Academic journal article The Journal of Bank Cost & Management Accounting

ConsumptionProfile Costing: An Enhancement to Activty Based Costing

Academic journal article The Journal of Bank Cost & Management Accounting

ConsumptionProfile Costing: An Enhancement to Activty Based Costing

Article excerpt

by Jane Blake*

In 1985, Company A, a division of one of the top ten insurance companies, had a problem...it was losing money. Its management knew it was based on poor pricing assumptions using industry standards and they knew that its services were not traditional, but third-party administration services. How could Company A get better information to make its pricing decisions? The number one element that was missing was better cost information, and management knew that only customer level information would help them. What they did not know when they started their project was that part of the method they would develop is now often referred to as Activity Based Costing. However, Company A had a slightly different approach. Compared to manufacturing companies, who coined the term Activity Based Costing (ABC), it had no product lines or products to cost; it had only customers. The new method would require all costs and process (transaction) volumes to be collected at the lowest level of information, the customer. Ironically, the basis for this method was developed for them based on a previous model used exclusively in the trust division of banks that had the same problem and needed all information centered around each trust account.

What happened to Company A after its new cost information was developed? It changed. Armed with new management information it became profitable within a year and has updated and used that model continuously to monitor all aspects of its business. What surprised management was what they changed. Never did they think that a "cost" system would provide them with true operational analysis information. The volume of processes performed for each customer alone pointed to inadequate pricing assumptions and quoting procedures. For some customers, Company A was able to increase fees by as much as 35%. Next, management viewed this information as critical to its operations and evaluated and redesigned every process and activity performed based on the output unit cost. It worked. Each year they continue to watch their unit costs decrease due to efficiencies. Any changes in customers' consumption of services are monitored related to its operational and pricing assumptions.

THE INITIAL DESIGN

What was significant about this Company's model was that it was designed in two pieces. The costs ran through a detailed "mapping" of each cost center's charges to a series of appropriate services performed for its customers. Now known as the process "cost pool," these were based on documented step-by-step activities performed company-wide. Then the actual volume of transactions for that process was applied to determine the unit cost. This became the "calculator" approach to determining only the unit cost rate. Information by customer would be linked together later. The "calculator" was completed on a PC-spreadsheet because of the ongoing capabilities to model new information or budgets.

Next came the customer process (transaction) volumes. The process volume information, however, had to be collected from mainframe computer databases. While Company A had only identified 40-50 processes for its entire organization, these processes had thousands of volumes managed on multiple computer systems. This could have presented a programming nightmare. However, they elected to use a leading edge reportwriter software package to extract the volumes using a query language and build all of the end-user management reports using this tool. Now customer costs could be determined by using two tables of information: the unit cost rate table and the actual customer volumes table as seen here in diagram-1 on the next page. (Diagram-1 omitted)

The simple "rate" table was created using the reportwriter package and updated with the 40-50 unit costs previously processed with their "calculator." The unit cost was multiplied by the customer volumes for each process whenever a monthly or year-to-date report was needed. …

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