Concept explainers
Customers as a Cost Object
Morrisom National Bank has requested an analysis of checking account profitability by customer type. Customers are categorized according to the size of their account: low balances, medium balances, and high balances. The activities associated with the three different customer categories and their associated annual costs are as follows:
Additional data concerning the usage of the activities by the various customers are also provided:
Required:
(Note: Round answers to two decimal places.)
- 1. Calculate a cost per account per year by dividing the total cost of processing and maintaining checking accounts by the total number of accounts. What is the average fee per month that the bank should charge to cover the costs incurred because of checking accounts?
- 2. Calculate a cost per account by customer category by using activity rates.
- 3. Currently, the bank offers free checking to all of its customers. The interest revenues average $90 per account; however, the interest revenues earned per account by category are $80, $100, and $165 for the low-, medium-, and high-balance accounts, respectively. Calculate the average profit per account (average revenue minus average cost from Requirement 1). Then calculate the profit per account by using the revenue per customer type and the unit cost per customer type calculated in Requirement 2.
- 4. CONCEPTUAL CONNECTION After the analysis in Requirement 3, a vice president recommended eliminating the free checking feature for low-balance customers. The bank president expressed reluctance to do so, arguing that the low-balance customers more than made up for the loss through cross-sales. He presented a survey that showed that 50% of the customers would switch banks if a checking fee were imposed. Explain how you could verify the president’s argument by using ABC.
1.
Compute the value of costs per account per year. Also, compute the average fee per month that should be charged by the bank to cover their costs incurred in verifying the accounts.
Explanation of Solution
Activity Based Costing (ABC):
Activity based costing is an apportionment of costs that first considers the activity drivers that helps in the allocation of costs to various activities and then allocates costs to different cost objects by using the drivers.
Use the following formula to calculate value of costs per account per year:
Substitute $6,105,000 for total costs and 75,000 for number of statements used in the above formula.
Therefore, a cost per account per year is $81.40.
Use the following formula to calculate value of average fee per month:
Substitute $81.40 for costs per account per year in the above formula.
Therefore, average fee per month is $6.78.
2.
Compute the costs per account by customer category with the help of activity rates.
Explanation of Solution
Computation of costs per account by customer category:
Activity | Rate(R) | Quantity (Q) |
Low ($) |
Medium ($) |
High ($) |
(A)Opening and closing | 101 | 22,500 | 225,000 | ||
101 | 4,500 | 45,000 | |||
101 | 3,000 | 30,000 | |||
(B)Issuing monthly statements | 0.502 | 675,000 | 337,500 | ||
0.502 | 150,000 | 75,000 | |||
0.502 | 75,000 | 37,500 | |||
(C)Processing transactions | 0.103 | 27,000,000 | 2,700,000 | ||
0.103 | 3,000,000 | 300,000 | |||
0.103 | 750,000 | 75,000 | |||
(D)Customer inquiries | 0.204 | 1,500,000 | 300,000 | ||
0.204 | 900,000 | 180,000 | |||
0.204 | 600,000 | 120,000 | |||
(E)Providing ATM services | 0.705 | 2,025,000 | 1,417,500 | ||
0.705 | 300,000 | 210,000 | |||
0.705 | 75,000 | 67.500 | |||
Total Cost | 4,980,000 | 810,000 | 315,000 | ||
Number of accounts | 57,000 | 12,000 | 6,000 | ||
Cost per account | 87.37 | 67.50 | 52.50 |
Table (1)
Working Note:
1. Calculation of opening and closing rates:
2. Calculation of issuing monthly transactions rate:
3. Calculation of processing transaction rate:
4. Calculation of rate of customer inquiries:
5. Calculation of rate of providing ATM services:
3.
Compute the average profit per account. Also, compute the profit per account with the help of ABC approach.
Explanation of Solution
Use the following formula to calculate average profit per account:
Substitute $90.00 for interest revenue average and $81.40 for costs per account per year in the above formula.
Therefore, an average profit per account is $8.60.
Use the following formula to calculate profit per account with the help of ABC approach of low balance customers:
Substitute $80.00 for interest revenue average and $87.37 for costs per account per year in the above formula.
Therefore, the loss per account of low balance customers is $7.37.
Use the following formula to calculate profit per account with the help of ABC approach of medium balance customers:
Substitute $100.00 for interest revenue average and $67.50 for costs per account per year in the above formula.
Therefore, the profit per account of medium balance customers is $32.5.
Use the following formula to calculate profit per account with the help of ABC approach of high balance customers:
Substitute $165.00 for interest revenue average and $52.50 for costs per account per year in the above formula.
Therefore, the profit per account of high balance customers is $112.50.
4.
Discuss the steps for verifying the argument of president with the help of ABC approach.
Explanation of Solution
The steps for verifying the argument of president with the help of ABC approach are explained below:
- • Compute the value of profits from various loans provided by the organization to their customers such as credit card with the help of ABC approach.
- • Compare the 50% of the profit of cross sales of the low balance customers with the total loss of low balance customers in verifying the accounts.
- • At the end, if the amount of profit of cross sales are more than the loss of cross sales, argue of president is valid.
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Chapter 5 Solutions
Managerial Accounting: The Cornerstone of Business Decision-Making
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