While funds transfer pricing may seem somewhat technically intricate and system intensive, once set up and established some believe it is the easier portion of the profitability equation. In many respects, the cost assignment portion is inherently more difficult and complicated. In addition, cost assignment can frequently become a contentious political football throughout an organization. Line and staff managers often become extremely sensitive and defensive when it is time to take responsibility for non-interest expenses. It is therefore important to educate the user base about the various assignment techniques and methodologies, as well as to solicit and receive feedback from line and staff personnel about the implications of the chosen assignment criteria.
Common terms to express costing methodologies include cost assignment, cost allocation, activity-based costing, variable and fixed costs, direct and indirect costs, full absorption versus standard costing or pricing, isolating efficiencies and inefficiencies, performance measurement, and capacity utilization. While each of these methodologies represents a variation of cost assignment, the message should remain constant that costs must be shared across all functions and/or slices of profitability.
The entire profitability analysis process is dynamic. This means that profitability criteria, whether in funds transfer pricing, or cost or capital assignment, are constantly in a state of change and continuously require monitoring and periodic updating. From a funds transfer pricing perspective this may mean new or deleted products, application system changes, adjusting customer relationship coding, and perhaps changing maturity characteristics as products and customer relationships evolve. From a costing perspective, it can include all of the above, plus the builtin conflicts of, "who should be charged for what, and why."
In its most generic form, cost accounting is the art and science of spreading, allocating, or assigning various units of measure to their respective organizational units, branches, products, customers/relationships, and market segments. While the focus of this area appears to be only cost related, the assignment process is also inclusive of non-interest income. In addition, sometimes even spread related items such as interest income and interest expense may need to be assigned through an allocation process.
Understanding the assignment process involves a review of cost assignment methodologies, techniques for rolling up, measuring and reporting assignment results, and survey techniques.
Cost Assignment Methodology
In the financial services industry, the most dominant units of measure that must be confronted for the purpose of cost assignment are salaries and salary-related expenses. The term "related" in this context would also imply expense categories beyond staff benefits, such as occupancy and depreciation expense and various types of "other" expense. The rationale is that these related expenses usually occur to facilitate work performed by staff employees, causing an obvious linkage to the primary measure of staff expense, salaries. As a result, once it is determined how to allocate salary expense, many other categories of expense can often be logically "piggy-backed" upon the methodology set up for salaries and benefits.
Whatever the unit of measure, cost assignment systems provide various ways to implement an allocation. Some common methods are listed below:
* Average Balance
* Weighted Statistics
* Direct Dollar Assignment
* Rate x Volume (Activity-Based Costing)
The ability to allocate using the average balance technique is common to all systems. Essentially, related units of measure (e.g., salaries, occupancy, office supplies, fee income) are allocated to, for example, product units based upon the average balance outstanding of each product unit. …