ACTIVITY-BASED COSTING IN THE SERVICE SECTOR - NAM DUONG BANK
Nam Duong Bank began operations in the mid-1990s. The bank quickly grew by providing checking account services to many small businesses that preferred to do business with a "local" bank. Although Nam Duong initially offered checking account services for individual accounts (retail customers), the bank primarily focused on serving its business customers. During the Asian financial crisis after the mid-1990s that weakened the Vietnamese economy, growth in business customer accounts began to decline. In response, Nam Duong's senior management adopted a new strategy, focusing on increasing the number of retail customer accounts. By ...view middle of the document...
First, Nam Duong established a service call center to respond to customer inquiries about account balances, checks cleared, fees charged, and other banking concerns. Second, Nam Duong's directors authorized year-end bonuses to branch managers who met their branch's target increase in the number of customers. However, even though 80 percent of the branch managers met the targeted increase in customer accounts, the Bank's profits continued to decline. CEO Anh Tran does not understand why profits are declining, given that the Bank is serving more customers. Nam Duong's southeast regional manager, Dai Nguyen, has also noticed that while small retail customers flock to the bank, the number of business customers is barely stable.
Dai Nguyen suspects that Nam Duong's costing system may be part of the problem. Nam Duong developed its simple costing system when the bank began operations in 1995. The bank does not trace any costs directly to individual customers. It simply treats all (noninterest expense) operating costs identified in the Income Statement in Exhibit A as indirect with respect to the customer line. The bank allocates these indirect costs to either the retail customer line or the business customer line, based on the total dollar value of checks processed (which is readily available because each branch must provide the dollar values of daily transactions for internal control). For the current period, Nam Duong processed a total of $95 million in checks, of which $9.5 million was written by retail customers, and $85.5 million was written by business customers. This costing approach was fairly typical of banks and other financial institutions at the time Nam Duong developed its cost system.
Nam Duong Bank
Consolidated Income Statement
For the three years ending December 31, 20x5
($000) | 20x4
($000) | 20x3
Net interest income* | $3,486 | $3,417 | $3,349 |
Provision for credit losses | 484 | 475 | 465 |
Net interest income after provision for credit losses | 3,002 | 2,942 | 2,884 |
Noninterest income | 1,207 | 1,199 | 1,190 |
Income prior to noninterest expenses and income tax | 4,209 | 4,141 | 4,074 |
Noninterest expenses | 3,805 | 3,539 | 3,362 |
Income before income taxes | 404 | 602 | 712 |
Income tax expense | 130 | 194 | 230 |
Net income | 274 | 408 | 482 |
| | | |
* Net interest income equals interest income less interest expense. The bank's primary income is from interest-bearing checking accounts. Noninterest income includes fees charged for various services, such as checking account fees charged if the account balance falls below the required minimum level. Noninterest expenses are all of the bank's operating costs, including those associated with paying checks, providing teller services, and responding to customer account inquires. |
In college, Dai Nguyen learned about an alternative costing approach called activity based costing (ABC). However, the examples...