are year-end amounts. Age Group OperatingRevenue AccountsReceivable AverageAge AccountsWritten Off Two years ago $1,160,000 $ 136,000 5 days $0 Last year 1,460,000 146,000 7 days 1,000 Current year 1,560,000 316,000 40 days 0 Paul, the CEO of Letni, notices that accounts written off over the past three years have been minimal and, therefore, suggests that no allowance for uncollectible accounts be…arrow_forward
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- Reed Kohler is in his final year of employment as controller for Quality Sales Corporation: he hopes to retire next year. As a member of top management, Kohler participates in an attractive company bonus plan. The overall size of the bonus is a function of the firm's net income before bonus and income taxes - the larger the net income, the larger the bonus. Due to a slowdown in the economy due to Coronavirus, the company has encountered difficulty in managing its cash flow. The company auditors have recommended that the company change its inventory method from FIFO to LIFO . The change would cause a significant increase in the cost of goods sold for the year. Kohler thinks the company shouldn't switch to LIFO b/c its inventory quantities are too large. After expressing this opinion to the firm's treasurer, Kohler is stunned at the treasurer's reply "Reed, I can't believe that after all these years with the company, you put your personal interests ahead of the companies…arrow_forwardThe Board of Directors were worried over the dwindling financial performance and precariousfinancial position of the Company. The company products were ageing; the economicdepression biting harder as a result of the fluctuating exchange rate due to Brexit. TheCompany imports 60% of the goods sold in Garden City. The fluctuating exchange rate hadaffected the company’s importation. Consequently, the revenue of the Company droppedsignificantly. Write a brief and formal technical report to the Board of Directors to assess theperformance, liquidity and stability of company using only:i) Return on Capital Employedii) Total Assets Turnoveriii) Quick Ratioiv) Fixed Interest Coverv) Debt Equity Ratioarrow_forwardThe Board of Directors were worried over the dwindling financial performance and precariousfinancial position of the Company. The company products were ageing; the economicdepression biting harder as a result of the fluctuating exchange rate due to Brexit. TheCompany imports 60% of the goods sold in Garden City. The fluctuating exchange rate hadaffected the company’s importation. Consequently, the revenue of the Company droppedsignificantly.You are required to:A) Calculate the following ratios for the year ended September 30, 2015 and 2016 in Columnarform:i) Return on Capital Employedii) Total Assets Turnoveriii) Quick ratioiv) Debt Equity Ratiov) Fixed Interest covervi) Earnings Yieldvii) Price Earnings RatioViii) Dividend Yield The first 3 has been calculated : Return on capital employed for 2016 is 40.32% and for 2015 is 86.84%. 2016 2015 Capital employed = 96500-43800 =52 700 Capital employed = 107500-60000 = 47500 Return on capital employed = 21250/52700 x 100…arrow_forward
- Cornerstones of Cost Management (Cornerstones Ser...AccountingISBN:9781305970663Author:Don R. Hansen, Maryanne M. MowenPublisher:Cengage LearningPrinciples of Accounting Volume 1AccountingISBN:9781947172685Author:OpenStaxPublisher:OpenStax CollegeEBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT